New Tax Law: Deduction for Qualified Business Income and More.
For tax years beginning after 2017 and before 2026, under new IRC Sec. 199A, an individual generally may deduct 20 percent of qualified business income from a partnership, S corp or sole proprietorship, as well as 20 percent of aggregate qualified real estate investment trust (REIT) dividends, qualified cooperative dividends and qualified publicly traded partnership income. Special rules apply to specified agricultural or horticultural cooperatives.This new deduction is allowed only for federal income tax purposes.
A limitation based either on wages paid or on wages paid plus a capital element is phased in above a threshold amount of taxable income A disallowance of the deduction with respect to specified service businesses also is phased in above the threshold amount of taxable income. For purposes of this new deduction, taxable income is computed without regard to the 20 percent deduction.
The new deduction is not allowed in computing adjusted gross income, but is allowed to reduce taxable income so that is available to both non-itemizers and itemizers.
THRESHOLD AMOUNT
The threshold amount is $157,500 or $315,000 for joint returns, indexed for inflation for tax years beginning after 2018.
The range over which the phase in of the limitations on specified service businesses, wages and capital applies is $50,000 or $100,000 for joint returns.
Adjustment
If taxable income exceeds the threshold amount but does not exceed $207,500, or $415,000 for joint returns, and if the W-2 wages/qualified property limitation for a qualified business, discussed below, is less than 20 percent of the qualified business income for that business, then:
A. The W-2 wages/qualified property limitation does not apply for that business; and
B. The 20 percent tentative deduction for the qualified business income from that business is reduced by the following computation:
(1) Subtract the W-2 wages/qualified property limitation from that 20 percent tentative deduction; and
(2) Multiply the result obtained under (1) immediately above by the following fraction:
[Taxable income exceeding the threshold]/$50,000 ($100,000 for joint returns)
Example: H & W file a 2018 joint return reporting $345,000 taxable income. H has a qualified business that is not a specified service business (discussed immediately below), has qualified business income of $75,000 and $20,000 of W-2 wages. (For illustrative simplicity, there is no qualified property.)
The $15,000 tentative deduction ($75,000 x .20) is reduced by the following computation:
Step I: [$345,000 taxable income less $315,000 threshold or $30,000]/$100,000
Step 2: Step (i) result is 30 percent
Step 3: Excess of $15,000 tentative deduction over $10,000 (50 percent of W-2 wages) is $5,000
Step 4: $5,000 x .30 is $1,500
Step 5: Deduction for qualified business income is $13,500 ($15,000 less $1,500)
SPECIFIED SERVICE BUSINESSES
A specified service business is any business involving the performance of services in the following fields:
* Health
* Law
* Accounting
* Actuarial science
* Performing arts
* Consulting
* Athletics
* Financial services
* Brokerage services
* Any business whose principal asset is the reputation or skill of one or more of its employees or owners.
* Investing and investment management, trading or dealing in securities [defined in Sec. 475(c)(2)], partnership interests or commodities [defined in Sec. 475(e)(2).
LIMITATION BASED ON W-2 WAGES AND CAPITAL
This limitation is the greater of:
* 50 percent of the W-2 wages paid with respect to the qualified business; or
* The sum of 25 percent of the W-2 wages with respect to the qualified business, plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.
Example: A taxpayer subject to this limitation does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020.
The business has no employees in 2020. The 2020 limitation is the greater of:
A. 50 percent of W-2 wages or $0; or
B. The sum of 25 percent of W-2 wages ($0) plus 2.5 percent of the machine's unadjusted basis immediately after its acquisition: $100,000 x .025 = $2,500.
The limitation on the taxpayer's deduction is $2,500.
DETERMINATION OF TAXPAYER'S DEDUCTION
The deduction for qualified business income for the tax year is equal to the sum of:
I. The lesser of the combined qualified business income amount the for the tax year or an amount equal to 20 percent of the excess of the taxpayer's taxable income over any net capital gain [defined in Sec. 1(h)] and qualified cooperative dividends; plus
2. The lesser of 20 percent of qualified cooperative dividends or taxable income (reduced by net capital gain).
This sum may not exceed the taxpayer's taxable income for the tax year (reduced by net capital gain).
The 20 percent deduction with respect to qualified cooperative dividends is limited to taxable income (reduced by net capital gain) for the tax year.
The combined qualified business income for the tax year is the sum of the deductible amounts determined for each qualified business carried on by the taxpayer and 20 percent of the taxpayer's qualified REIT dividends and qualified publicly traded partnership income.
The deductible amount for each qualified business is the lesser of:
(a) 20 percent of the taxpayer's qualified business income with respect to the business; or
(b) The greater of 50 percent of W-2 wages with respect to the business or the sum of 25 percent of the W-2 wages with respect to the business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.
TRUSTS AND ESTATES
Trusts and estates are eligible for this 20 percent deduction. Rules similar to those under old Sec. 199, as in effect on Dec. 1, 2017, apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property for the relevant limitation.
ACCURACY-RELATED PENALTY
For purposes of determining a substantial understatement of income tax under Sec. 6662(d)(I)(A) for a taxpayer claiming this new Sec. 199A deduction for a tax year, a substantial understatement exists if the amount of the understatement exceeds the greater of
* 5 percent, instead of 10 percent, of the tax required to be shown on the return; or
* $5,000.
BUSINESS MEALS, ENTERTAINMENT AND TRANSPORTATION
For amounts paid or incurred after 2017, no deduction is allowed for:
* An activity generally considered to be entertainment;
* Membership dues to any club organized for business, pleasure, recreation or other social purposes; or
* A facility used in connection with any of the above items.
* Also, no deduction is allowed for expenses to provide any qualified transportation fringe benefit to a taxpayer's employees and, except as necessary for ensuring an employee's safety, an expense for commuting transportation.
Taxpayers may still, generally, deduct 50 percent of food and beverage expenses for operating their business (e.g., meals consumed by employees on work travel).
For amounts incurred and paid after 2017, but only until Dec. 31, 2025, this 50 percent limitation is expanded to an employer's expenses for providing food and beverages to employees through an eating facility meeting the requirements for a de minimis fringe benefit and for the employer's convenience.
by Stuart R. Josephs, CPA
Stuart R. Josephs, CPA has a San Diego-based Tax Assistance Practice that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at (619) 469-6999 or stuartrjosephs@yahoo.com.
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| Title Annotation: | FedTax |
|---|---|
| Author: | Josephs, Stuart R. |
| Publication: | California CPA |
| Date: | Mar 1, 2018 |
| Words: | 1292 |
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