QBI, QBIA, and QBID. New 199A: Qualified Business Income Deduction or Amount

Transcription

1 IRC Sec. 199A QBID

2 QBI, QBIA, and QBID New 199A: Qualified Business Income Deduction or Amount 2

3 The first part of this presentation refers to the Section 199A deduction as QBID (Qualified Business Income Deduction). Examples in the second part of the presentation use QBIA (Qualified Business Income Amount) to identify the Section 199A deduction. That is the term used in the Internal Revenue Code and IRS examples. The acronyms have the same meaning. For purposes of explaining how the new law operates your author believes QBID more clearly communicates the nature of the calculated deduction from otherwise taxable income. 3

4 It s Complicated 4

5 Can it be simplified? -NO... But it can be explained... Proposed Regulations...

6 1.199A-1

7 Operational Rules Definitions Computing the 199A deduction - Income not exceeding the threshold amounts... 4 examples - Income above the threshold amounts examples Special rules

8 1.199A-2

9 Determination of W-2 Wages And UBIA W-2 Wages - Definitions - Operating Rules Unadjusted Basis Immediately After Acquisition - 3 examples

10 1.199A-3

11 Qualified Business Income Definitions Operating rules... No examples - Investment income not taken into account - Reasonable compensation to S shareholder - Allocation among directly conducted trades or businesses

12 Qualified REIT Dividends Definition... No examples

13 Qualified PTP Income Definition Special Rules... No examples

14 1.199A-4

15 Aggregation Aggregation Rules Operating Rules Family Attribution 14 Examples

16 1.199A-5

17 SSTBs Specified service trades or businesses - Listed - Meaning of services performed in each field... 9 examples - Less than substantially all - Common ownership... 2 examples - De minimis Rule

18 Performing Services as an Employee Definition Presumption that former employees are still employees... 3 examples

19 1.199A-6

20 Relevant Passthrough Entities Computation Rules - S corporations... Items are allocated in accordance with ownership percentage of S shares - Partnerships, LLCs, may allocate items subject to general rules of Subchapter K Reporting Rules Application to estates, trusts, and beneficiaries... Text explanation and 2 examples

21 P T Ps Publicly Traded Partnerships - QBID from each publicly traded partnership

22 1.643(f)-1

23 Treatment of Multiple Trusts General rule Principal purpose... 2 examples

24 Where Should We Start? History!! IRC Sec. 199 (no A ) was intended to provide tax incentive to activities that produced something Sec. 199 said nothing about jobs Sec. 199 reduced tax rates on all production activities without regard to type of entity

25 To Whom Does The New Provision Apply These taxpayers qualify for the 199A deduction: - Sole proprietors - S corporation shareholders - Partners in a partnership - Members of multiple-member LLCs treated as partnerships for federal income tax purposes - Beneficiaries of estates and trusts - Members of qualified co-ops - Owners of interests in REITs

26 IRC Sec. 199A Important part of Tax Cuts and Jobs Act (author s emphasis ) Activities that offer full benefit are those that do both: -Produce tangible property, and -Provide employment ( Jobs )

27 IRC Sec. 199A Offers a deduction (QBID)from taxable income to owners of pass-through entities, engaged in a trade or business, in the U.S. Deduction is 20% of Qualified Business Income As you might expect, there are a number of special rules, limitations, and special calculations

28 IRC Sec. 199A We ve organized this presentation so that we all understand the purpose of IRC Sec. 199A and how it works... BUT FIRST... Let s get some of the simple stuff out of the way, and answer some FAQs that make understanding and working with the new rules easier

29 Simple Stuff... 1 QBI is trade or business income from S corporation, LLC, Partnership, or Form 1040; Schedule C - Does NOT apply to C corporation QBI is NOT subject to AMT QBID does NOT reduce SE income QBID does NOT reduce Net Investment Income QBID is 20% of QBI

30 Simple Stuff... 2 Most complex change in TCJA Sunsets in % of individual s income from pass-through entity is tax-free Guidance available: - IRC Sec. 199A - Committee Reports - Proposed Regulations (Make a copy and READ the Regs!)

31 Simple Stuff... 3 Below-the-line deduction - Not like itemized deductions - More like personal exemptions QBI also includes: - REIT ordinary dividends - Publicly traded partnership income - Qualified co-op dividends

32 Simple Stuff... 4 QBI does NOT include: - Wages - Guaranteed payments... for services - Investment type income (dividends, interest, capital gains, etc.) - Specified Service Trade or Business income above threshold amounts - More about SSTBs later!

33 Marginal Rates After QBID

34 Qualified Trade or Business... 1 Section 199A(d) requires that QBI be earned in a qualified trade or business A qualified trade or business means any trade or business other than a specified service trade or business and other than the trade or business of being an employee The term trade or business is not defined by the Code There are different opinions about what constitutes a trade or business

35 Qualified Trade or Business... 2 The proposed Regulations do not offer a definition; only the following... - (13) Trade or business means a Section 162 trade or business other than the trade or business of performing services as an employee. - That s not much help and, especially with regard to rental activities, practitioners are desperate for guidance. Some guidance can be taken from the cases and ruling cited following. - HOWEVER... You must consider the facts of each situation. There is NO universal rule

36 Qualified Trade or Business... 3 Regular, continuous, and substantial Profit motive Attributes of a business - Business plan - Advertising... Letterhead, business cards, etc. - Records - Bank Account - EIN - More than one customer

37 Rule of Attribution To determine ownership for aggregation purposes, an individual is considered to own the interest in each trade or business owned, directly or indirectly, by or for (i) The individual's spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and (ii) The individual's children, grandchildren, and parents. Same as IRC Sec. 318

38 Rules for Aggregation

39 Qualification... 1 An individual must demonstrate that (1): - Same person or group of persons, directly or indirectly, owns 50% or more of each trade or business to be aggregated, AND - That ownership exists for a majority of the taxable year in which the items attributable to each trade or business to be aggregated are included in income, - All items attributable to each trade or business to be aggregated are reported on returns with the same taxable year (not counting short taxable years),

40 Qualification... 2 An individual must demonstrate that (2): - No trade or business to be aggregated is a specified service trade or business (SSTB) as defined in Proposed Regulation 1.199A-5, and - All trades or businesses to be aggregated satisfy at least two of the following factors (based on all facts and circumstances):

41 Qualification... 3 An individual must demonstrate that (3): - (at least two of the following factors are present): - Provide products or services that are the same or customarily offered together - Share facilities or share significant centralized business elements, personnel, accounting, legal, manufacturing, purchasing, HR, or IT - Operated in coordination with, or reliance on, one or more of the businesses in the aggregated group (supply chain dependence)

42 Disclosure For each taxable year, the individual must attach a statement to her/his return identifying each trade or business to be aggregated, which must include... - Description of the trade or business - Name & EIN of each entity in which trade or business operates - Information identifying any trade or business acquired, disposed of, formed, or stopped during the taxable year, and - Such other information as the Commissioner may require in forms, instructions, or other published guidance

43 Basic Calculation Rules

44 Calculation of the Section 199A Deduction (QBID)... 1 The LESSER of: - 20% of the taxpayer s QBI (or taxable income*, if less than QBI)... OR The GREATER of: - 50% of the W-2 wages with respect to the business, or - 25% of the W-2 wages with respect to the business, plus 2.5% of the unadjusted basis of all qualified property * For QBI testing, taxable income must be reduced by net capital gain which includes qualified dividends [IRC Sec. 1(h)]

45 Calculation of the Section 199A Deduction (QBID)... 2 The deduction is generally 20% of QBI but limited to 20% of taxable income, reduced by net capital gain, if that amount is less than QBI QBI is the ordinary income less ordinary deductions earned from an eligible trade or business

46 Calculation of the Section 199A Deduction (QBID)... 3 A single individual with taxable income of $157,500 or less may take the 199A deduction without limitation Married individuals filing jointly with taxable income of $315,000 or less may take the 199A deduction without limitation At this level of income it does not matter that the trade or business might be a Specified Service Trade or Business (SSTB)

47 Calculation of the Section 199A Deduction (QBID)... 4 Taxpayer must determine total taxable income, not just QBI, in order to determine the Section 199A deduction See Line 43 (Taxable Income) of Form 1040 from 2017 Net capital gain is not included in taxable income for purposes of calculating taxable income for Section 199A purposes

48 Limitations

49 Five Limitations on the Section 199A Deduction... 1 So long as income is below the threshold amounts, the Section 199A deduction calculation is fairly simple. HOWEVER!!! For qualified taxpayers whose taxable income exceeds $315,000 MFJ, or $157,500 for all others, five limitations may apply

50 Five Limitations on the Section 199A Deduction... 2 Taxable income limitation W-2 wage limitation W-2 wage and qualified property limitation Investment income limitation Specified service trade or business (SSTB) limitation

51 Limitation 1:Taxable Income Limitation Deduction (QBID) is generally 20% of QBI, however..... Limited to 20% of taxable income when taxable income is less than QBI

52 Example... Sally Sally is a small business owner with a Schedule C who makes $100,000 from her business (Sally s QBI is $100,000) Sally s taxable income is $70,000 Sally s 199A deduction is 20% * $70,000 or $14,000

53 Example Jane Jane conducts her business as a Schedule C sole proprietorship Jane grosses $100,000 from her business and has $40,000 of deductions (QBI = $60,000) Jane s taxable income equals $90,000 Jane s 199A deduction is 20% * $60,000 = $12,000

54 W-2 Wage Limit At and below $157,500 and $315,000 taxable income amounts, the taxpayer does not need W-2 wages or depreciable property to take the Section 199A deduction The only limitation in this circumstance is the taxable income limitation which applies when taxable income is less than QBI

55 Limitation 2: W-2 Wage Limitation... 1 Wages includes taxable wages and deferred compensation, with an add-back for employees elective deferrals Allocable W-2 wages for a shareholder are, like all other items of an S corporation, allocated pro-rata, on a per-share/per-day basis Wages paid to an employee include any elective deferrals into a 401(k)-type vehicle or other deferred compensation

56 Limitation 2: W-2 Wage Limitation... 2 W-2 wages DO NOT INCLUDE payments to an independent contractor or management fees reported on a Form 1099 W-2 wages do not include K-1 amounts for guaranteed payments for services to a partner/member of an LLC treated as a partnership

57 Limitation 2: W-2 Wage Limitation... 3 Partner s allocable share of a partnership s W-2 wages is determined in the same manner as his or her share of the partnership s wage deduction - A special allocation of income will control a wage allocation A 20% partner may be specially allocated 80% of any depreciation but only 30% of Schedule K-1, Line 1 ordinary income under the partnership agreement

58 Limitation 2: W-2 Wage Limitation... 4 S Corporation shareholders treat as W-2 wages paid, their share of W-2 wages allocated to them in accordance with their percentage ownership of S shares

59 Limitation 2: W-2 Wage Limitation... 5 Applies to any trade or businesses EXCEPT a specified service trade or business (SSTB) QBID cannot exceed 50% of W-2 wages paid for work related to the activity producing the QBI, OR The limit on the following slide may apply instead

60 Limitation 2: W-2 Wage Limitation... 6 Section 199A deduction, when over the taxable income limit, is limited to the GREATER of either: 50% of taxpayer s allocable share of W-2 wages paid by the business; or 25% of the taxpayer s allocable share of W-2 wages paid by the business plus 2.5% of the taxpayer s allocable share of the unadjusted basis immediately after acquisition of all qualified property

61 Limitation 3: W-2 Wage and Qualified Property Limitation QBID cannot exceed 25% of W-2 wages, plus 2.5% of undepreciated cost of qualified property That factor gets tricky! It even has its own name and acronym... - Unadjusted Basis Immediately After Acquisition (UBIA) More about that later!

62 Qualified Property... 1 The term qualified property means, with respect to any qualified trade or business for a taxable year, tangible property of a character subject to the Allowance for depreciation under Section 167 which is held by, and available for use in, the qualified trade or business at the close of the taxable year...

63 Qualified Property Which is used at any point during the taxable year in the production of qualified business income; and The depreciable period for which has not ended before the close of the taxable year

64 Qualified Property... 3 Depreciable period means, with respect to qualified property, the period beginning on the date the property was first placed in service by the taxpayer and ending on the later of: - The date that is 10 years after such date; or - The last day of the last full year in the applicable recovery period that would apply to the property under Note that such property has an Applicable Recovery Period and a Class Life ( see Rev. Proc ) and the recovery period is usually shorter than the class life

65 Qualified Property... 4 Depreciation deductions relative to the property are not taken into account when calculating the 2.5% of basis limitation Depreciation deducted does not reduce basis of property immediately after acquisition (UBIA) Property is included in this calculation for the longer of its depreciable life or 10 years, the qualifying period

66 Qualified Property... 5 An allocation of qualified property, to a partner in a partnership, must be the same as the allocation of depreciation expense to that partner for purposes of calculating the 2.5% amount

67 Qualified Property... 6 The UBIA amount of property that has been the subject of: - A Section 1031 exchange, - Contribution to a partnership, - Distribution from a partnership,or - Contribution to a corporation in a Section 351 exchange of property for stock May NOT be its original cost without reduction for depreciation

68 Limitation 4: Investment Income Limitation QBI does not include investment income - Investment income generally means capital gains, interest, and dividends

69 Limitation 4: Investment Income Limitation QBI does not include specified investment-related income, deductions, or losses Specifically, qualified items of income, gain, deduction, and loss do not include: - List follows....

70 Investment Income Any item taken into account in determining net long-term capital gain or net long-term capital loss; 2. Dividends, income equivalent to a dividend, or payments in lieu of dividends; 3. Interest income other than that which is properly allocable to a trade or business;

71 Investment Income Excess of gain over loss from commodities transactions, other than those entered into in the normal course of the trade or business or with respect to stock in trade or property held primarily for sale to customers in the ordinary course of the trade or business, property used in the trade or business or supplies regularly used or consumed in the trade or business;

72 Investment Income The excess of foreign currency gains over foreign currency losses from Section 988 transactions, other than transactions directly related to the business needs of the business activity; 6. Net income from notional principal contracts, other than clearly identified hedging transactions that are treated as ordinary (i.e., not treated as capital assets); and 7. Any amount received from an annuity that is not used in the trade or business of the business activity

73 Limitation 5: Specified Service Trade or Business Limitation... 1 Applies ONLY to a trade or business identified in Section 199A as not qualifying for the general rule - Section 199A(d)(2) identifies an SSTB as any trade or business... - Listed in Section 1202(e)(3)(A), excluding engineering and architecture, and substituting employees or owners for employees, or

74 Specified Service Trade or Business (SSTB)... 2 Specified service activity (loses QBID when income is high) - Health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or investing, trading, or dealing in securities, partnership interests, or commodities.

75 Specified Service Trade or Business (SSTB) Section 199A(d)(2) identifies an SSTB as also including any trade or business: - Involving the performance of services consisting of investment management, trading, or dealing in securities, partnership interests, or commodities

76 Specified Service Trade or Business (SSTB)... 4 Taxpayers in an SSTB are subject to Phase-In / Phase-Out - Section 199A deduction is subject to a phase-in of the W-2 limit when personal taxable income is in the transition range, i.e. between $157,500 and $207,500 or $315,000 and $415,000 - Section 199A deduction is also subject to an income based phase-out - The closer the taxpayer s income is to the top of the range ($415,000 married / $207,500 single), the less the taxpayer s 20% deduction will be

77 Phase In/Phase Out Example - Earl Earl is a CPA who does business as an S Corporation Earl s taxable income is $100,000 (after payment of a reasonable salary), which he earns entirely from his CPA practice Earl s 199A deduction is $100,000 * 20% = $20,000

78 Phase In/Phase Out Example - James James is a CPA who does business as an S corporation His taxable income is $500,000 and he files jointly with his spouse James and his spouse are not eligible for the Section199A deduction

79 In Between Those Two Examples: It s Complicated 79

80 Specified Service Trade or Business (SSTB)... 5 Any trade or business where the principal asset is the reputation or skill of one or more employees or owners would seem to exclude many highly specialized, single-owner businesses, but it does not The Prop. Regs. and Preamble clarify that this rule does not apply to a Real Estate Broker, or similar business based on the personal reputation of the owner or employees, but rather to the business trading on the fame or notoriety of one or more persons. For example, a business whose revenue was from personal appearance fees, or signing autographs, or designing golf courses, would be an SSTB

81 Rental Activity... 1 Is a rental activity a trade or business? That will depend on facts and circumstances Anyone offering a simple answer is a fool Some guidance is available from litigated tax cases and IRS guidance Some guidance is available from general principles of tax law

82 Rental Activity... 2 General Principles of Tax Law Litigated Tax Cases IRS Guidance

83 Rental Activity... 3 General principles of tax law - Regular, continuous and substantial - Profit motive - Attributes of a business - Records - Bank account - Business plan

84 Rental Activity... 4 Litigated Tax cases... Tax Court has held: - Rental of a single piece of real property... [is] a... business. - Curphey v. Comm r, 73 TC 766; involves 162 and cites Lagreide decision. Decisions in charts that follow are frequently cited by commentators as providing guidance on rental activity as a Qualified Trade or Business

85 Rental Real Estate: Business? Facts Trade or Bus? Venue/comments Murtaugh v. Cmr. 2 timeshares, mgt. co. had subst. activity Yes Tax Court/mgrs. activity counts (post Groetzinger case) LaGreide v. Cmr. Inherited, singlefamily residence Yes Tax Crt/rental single prop.= business. Hazard v. Cmr. Single-family, taxpayer lived in different city. Yes Tax Crt/rental of single property = business. Reiner v. U.S. Single-family, mgt. co. Yes CA7/cited LaGreide.

86 Rental Real Estate: Business? Facts Trade or Bus? Venue/comments Grier v. U.S. Single-family, only one tenant, made repairs. No CA2/ Circuit has least favorable position. Balsamo v. Cmr. Inherited, no repairs, sold 3 mos. after inherit. No Tax Court used CA2 law, bound by Golsen. Union Bank of Troy Triple net lease*, tenant maintained bldg No. Distr. Ct. NY. PLR Triple net lease*, tenant maintained building. No. administrative guidance only. No precedent for an other taxpayer * Tenant pays RE taxes, insurance, and maintenance.

87 Rental Activity... 5 Real estate rented to commonly controlled entity (not an SSTB) - QBI even if not separately a trade or business - Example: (See Prop. Reg. Sec A-1(b)(13) - Construction contractor, an S corporation, builds office building for its sole shareholder which is then leased to the corporation. It will not mater that the rental activity cannot meet the requirements for a trade or business. It is aggregated, for that purpose, with the commonly controlled S corporation.

88 Rental Activity... 6 Rented to commonly controlled SSTB - Rental is treated as SSTB. (See Prop. Reg A-5(c)(2) - Accountant practicing as a sole proprietorship rents a building from his wife. - Accounting practice and building can be aggregated for purposes of Section 199A. - Rule of attribution includes spouse

89 Calculations, Examples, and Commentary How to Help Your Client Get the Best Result From Section 199A The following examples use QBIA (Qualified Business Income Amount) to identify the Section 199A deduction. That is the term used in the Internal Revenue Code and IRS examples. Earlier in this presentation, the Section 199A deduction is referred to as QBID (Qualified Business Income Deduction). The acronyms have the same meaning. Your author believes QBID more clearly communicates the nature of the calculated deduction from otherwise taxable income.

90 90 Calculating the Deduction Under the Taxable Income Exception Method 1 The deduction is equal to 20% of combined QBIA Not to exceed 20% of the sum of taxable income less qualified capital gains

91 91 Example 1 A married couple, filing jointly, has taxable income of $300,000 which includes $81,250 in QBI from 1 business and $25,000 of qualified capital gain income. They meet the taxable income exception. 20% of $81,250 (QBI) = $16,250 20% of Taxable income less QCG = $55,000 ($300,000 25,000) x 20% The taxpayer s combined qualified business income amount (the deduction) is $16,250

92 92 Example 2 A single taxpayer with taxable income of $155,000 which includes $10,000 of QBI from 1 business and $100,000 of qualified capital gain income. 20% of $10,000 (QBI) = $2,000 20% of Taxable income less QCG = $11,000 ($155, ,000) x 20% The taxpayer s combined qualified business income amount (the deduction) is $2,000

93 93 Example 3 A single taxpayer with taxable income of $155,000 which includes $10,000 of QBI from 1 business, a $15,000 loss from another qualifying trade or business, and $100,000 of qualified capital gain income. 20% of $10,000 (QBI) = $2,000 20% of ($15,000) (QBI) = ($3,000) Combined Qualified Business Income Amount is ($1,000) 20% of Taxable income less QCG = $11,000 ($155, ,000) x 20% The taxpayer s combined qualified business income amount (the deduction) is zero and the $5,000 loss is carried forward to the following year to reduce future QBI

94 Example 4 Planning Opportunity A single taxpayer with taxable income of $105,000 which includes $130,000 of QBI from 1 business and deductions of $13,000 for ½ of SE Tax & SEHI, and a standard deduction of $12, % of $130,000 (QBI) = $26,000 20% of Taxable income of $105,000 = $21,000 The taxpayer s combined qualified business income amount (the deduction) is $21,000 but she has an opportunity to increase it to the maximum of $26,000 by generating other ordinary income of $25,000, the amount that QBI exceeds taxable income. Under present circumstances, taxable income is $84,000 after taking the 199A deduction.

95 Assume that the taxpayer converted $25,000 of their IRA to a Roth IRA, increasing their pre-199a taxable income to $130,000, the same amount as QBI, which results in a 199A deduction of $26,000. Taxable Income Before 199A Deduction $ 105,000 IRA Conversion $ 25,000 Adjusted Taxable Income $ 130,000 Adjusted 199A Deduction $ ( 26,000) Adjusted Taxable Income After 199A Deduction $ 104,000 Taxable Income Before Conversion $ ( 84,000) Total Increase in Taxable Income $ 20,000 Tax 24% $ 4,800 Effective Tax Rate on Conversion Amount 19.2%

96 96 Taxable Income Exceeds the Threshold Amount A Phase-In Amount (Allowance) is provided to phase-in the benefit of wages & property $50,000 for Individual Returns $100,000 for Joint Returns

97 Phase-In Range Individual Returns $157,500 - $207,500 Joint Returns $315,000 - $415,000

98 98 SSTBs Continue to Qualify Up to Threshold Amount SSTBs become subject to Applicable Percentage Qualified Wages & Qualified Property become an integral part of the calculation

99 99 Taxable Income Exceeds the Threshold Amount Plus the Phase-In Amount Income from an SSTB no longer qualifies for the deduction Wages & Property are fully phased-in

100 100 W-2 Wages All remuneration paid as described in 3401(a) plus the total amount of elective deferrals (within the meaning of section 402(g)(3)) and compensation deferred under section 457, including the amount of designated Roth contributions Paid by & through the business to employees of the business Attributable & allocable to qualified business income Reported on a timely filed W-2 with a 60-day grace period

101 101 Not Wages Contractor Payments reportable on 1099 Guaranteed Payment to Partners Wages not related to the business & those not related to producing qualified business income Re-characterizations of wages under audit?

102 102 Regulation Wages Paid by Other Entity (2) In determining W-2 wages, a taxpayer may take into account any wages paid by another entity and reported by the other entity on Forms W-2 with the other entity as the employer listed in Box C of the Forms W-2, provided that the wages were paid to employees of the taxpayer for employment by the taxpayer.

103 103 Qualified Property Tangible & depreciable under 167 not amortizable not intangible land is not qualified property Held & available for use at year end Used at any time during the year to produce QBI Recovery period not expired with minimum life of 10 years last full year depreciation convention

104 104 Lesser of A or B: A. 20% of QBI Greater of B1. 50% of Qualified Wages Deduction Where Taxable Income Exceeds Threshold Plus the Phase-In Amount B2. The sum of 25% of qualified wages plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property

105 105 Baselines for Maximizing the Deduction Wages should be at least 40% of QBI Property should be at least 400% of QBI

106 106 Labor Intensive Business Wages at least 40% of QBI 20% QBI / 50% wages = 40% QBI $100,000 x 20% = $20,000 Wages $40,000 x 50% = $20,000 Wages $ 40,000 x 25% = $10,000 plus Property $400,000 x 2.5% = $10,000 Total Wages plus Property = $20,000

107 107 Capital Intensive Business No Wages Real Estate Companies Property at 8 times QBI 20% QBI / 2.5% Property = 8 QBI $100,000 x 20% = $20,000 Qualified Property $800,000 x 2.5% = $20,000

108 108 Blended Intensity Every 1% decrease in qualified wages below 40% requires a 10% increase in property over 400% to maximize the deduction QBI $100,000 x 20% = $20,000 Wages $30,000 x 50% = $15,000 25% Wages / 2.5% Property = 10 Property must be $500,000 to maximize deduction Wages $ 30,000 x 25% = $ 7,500 plus Property $500,000 x 2.5% = $ 12,500 Total Wages plus Property = $ 20,000

109 109 Deduction Computation Where Taxable Income Exceeds Threshold Plus Phase-In Amount Method 2 Example 5 A single taxpayer owns a 40% interest in a business that has $750,000 in QBI, paid qualified wages of $600,000, and has qualified property of $1,000,000. Her taxable income is $382,500 including $12,500 of QCGI. A. QBI $750,000 x 40% x 20% = $60,000 B1.Wages $600,000 x 40% x 50% = $120,000 B2. Wages $ 600,000 x 40% x 25% = $60,000 plus Property $1,000,000 x 40% x 2.5% = $10,000 Total Wages plus Property = $70,000 TI Limitation ($382,500 - $12,500) x 20% = $74,000 QBIA = $60,000

110 110 Example 6 A married couple operates a business that has $400,000 in QBI, paid qualified wages of $150,000, and has qualified property of $700,000. Their taxable income is $500,000 including $10,000 of Qualified Capital Gain. A. QBI $400,000 x 20% = $80,000 B1.Wages $150,000 x 50% = $75,000 B2. Wages $150,000 x 25% = $ 37,500 plus Property $700,000 x 2.5% = $ 17,500 Total Wages plus Property = $ 55,000 TI Limitation ($500,000 - $10,000) x 20% = $98,000 QBIA = $75,000 Note that wages are less than 40% and that property is less than 400% of QBI. This is an indicator that the QBIA will be determined by the wage / wage plus property calculation

111 111 Example 7 A single taxpayer owns a business that has $325,000 in QBI, paid qualified wages of $600,000, and has qualified property of $1,000,000. His taxable income is $262,500 including $12,500 of QCGI. A. QBI $325,000 x 20% = $65,000 B1.Wages $600,000 x 50% = $300,000 B2. Wages $ 600,000 x 25% = $150,000 plus Property $1,000,000 x 2.5% = $ 25,000 Total Wages plus Property = $175,000 TI Limitation ($262,500 - $12,500) x 20% = $50,000 QBIA = $50,000

112 Example 8 A single taxpayer owns a business that has $125,000 in QBI, paid no qualified wages, and has qualified property of $2,000,000. His taxable income is $262,500 including $12,500 of QCGI. A. QBI $125,000 x 20% = $25,000 B1.Wages $0 x 50% = $ 0 B2. Wages $ 0 x 25% = $ 0 plus Property $2,000,000 x 2.5% = $ 50,000 Total Wages plus Property = $ 50,000 TI Limitation ($262,500 - $12,500) x 20% = $50,000 QBIA = $25,000

113 113 Taxable Income Within The Phase-In Range Method 3 Applies when 20% of QBI is greater than the wage / wage plus property calculation Has the effect of phasing-in the wage / wage plus property calculation by phasing-out 20% of QBI Wage / wage plus property calculation remains static

114 Phase-In Range Individual Returns $157,500 - $207,500 Joint Returns $315,000 - $415,000

115 115 Phase-Out Percentage The excess of taxable income over the threshold amount divided by the allowance amount provided Applied to the excess of 20% QBI over the wage / wage plus property calculation 20% of QBI is lowered

116 116 Individual Married Taxable Income $175,000 $360,000 Applicable Threshold Amount $157,500 $315,000 Excess $ 17,500 $ 45,000 Phase-In Amount (Allowance) $ 50,000 $100,000 Ratio as a Percentage - Phase-Out Percentage 35.0% 45.0%

117 117 Example 9 A single taxpayer with taxable income of $175,000 has qualified business income of $100,000 from a business that paid $30,000 in qualified wages and has $25,000 of qualified property. Wages are less than 40% of QBI alerting us that 20% of QBI will be higher, requiring application of a phase-out percentage. A. QBI $100,000 x 20% = $20,000 B1. Wages $30,000 x 50% = $15,000 B2. Wages $30,000 x 25% = $ 7,500 plus Property $25,000 x 2.5% = $ 625 Total Wages plus Property = $ 8,125 Excess amount is A $20,000 less B1 $15,000 = $5,000 Phase-out amount - $5,000 x 35% = $1,750 QBIA = $20,000 less $1,750 = $18,250

118 118 Example 10 A married couple with taxable income of $360,000 has qualified business income of $95,000 from a business that paid $20,000 in qualified wages and has $60,000 of qualified property. Wages are less than 40% of QBI alerting us that 20% of QBI will be higher, requiring application of a phase-out percentage. A. QBI $95,000 x 20% = $19,000 B1. Wages $20,000 x 50% = $10,000 B2. Wages $20,000 x 25% = $ 5,000 plus Property $60,000 x 2.5% = $ 1,500 Total Wages plus Property = $ 6,500 Excess amount is A $19,000 less B1 $10,000 = $9,000 Phase-out amount - $9,000 x 45% = $4,050 QBIA = $19,000 less $4,050 = $14,950

119 119 Example 11 A married couple with taxable income of $360,000 has qualified business income of $75,000 from a business that paid $50,000 in qualified wages and has $60,000 of qualified property. Wages are greater than 40% of QBI alerting us that 20% of QBI will be lower, thus not requiring application of a phase-out percentage. A. QBI $75,000 x 20% = $15,000 B1. Wages $50,000 x 50% = $25,000 B2. Wages $50,000 x 25% = $12,500 plus Property $60,000 x 2.5% = $ 1,500 Total Wages plus Property = $14,000 Excess amount is A $15,000 less B1 $25,000 = ZERO Phase-out amount - ZERO x 45% = ZERO QBIA = $15,000

120 120 Specified Service Trade or Business Method 4 Applicable Percentage A multiplier applied solely to QBI, W2 wages, and qualified property of an SSTB Applied when taxpayer s taxable income is in phase-in range Will always be less than 100% and reduced to zero when TI exceeds threshold plus phase-in amount (allowance) Calculated by subtracting from 100% the phase-out percentage therefore the inverse of the phase-out percentage

121 121 SSTBs are subject to both the Phase-Out Percentage & Applicable Percentage

122 122 Example 12 A single taxpayer with taxable income of $175,000 has qualified business income of $100,000 from an SSTB that paid $30,000 in qualified wages and has $25,000 of qualified property. Wages are less than 40% of QBI alerting us that 20% of QBI will be higher, requiring application of a phase-out percentage. A. QBI $100,000 x 20% = $20,000 B1. Wages $30,000 x 50% = $15,000 B2. Wages $30,000 x 25% = $ 7,500 plus Property $25,000 x 2.5% = $ 625 Total Wages plus Property = $ 8,125 Excess amount is A $20,000 less B1 $15,000 = $5,000 Phase-out amount - $5,000 x 35% = $1,750 QBIA = $20,000 less $1,750 = $18,250 SSTB QBIA = $18,250 x 65% = $11,863

123 123 Example 13 A single taxpayer operates a CPA practice as a sole-proprietor. The practice has QBI of $265,000, paid $30,000 in qualified wages, and has $10,000 of qualified property. The taxpayer s TI is $195,000 which includes $1,000 in QCGI. Phase-out percentage = 75% (($195,000 $157,500) / $50,000)) Applicable percentage = 25% (100% - 75%) A. QBI $265,000 x 20% = $53,000 B1. Wages $30,000 x 50% = $15,000 B2. Wages $30,000 x 25% = $ 7,500 plus Property $10,000 x 2.5% = $ 250 Total Wages plus Property = $ 7,750 Excess amount is A $53,000 less B1 $15,000 = $38,000 Phase-out amount - $38,000 x 75% = $28,500

124 124 QBIA after applying phase-out percentage = $24,500 ($53,000 less $28,500) Applicable Percentage QBIA 25% x $24,500 = $6,125 Amount of deduction erased by SSTB treatment - $18,375 ($24,500 less $6,125)

125 125 Example 14 A single taxpayer operates a CPA practice as a sole-proprietor. The practice has QBI of $265,000, paid $30,000 in qualified wages, and has $10,000 of qualified property. The taxpayer s TI is $195,000 which includes $1,000 in QCGI. (Applying Applicable Percentage First) Phase-out percentage = 75% (($195,000 $157,500) / $50,000)) Applicable percentage = 25% (100% - 75%) A. QBI $265,000 x 25% x 20% = $13,250 B1. Wages $30,000 x 25% x 50% = $3,750 B2. Wages $30,000 x 25% x 25% = $ 1,875 plus Property $10,000 x 25% x 2.5% = $ 63 Total Wages plus Property = $ 1,938 Excess amount is A $13,250 less B1 $3,750 = $9,500 Phase-out amount - $9,500 x 75% = $7,125 QBIA after applying phase-out percentage = $6,125 ($13,250 less $7,125)

126 126 Example 15 A married couple, each with an SSTB, has taxable income of $380,000. H has QBI of $200,000 paying no qualified wages and owning no qualified property. W has QBI of $225,000 paying qualified wages of $40,000 and owning qualified property at year end of $25,000. Taxable Income $380,000 Threshold Amount $315,000 TI Exceeding Threshold $ 65,000 Phase-In Amount (Allowance) $100,000 Phase-Out Percentage 65% Applicable Percentage 35%

127 127 Qualified Business Income (QBI) $ 200,000 $ 225,000 Initial Qualifying Business Income Amount (QBIA) 20% 40,000 45,000 Qualified Wages Paid $ - $ 40,000 Qualified Property Owned $ - $ 25,000 Wages Paid Limitation 50% $ - $ 20,000 Wages Paid 25% $ - $ 10,000 Property Owned 2.5% Wage / Property Limitation $ - $ 10,625 Greater of Wage / Property Calculation (WPC) $ - $ 20,000 Excess Amount Subject to Phase-Out $ 40,000 $ 25,000 Less: Phase-Out Amount 65% 26,000 16,250 Reduced QBIA Due to Phase-Out $ 14,000 $ 28,750 Adjusted for SSTB Applicable % - 199A(1)(a)(1) Amount 35% $ 4,900 $ 10,063 Combined QBIA $ 14,963

128 128 A Table View of Entity Eligible Income with Taxable Income & Phase-in Limitations Taxable Income Thresholds Specified Service Trade or Business Other Qualifying Trade or Business Taxable Income is less than or equal to $157,500 (individual) or $315,000 (joint) Is treated as a qualifying trade or business eligible for deduction; W2 wages and qualified property limitations do not apply W2 wages and qualified property limitations do not apply Taxable Income exceeds $157,500 but is less than $207,500 (individual) or exceeds $315,000 but is less than $415,000 (joint) Eligible for reduced deduction - Applicable Percentage is applied to net QBI, W2 wages, qualified property. Then W2 wages and qualified property limitations are phased-in utilizing the $50,000 or $100,000 phase-in amounts W2 wages and qualified property limitations are phased-in utilizing the $50,000 or $100,000 phase-in amounts Taxable income exceeds $207,500 (individual) or $415,000 (joint) SSTB Income is no longer eligible W2 wages and qualified property limitations fully applied

129 129 Special Rule With Respect to Income Received From Cooperatives In the case of a patron of a specified agricultural or horticultural cooperative, the Qualified Business Income Amount shall be reduced by the lesser of: A. 9% of so much of the QBI with respect to the trade or business as is properly allocable to qualified payments received from such cooperative OR B. 50% of so much of the W-2 wages with respect to such trade or business as are so allocable

130 Definition of a trade or business a. A single rental property b. Flipping one house Questions & Issues 2. Suspended passive loss carryovers a. Basis? b. Effect on taxable income by triggering other tax attributes suspended with losses 3. Filing status splitting returns where one spouse has QBI and other has wages with joint income exceeding threshold 4. Effective tax rates lowered minimizing value of deductions, particularly for those with TI below the threshold 5. Fiscal year entities

131 131 Entity Comparisons

132 132 Considerations Sub-S Wages & Reasonable Compensation Guaranteed Payments Employee Benefits Treatment of Pension Contributions & Limitations Tax Rates both current & future Deductibility of State Income Taxes Accumulated Earnings Tax 7 Year Provision

133 133 Wage Equalization To calculate the wages necessary to raise the floor in a phase-out range (QBI x.20) -- 1.Y(.20X) = (Wages x.50) +.5X Where Y equals payroll tax expense or other payroll costs stated as a percentage of wages AND X equals the additional wages necessary. QBI = $10,000 Wages = $1,000 Payroll Costs = 8% $10,000 x (.2X) = ($1,000 x.50) +.5X $2, X = $ X $1,500 =.716X $2,095 = X

134 134 Qualified Business Income Before Adjustment $ 10,000 Adjustment Wages plus Costs - $2,095 x 1.08 (2,263) Adjusted QBI $ 7,737 Qualified Business Income 20% $ 1,547 Total Wages Paid ($1,000 + $2,095) $ 3,095 Wage 50% $ 1,547 This calculation seeks to maximize the deduction only by equalizing the 20% of QBI with the 50% Wage calculation. It does not speak to total taxable income.

135 135 The formula can also be expressed as QBI X = 2.5X (Wages already paid x ) where.0765 equals estimated payroll costs Example $100, X = 2.5X ($10,000 x ) $100, X = 2.5X - $10,765 $110,765 = X $ 30,970 = X where X equals the total wages needed to achieve 40% $ 30,970 - $10,000 = $20,970 x = $22,574 $100,000 - $ 22,574 = $ 77,426 x.2 = $ 15,485 $ 30,970 x.50 = $ 15,485

136 136 Where did the 2.5X come from? We want wages to be at least 40% of QBI to maximize the deduction so we need to find for wages which we call X. Therefore X /.4 = 2.5X Income before wages X costs as % of X = 2.5X $400,000 X = 2.5X $400, X = 2.5X $400,000 = X $111,841 = X where X equals wages $111,841 x = $120,397 $400,000 $120,397 = $279,603 x 20% = $ 55,920 $111,841 x 50% = $ 55,920

137 Trusts Trusts determine Items from any trade or business separately from items passed through to the trust Detail must be maintained and provided to beneficiaries

138 Estates Estates are subject to the same rules as trusts

139 Losses NOL does not include a Section 199A deduction nor does it include Negative QBI That will be a separate calculation

140 Other Stuff

141 Losses If the net amount of qualified income, gain, deduction and loss with respect to qualified trades or businesses of the taxpayer for any taxable year is less than zero, such amount shall be treated as a loss from a qualified trade or business in the succeeding taxable year When taxpayer has a loss in Year 1 from a QBI activity, loss carries over and reduces Year 2 QBI solely for purposes of computing the QBI deduction

142 Loss Carryover Illustrated QB income or loss ($100) $200 Carryover loss $- ($100) Net QBI $0 $100 QBID (assuming no wage limit) $0 $20

143 Negative QBI - Example Dale owns 50% of an S corporation which, in 2018, allocates a $200,000 loss to him He materially participates in the S corporation and partially offsets his spouse s $400,000 of wages with the $200,000 loss

144 Negative QBI - Example In 2019, the S corporation allocates $400,000 of income to Dale Without an adjustment for the prior year loss, Dale would determine his Section199A deduction by taking 20% of $400,000, but When determining his QBI deduction for 2019, the $400,000 of income must be reduced by the $200,000 loss from 2018

145 Compliance Partners & S-Corporation Shareholders take into account their allocable share of each item of qualified income, gain, deduction, loss, W2 wages, and unadjusted basis of qualified property to compute the deduction CAUTION... Unless wages and property are reported on Form K-1, they are deemed to be zero

146 Schedule K-1, Line 20, Letter Codes AA Section 199A W-2 Wages AB Section 199A unadjusted basis AC Section 199A REIT dividends AD Section 199A PTP income

147 ? QUESTIONS?

148 Your Program Leaders... 1 Dennis C. Ponton, CPA, CFP 401 Fairway Road Myrtle Beach, SC DPontonCPA@aol.com

149 Your Program Leaders... 2 E. Lynn Nichols, CPA 4100 Galt Ocean Drive #809 Ft. Lauderdale, FL