One of the more important provisions in the Tax Cuts and Jobs Act, passed in December of 2017, is the new Section 199A – the deduction for qualified business income (QBI). Section 199A allows a deduction for up to 20% of QBI from partnerships, limited liability companies (LLCs), S corporations, trusts, estates, and sole proprietorships.
Listed below are answers to a few basic questions about the new 20-percent deduction for pass-through businesses that was created by the Tax Cuts and Jobs Act.
What is the Qualified Business Income Deduction or QBID?
Section 199A of the Internal Revenue Code provides many taxpayers a deduction for Qualified Business Income from a qualified trade or business operated directly by the Taxpayer or through what is known as a pass-through entity (for example, an S-Corporation or Partnership). This deduction is also known as the Section 199A Deduction.
This new deduction has two elements:
Eligible taxpayers may be entitled to a deduction of up to 20 percent of the qualified business income (or QBI) from a domestic business managed as a sole proprietorship (Schedule C), partnership (1065), S corporation (1120-S), trust or estate (1041). For taxpayers who have taxable income that exceeds $321,400 for a married couple filing jointly, $160,725 for married filing separately or $160,700 for all other taxpayers, the deduction is subject to limitations. These limitations include: the type of trade or business; the taxpayer’s taxable income; and the amount of W-2 wages paid by the qualified business. Another limitation to the deduction is caused by what is known as the unadjusted basis immediately after acquisition (or UBIA) of qualified property held by the trade or business. Income earned by providing services as an employee or earned through a C corporation is not eligible for the 20 percent deduction.
Eligible taxpayers may also be entitled to a 20 percent deduction of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This element of the section 199A is not limited to the UBIA of qualified property or by W-2 wages.
The sum of the two amounts described above is known as the Combined Qualified Business Incomeamount.
The deduction is the lesser of:
20 percent of the combined qualified business income amount……
Or an amount equal to 20 percent of the taxable income minus the taxpayer’s net capital gain amount (if any).
The deduction is available for taxable years beginning after December 31, 2017.
Most eligible taxpayers were able to claim the deduction for the first time when filing their 2018 tax returns in 2019. The Qualified Business Income Deduction is available whether a taxpayer itemizes deductions on Schedule A or takes the standard deduction.
Who is qualified to take the Section 199A deduction?
Individuals and trusts and estates with qualified business income, and taxpayers who have qualified REIT dividends or qualified PTP income may be eligible to take the Qualified Business Income Deduction.
What is the definition of Qualified Business Income (QBI)?
Qualified Business Income, or QBI, is the net amount of qualified income, gain, deduction and loss from any qualified trade or business. The only items counted are those included in taxable income. The income must also relate to a U.S. trade or business. Items such as capital gains and losses, along with certain types of dividends and interest income are excluded from QBI.
What is the definition of a Qualified Trade or Business?
A qualified trade or business is ANY trade or business, with two exceptions –
The first exception is for a “specified service trade or business” (SSTB), which includes a trade or business involving the performance of services in the fields of:
- Health
- Law
- Accounting
- Actuarial science (the discipline that assesses financial risks in the insurance and finance fields, using mathematical and statistical methods)
- Performing arts
- Consulting
- Athletics
- Financial services
- Investing and investment management
- Trading
- Dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.
This first exception only applies if a taxpayer’s taxable income is greater than $321,400 for a married couple filing a joint return, $160,725 for a taxpayer filing married filing separately or $160,700 for all other taxpayers.
The second exception is performing services as an employee.
How is the Qualified Business Income Deduction calculated?
The specified service trade or business (SSTB) limitation discussed above does not apply if a taxpayer’s taxable income is below the $321,400 threshold for a married couple filing jointly, $160,725 for married filing separately and $160,700 for all other taxpayers.
The Deduction is the lesser of:
- 20 percent of the taxpayer’s qualified business income (QBI), plus 20 percent of the taxpayer’s qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or
- 20 percent of the taxpayer’s taxable income minus any net capital gains.
If the taxpayer’s taxable income is above the $321,400 / $160,725 / $160,700 thresholds, the deduction may be limited based on the following:
- Whether the business is a specified service trade or business (SSTB)
- The W-2 wages paid by the business
- The unadjusted basis of certain property used by the business
These limitations are phased in for joint filers with taxable income between $321,400 and $421,400, for married filing separately $160,725 and $210,725 and for all other taxpayers with taxable income between $160,700 and $210,700. These threshold amounts, and phase-in ranges are for tax year 2019.
Do the income thresholds get adjusted each year?
Yes, the income threshold amounts will be adjusted each year based on the annual inflation adjustment that have been determined by Congress. In 2018 the income threshold amounts were $315,000 for married filing jointly and $157,500 for all other filing statuses.
For 2019, the threshold amounts for the taxpayer’s taxable income is $321,400 for a married couple filing jointly, $160,725 for married filing separately return and $160,700 for all other taxpayers. The phase out upper limit amounts is $100,000 higher for married filing jointly and $50,000 for all other filing statuses.
When the taxpayer has income from a specified service trade or business (SSTB). How will that affect the deduction?
If the taxpayer’s income is below the $321,400 for married filing jointly filers, $160,725 for married filing separately or $160,700 for all other filers the threshold amounts discussed previously, the SSTB limitation does not apply. For taxpayers whose taxable income is within the phase-in range discussed in Question 5, the taxpayer’s share of qualified business income, W-2 wages, and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB.
For tax year 2019, I will file a joint return and my taxable income will be under $321,400. Do I need to determine if I am in a specified service trade or business (SSTB) to take the deduction? And if so, is there a limitation on my deduction?
No, if your 2019 taxable income is below $321,400, and you are filing a joint return, it doesn’t matter what type of business you’re in. The taxpayer will be able to deduct the lesser of:
- 20 percent of your qualified business income (QBI), plus 20 percent of your qualified REIT dividends and qualified PTP income, or
- 20 percent of your taxable income minus your net capital gains, if any.
For tax year 2019, my filing status will be Single, and I will report taxable income between $160,700 and $210,700. I will receive qualified business income. Will it matter if the income is from a specified service trade or business?
Yes. Because your taxable income is above the threshold amount, your section 199A deduction with respect to any SSTB will be limited. However, because you are within the phase-in range, you may be allowed some section 199A deduction with respect to an SSTB.
Also, for taxpayers above the threshold amounts, the section 199A deduction with respect to ANY trade or business, including an SSTB, may be limited by the amount of W-2 wages paid by the trade or business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business.
Remember, the phase-in range is $321,400 to $421,400 for joint filers, $160,725 to $210,725 for married filing separately and $160,700 to $210,700 for all other filing statuses.
For tax year 2019, my filing status will be Single, and I will report taxable income over $210,700. My only income will be from a specified service trade or business (SSTB). Will I be entitled to any deduction with respect to my SSTB?
No. The same holds true for a married filing joint couple whose taxable income exceeds $421,400 or married filing separately whose income exceeds $210,725. However, you may still be entitled to a deduction for qualified business income earned from another trade or business that is not an SSTB.
For tax year 2019, my filing status will be Single, and I will report taxable income over $210,700. My income will NOT be from a specified service trade or business (SSTB). Will I be entitled to the deduction?
Yes. If you have qualified business income, qualified REIT dividends or qualified PTP income. For eligible taxpayers with total taxable income in 2019 over $210,700 ($421,400 for married filing joint returns or married filing separately whose income exceeds $210,725), the deduction for QBI may be limited by the amount of W-2 wages paid by the qualified trade or business and the UBIA of qualified property held by the trade or business.
How do S corporations and Partnerships handle the deduction?
In general, S corporations and partnerships are not taxpayers and are not eligible for the deduction themselves. However, S corporations and partnerships report each individual shareholder’s or partner’s share of QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends and qualified PTP income on Schedule K-1 so the shareholders or partners may determine their deductions.
Where will the QBI deduction be claimed on the new 1040 Form?
As a “below the line” deduction on Line 10 of the 1040. It will be subtracted from Adjusted Gross Income as part of the calculation for Taxable Income. To claim the deduction, the taxpayer is required to attach Form 8995 or Form 8995-A to the 1040.
What specific items constitute Qualified Business Income?
Qualified Business Income is the net amount of the qualified items of income, gain, deduction, and loss with respect to the qualified trade(s) or business(es) of the taxpayer.
Qualified Business Income (“QBI”) is determined for each qualified trade or business of the taxpayer.
QBI includes Operating Income and Income from rental activities (at least for real estate professionals and for taxpayer’s electing the Safe Harbor Election under Section 3.03 of Notice 2019-07)
Specific items EXCLUDED from QBI are:
- Any item considered when determining net long-term capital gain or loss
- Dividends, income equivalent to dividends and any payment in lieu of a dividend
- Interest income unless it is properly allocated to the trade or business
- Guaranteed Payments from a partnership
- Income that comes from “a qualified trade or business in the capacity of being an employee” or the “reasonable compensation amount” that an owner should receive as an employee
What constitutes the “net amount” of “qualified items of income, gain, deduction, and loss”?
To correctly calculate the Qualified Business Income (Loss) certain items that are associated with the income or loss generated by the pass-through business must also be deducted. These deductions include:
- The self-employment tax deduction which is connected to the income generated from the pass-through business (typically Schedule C & F or income from a partnership)
- The self-employment health deduction
- Any contribution to a qualified retirement plan based on the self-employment income
- Any unreimbursed partnership expenses claimed
- Any charitable deductions made by the pass-through business that are reported on a Schedule K-1 AND which the taxpayer claims as an itemized deduction on Schedule A of their tax tax return. Charitable deductions made by the pass-through business that are not claimed as an itemized deduction because the taxpayer takes the applicable standard deduction are not considered a deduction and netted against the taxpayer’s qualified items of income, gain and loss.
- The interest expense incurred by a taxpayer to purchase a partnership or ownership interest in a S Corporation
How will the deduction specifically be calculated for amounts above the previously mentioned income thresholds?
Above the income threshold, the 20% QBID is limited to the GREATER of:
- 50% of the W-2 wages with respect to the qualified trade or business, or
- The sum of the following:
- 25% of the W-2 wages with respect to the qualified trade or business
- 2.5% of the unadjusted basis immediately after acquisition of all qualified property.
What if I have more than one trade or business that is eligible for the deduction?
You will need to: (1) calculate the deductible QBI amount for each qualified business and (2) combine the deductible QBI amounts to determine the combined QBI amount. If a taxpayer has only one qualified business, the combined QBI amount is the deductible QBI amount for that business.
Are there certain business eligible for the deduction regardless of the taxpayer’s income?
Service trades or businesses – for example, engineering, architecture, or manufacturing that are not specified service trades or businesses are eligible for the deduction regardless of the taxpayer’s taxable income. Businesses providing specified services – such as law, accounting, consulting, investment management — of taxpayers who have taxable income above the higher taxable income threshold limit — are barred from the deduction.
What exactly is meant by the term “unadjusted basis immediately after acquisition” (UBIA) in regard to the qualified income business deduction?
The basis of qualifying property is calculated as the unadjusted basis immediately after acquisition of that property.
Qualifying property means:
- tangible property,
- depreciable property
- property that is available for use in the business at the close of the tax year
- property used in the production of QBI at any time during the year
- property for which the depreciable period has not ended before the close of the tax year
This is where the limitation calculations come into play. If a taxpayer has taxable income above the higher taxable income threshold and owns a business that is not a specified service trade or business, the QBI deductible amount for the business is subject to a limitation based on W-2 wages and/or capital.
‘Capital’ is measured as the unadjusted basis of certain business assets.
The deductible QBI amount for the business is equal to the lesser of:
- 20% of the business’s QBI, or
- The greater of: (a) 50% of the W-2 wages for the business, or (b) 25% of the W-2 wages plus 2.5% of the business’s unadjusted basis in all qualified property.
What if my qualified business suffers a net loss in earnings for the taxable year? What happens to the Section 199A deduction?
The Sec. 199A deduction cannot be taken in loss years. If QBI is less than zero in a year, the amount will be treated as a loss from a qualified business in the next year.
NOTE: This is a guide on frequently asked questions regarding the Qualified Business Income Deduction and how it can be entered into the tax program. This is not intended as tax advice.
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