. . . and WHAT’S the RUCKUS?
Here’s the ruckus: This deduction, created by the 2017 Tax Cuts and Jobs Act, allows non-corporate taxpayers to deduct up to 20 percent of their Qualified Business Income (QBI), plus 20% of qualified Real Estate Investment Trust (REIT) dividends and qualified Publicly Traded Partnership (PTP) income.
It could mean a lower tax bill . . .
It sounds fantastic, right? But it’s only for certain circumstances. For instance, income earned through a C corporation is not eligible.
Any time we know there’s a way to lower our taxes legitimately, we’re all ears. And we’ve already had several questions about this relatively new qualified business income (QBI) deduction. The QBI deduction is also known as the section 199A deduction. The reason we’re talking about it is that this deduction may be available to individuals—including owners of partnerships, S corporations, and sole proprietorships. Some estates and trusts may also be able to take the QBI deduction.
Income earned by providing services as an employee or through a C corporation is not eligible for this deduction.
What is the Qualified Business Income Deduction?
Section 199A of the Internal Revenue Code extends to various types of business (such as sole proprietorships, partnerships, S corporations, and some trusts and estates) a deduction of income from their qualified (see below) trade or business. The deduction has two components.
QBI Component #1
Component #1 of the deduction is equal to 20 percent of QBI from a domestic business operated as a sole proprietorship or through an S corporation, partnership, trust, or estate. Depending upon the taxpayer’s taxable income, the QBI component could be subject to multiple limitations, including the type of trade or business, the sum of W-2 wages paid by the qualified trade or business, and the ‘Unadjusted Basis Immediately After Acquisition’ (UBIA) of qualified property held by the trade or business. It may also be reduced by the ‘patron’ reduction if the taxpayer is a patron of an agricultural or horticultural cooperative (as defined in 26 CFR § 1.199-6 – Agricultural and horticultural cooperatives.) Still, keep in mind that income earned through a C corporation or by providing services as an employee cannot be used for the deduction. If you’re still with us, read on.
REIT / PTP Component #2
Component #2 of the deduction equals 20 percent of the combined qualified Real Estate Investment Trust (REIT) dividends—including REIT dividends earned through a Regulated Investment Company (RIC)—and qualified Publicly Traded Partnership (PTP) income. This component is not limited by the UBIA or W-2 wages for qualified property. However, depending on the taxpayer’s income, the amount of PTP income that qualifies may be limited depending on the PTP’s business type.
The deduction is limited to the lesser of the QBI component plus the REIT/PTP component or 20 percent of the taxpayer’s taxable income minus the net capital gain. Accountants can help you with these numbers.
The deduction is available for taxable years beginning after December 31, 2017, and ending before December 31, 2025. Most eligible taxpayers were able to claim this deduction for the first time when they filed their 2018 federal income tax return in 2019.
THE GOOD NEWS
The deduction is available, regardless of whether you itemize your deductions on Schedule A or you take the standard deduction.
Who May Take the QBI Deduction?
It’s worth repeating: Individuals and some trusts and estates with Qualified Business Income QBI, qualified Real Estate Investment Trust (REIT) dividends or qualified Publicly Traded Partnership (PTP) income may be eligible for the deduction. In some cases, patrons of agricultural or horticultural cooperatives are required to reduce their deduction under section 199A(b)(7) (patron reduction), which may apply to people here in California.
How Do S Corporations and Partnerships Handle the Deduction?
Partnerships and S corporations are generally not taxable and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI items. Therefore, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income items on a Schedule K-1, or a statement attached to the returns will allow the shareholders or partners to calculate the QBI deduction if any.
You could be eligible for the deduction.
What Is a Qualified Trade or Business?
A qualified trade or business is any Internal Revenue Code, § 162 trade or business, with these three exceptions:
- A trade or business conducted by a C corporation.
- For taxpayers with taxable income that exceeds the threshold amount, Specified Service Trades or Businesses (SSTBs). An SSTB is a trade or business involving the performance of services in the fields of [Inhale] health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets [Exhale], or any trade or business where the principal asset relies upon the reputation or skill of one or more of its employees or owners.
The principal asset of a trade or business is the reputation or skill of its owners or employees if the trade or business’s revenues come from endorsing products or services, the use of an individual’s image, likeness, voice, or other symbols associated with the individual’s identity, or appearances at events or on television, radio, or other media outlets. Therefore, Elvis impersonators would be excluded.
The SSTB exception does not apply to taxpayers with taxable income below the threshold amount and is phased in for taxpayers with taxable income above the threshold amount. For 2018, the threshold amount was $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers. For 2019, the threshold amount is $321,400 for taxpayers filing joint returns, $160,705 for married filing separately and $160,700 for single and head of household returns. The threshold incomes will be adjusted for inflation in subsequent years.
- The trade or business of performing services as an employee.
What Is Qualified Business Income?
The devil is in the details.
QBI is the net amount of qualified items of income, deduction, gain, and loss from any qualified trade or business. [See “What is a Qualified Trade or Business?” above.] Only taxable income items are counted. In addition, the elements must be functionally connected with a U.S. trade or business. Items such as capital gains and losses and interest income and certain dividends are excluded. W-2 income, amounts received as reasonable compensation from an S corporation, amounts received as guaranteed payments from a partnership, and payments received by a partner for services under Code section 707(a) are also not QBI.
How Is the Deduction for Qualified Business Income Computed?
Still with us? The SSTB limitation discussed above does not apply if your taxable income (before the QBI deduction) is at or below the threshold amount for the taxable year in question. The deduction is the lesser of:
- 20 percent of the taxpayer’s QBI, plus 20 percent of the taxpayer’s qualified REIT dividends and qualified PTP income, or
- 20 percent of the taxpayer’s taxable income minus net capital gain.
If your taxable income (before the QBI deduction) is above the threshold income amount, the deduction may be limited based on whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis immediately after acquisition of specific property used by the company.
The Qualified Business Income QBI Deduction looks tempting. Who doesn’t like to save on taxes? However, this one is a little tricky. It’s often wise to work with an accountant to double-check your eligibility and computations—and see that the available IRS worksheets you might want to use are up to date.
It’s a good idea to check with your accountant regularly, anyway, to learn what items you might be missing out on, or where recent laws have made your tax situation better (or worse).
If you have more questions
Do you wonder if you are entitled to this Qualified Business Income deduction? What else is out there?
Please contact us before the year-end to find out.
The tax laws change from time to time, and the above information cannot be used to support a legal argument in a court of law. It is intended as a guideline, a test of your ability to remember what acronyms stand for, a listing of questions other people have asked us, and as a motivation for taxpayers to stay current with the latest tax laws.