Determine QBI For Section 199A: Net Business Income, Minus Gains And Dividends

Benefit claim should be considered in light of corporate income tax decrease

Tax time is here and returns are rolling in—if you haven’t nailed down how you’re going to handle Section 199As, your time is about up. The 2017 Tax Cuts & Jobs Act changed the tax code substantially, along with eligibility requirements and income thresholds for the 199A deduction.

In order to properly counsel clients, filers also need to be familiar with how to handle W2 wages and investment limits, the definition of “qualified business income,” and how to calculate the 199A deduction, affirms tax pro Arthur J. Werner, in his webinar for Eli Financial, “Section 199A Deduction: A Complete Primer.”

The 199A Deduction: Who, What, And How

Section 199A of the tax code is a new 20-percent deduction for pass-through businesses. Created by the 2017 Tax Cuts & Jobs Act, the deduction has two components, explains the IRS:

  • Eligible taxpayers may be able to deduct up to 20 percent of qualified business income from a domestic business operated as a sole proprietorship or through a partnership, S corp, trust, or estate. Limitations are in place for married-filing-jointly couples who earn more than $315,000 ($157,500 for all others).
  • Eligible taxpayers may also be entitled to a deduction of up to 20 percent of their combined qualified real estate investment trust dividends and qualified publicly traded partnership income.

While S corps and partnerships can’t take the deduction, they can report each partner’s or shareholder’s share of the qualified business income, W-2 wages, qualified property, qualified REIT dividends, and qualified publicly-traded partnership income on Schedule K-1 so shareholders or partners may determine their deduction.

How To Calculate QBI: Start With Taxable Income, Not AGI

Key to the pass-through is determining your client’s qualified business income, or QBI.

“It’s a powerful tool in reducing your tax liability, but calculating the deduction can be tricky,” says tax and auditing consultants BeeneGarter.

Start the calculation with your client’s taxable income, BeeneGarter says, not adjusted gross income, and then determine if the income is related to a qualified trade or business. Certain occupations, such as accounting, health, law, performing arts, consulting, and actuarial science, are likely unable to claim the deduction.

QBI then is the net amount of a business’ qualified income, gain, deduction, and loss, but excludes income, gain, deduction, and loss. QBI is not:

  • Amounts paid for services that are reasonable compensation
  • Guaranteed payments to a taxpayer for services performed
  • Money paid to a taxpayer outside their capacity as a partner for services
  • Qualified REIT dividends, cooperative dividends, PTP income, and income from foreign pass-through entities.

Taxpayers who can claim the 20 percent pass-through will incur a maximum effective rate of 29.6 percent on the QBI. While helpful, this should be considered in relation to the decrease in corporate rates from 35 percent to 21 percent, notes transaction consultants BDO.

“There are a number of factors that need to be considered but, from a simple after-tax cash flow perspective, a key determinative factor is the likelihood of the entity distributing vs. retaining operating earnings,” a BDO insight report notes. “While a common thought is to consider possibly incorporating an existing partnership in order to benefit from the 21 percent corporate tax rate, a corporate-to-partnership conversion should not be dismissed.”

Expert: Section 199A Is The “Tax Break Of The Century”

If you have a client who qualifies for the 199A, it could be a very big deal. Stephen Nelson, author of Quickbooks for Dummies, told the MadFientist that the tax break was one of the biggest to come through Congress in ages.

“The Section 199A tax deduction surely counts as the best small business and individual investor tax break of the 21st century,” he said. “Using Section 199A, business owners and real estate investors may get to simply “not” pay income taxes on the last 20% of the income they earn!”

While securing it won’t be easy, that kind of free money is hard to pass up, agrees Werner in his webinar, “Section 199A Deduction: A Complete Primer.” Make sure you are prepared when your clients call asking about it.

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Jeff Schmerker

Jeff has extensive professional experience writing on a variety of topics, from pharmaceutical research to environmental history. He has published more than a half-dozen books, and he has worked as a newspaper reporter, magazine editor and restaurant reviewer. He lives in Missoula, Montana with his wife and son.

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