On December 22, 2017 the Tax Cuts and Jobs Act was approved by Congress which meant that major tax reform was going to hit us like a ton of bricks, and very soon. Meanwhile, here we are six months later without final regulations that will greatly impact many individuals and businesses in relation to this “reform”. One of these new provisions without final signed regulations is the “Qualified Business Income Deduction” (QBID) or Section 199A for us tax geeks. In general the QBID is a 20% deduction available to an individual, estate, or trust that has domestic qualified business income that flows through to them at a personal or trust level. However, the 20% deduction isn’t so cut and dry as limitations and qualifications will come into play, as well as those long awaited final regulations that are still unknown. So the following is a list of what we know and a list of what we still need guidance on to help address this major tax change:
What we know:
- The QBID is available to individual taxpayers, estates, and trusts that have domestic qualified business income flow through to them from S Corporations, Partnerships or LLC’s, or sole proprietorships.
- The 20% QBID is calculated for each entity that may flow through to an individual, estate, or trust.
- The deduction is also available to farmers (Schedule F) and certain real estate businesses (Schedule E).
- The QBID is available for taxable years beginning after December 31, 2017 and before January 1, 2026.
- The 20% deduction on qualified business income is available to “ALL” taxpayers that have total taxable income of $315,000 or less for married filing joint filers, and $157,500 or less for single filers. Taxpayers with taxable income over these thresholds may still qualify for the deduction; however additional tests and potential phase-outs will need to be considered.
- A phase out of the QBID begins for “certain” service trade businesses such as health, law, accounting, consulting, financial, brokerage, investing, performing arts, athletics, etc. However engineers and architects are specifically excluded. The phase out range for married filing joint filers in these industries is $315,000 – $415,000 and $157,500 – $207,500 for single filers. Taxpayers in these industries that reach the top of these thresholds are completely excluded from the QBID.
- There is also a W-2 wage limitation to all taxpayers that meet the bottom level thresholds mentioned above. Once these thresholds are met, the maximum QBID that a taxpayer can claim is the greater of (i) 50% of the taxpayers W-2 wages paid in each entity, or (ii) the sum of 25% of the W-2 wages paid in each entity plus 2.5% of the unadjusted basis in all qualified tangible property (usually the cost of depreciable assets).
- The QBID is derived from “net” amounts of income, gain, deduction, and loss items. It does not include dividends, publicly traded partnership income, foreign source income, carryforward of losses, or investment income items.
What we still need guidance on:
- There is still a gray area in certain instances on what is considered a service trade or business. Currently the definition describes them as a business in which the principal asset is its reputation or skill of one or more of its employees or owners.
- The ability to separate activities for purposes of the QBID rather than grouping at the entity level. Example being such as one activity qualifying versus another that does not.
- What rental real estate activities will be allowable for the QBID? The law is unclear whether renting to ones-self qualifies and there is no indication on whether an individual who holds them selves out as a real estate professional will qualify.
- Will the flow through income subject to QBID be allowable for passive shareholders and investors? The law at this point does not suggest they will not qualify nor that a shareholder needs to be active, however regulations are not final.
- What happens if an individual has a qualified business loss flow through? It is unclear on what the effect of losses will have on the QBID and whether they will be allowed to carryover.
This is an exciting time to say the least in regards to tax reform and will without a doubt have a massive impact on some individuals and businesses. The qualified business income deduction is just one aspect of the 2018 Tax Cuts and Jobs Act and we have barely scratched the surface of Section 199A above.
Here at Willis & Jurasek, P.C we are continually monitoring the release of these final regulations to keep our clients informed and up to date on the potential tax impact. If you have any questions, please feel free to call either our Jackson or Grand Rapids offices to speak with one of our tax department representatives.