A new 20-percent deduction is available for qualified, pass-through business income.
This deduction is a welcomed relief to the closely held and/or small business owners. The Qualified Business Income Deduction or Provision 11011 Section 199A of the Tax Cuts and Jobs Act is the provision that allows pass-through entities to receive the tax reduction benefit offered to C-Corps and other tax-paying entities under the Tax Cuts and Jobs Act. Without this provision, the small business owner representing the vast majority of businesses would not receive the benefit of the reduced corporate tax rates.
There are a few items to touch on in this article about this new deduction.
- What is Qualified Business Income (QBI)
- Who qualifies for the deduction
- What type of income qualifies and limitations apply
- Where is the deduction reported
- How is the deduction computed
What is QBI
In general, QBI is taxable income from any qualified trade or business resulting from trade
or business within the United States. Capital gains and losses, dividends, and interest income are
excluded from QBI. The business income can be generated from a proprietorship, a partnership, or an S Corporation.
Who qualifies for the deduction
The deduction is taken by individuals, trusts and estates, qualified REIT dividends or qualified REIT dividends, or qualified TPT income.
What type of income qualifies and limitations apply
This is a very large swath and includes any trade or business, with two exceptions: (1) Specified service trade or business (SSTB); and (2) performing services as an employee. An SSTB includes businesses that perform the following services:
- Actuarial science
- Performing arts
- Consulting (see definition of Consulting below)
- Financial services
- Investing and investment management
- Dealing in certain assets
- Any business that the principal asset is the reputation or skill of one or more of its employees
The exception for SSTB’s is applicable if the taxpayer’s taxable income exceeds $415,000 for a married couple filing a joint return, or $207,500 for all other taxpayers. The Section 199A tax deduction is eliminated when taxable income is greater than this threshold for an SSTB business. The tax deduction is subject to limitations when taxable income is greater than 315,000/$157,500 and less than the $415.000/$207,500 threshold. Of course, complications arise and require further evaluation when taxable income is above the limits and business income is composed of both SSTB and non SSTB income.
Another issue is when a business provides 80% or more of its property or services to an SSTB business and they share 50% or more of common ownership. In this case, the business providing the property or services to the SSTB is also considered an SSTB.
Definition of Consulting
Consulting income is one of the SSTB’s that could result in limitation or exclusion of the QBI deduction. So, it is important to understand the definition and if possible how to classify income differently than consulting, if appropriate. Consulting includes providing advice and counsel to clients to achieve goals or solve problems.
This classification also includes activities like lobbying or attempts to influence government officials or legislative bodies. However, consulting and sales are considered different classifications. Sales income is not included in the list of SSTB’s. The facts and circumstances will determine if the activity should be classified as sales or consulting.
Where is the deduction reported
Since many of the QBI will be derived from S-Corps, Partnerships, and other entities that are not taxpayers, the QBI is passed through to the partners, members, and shareholders of these entities. These pass-through income sources will require the identification of the trade or business individually.
The Qualified business income deduction is a below-the-line deduction (applied after applying the standard deduction or itemized deductions.) The deduction reduces the total taxable income and is reported on Page 2, Line 9 of Form 1040. The deduction does not have a supporting form or schedule for filing. A simplified worksheet can be found in the 2018 Form 1040 instructions to assist taxpayers with the calculation.
How is the deduction calculated
Initially, the qualified business income (QBI) is determined. This determination is made separately if multiple qualified businesses are applicable. The QBI is the net amounts of income, gain, deduction, and loss associated with the qualified business. Short-term and long-term capital gains and losses, dividends, and interest income not applicable to the business are not
included in the calculation. Reasonable compensation payments and guaranteed payments made to the taxpayer for services provided to the qualified business are also excluded.
The deduction is 20% of the QBI.
- If multiple qualified businesses are applying the 20% is applied to the QBI for each business then totaled.
- When taxable income is below the lower $315,000/$157,500 threshold the 199A deduction is equal to the lesser of (1) 20% of the QBI or (2) 20% of taxable income minus net capital gains.
- When the taxable income is above the lower $315,000/$157,500 limits and depending on the type of the business then additional tests and limitations are applied to the deduction calculation.
The concept of the 199A deduction seems fairly simple especially when taxable income is under the threshold. Complications can be triggered which CPAs can provide further explanation of the rules and provide tax planning. If you have any questions about the Tax Cuts and Jobs Act, please contact us or your personal CPA.