The Qualified Business Income Deduction, or IRS Section 199A, allows a “Qualified Trade or Business” to deduct up to 20% of “Combined Business Income” for a Tax Year between 2018 and 2025 (yes, it will “sun-set” unless Congress makes it permanent). A “Qualified Trade or Business” is referring specifically to a “§ 162 trade or business other than the trade or business of performing services as an employee.” OK, I’m going into the Accounting Weeds here; however, Case Law has determined that to reach the standard of a § 162 trade or business, a taxpayer must be involved in the activity “with continuity and regularity” (and not “merely sporadically”); and the taxpayer’s primary purpose for engaging in the activity must be for income or profit. (Groetzinger v. Comm’r, 480 U.S. 23 (1987)). FYI: The IRS considers ” … for income or profit” showing a profit for 3 out of 5 consecutive years (7 in a horse operation), and a word to the wise. Just for enlightenment purposes, an area that might cause a problem is a Rental Property Business with ONE Rental Property, specifically if the business is done via a “Triple-Net Lease”; i.e.: where the property owner passes the responsibility for real estate taxes, insurance and repairs on to their tenants. In these situations, because the building owner bears little of the responsibility of operating the building, the ownership of real estate rented on a triple-net basis has been viewed by the IRS as akin to holding stock, and the property treated as an investment rather than a § 162 trade or business. (Neill v. Comm’r, 46 BTA 197 (1942) and Rev. Rul. 73-522).
Now, what is “Combined Business Income”? As identified in the IRS Regulation: “Combined Business Income” for a tax year is comprised of two components:
- A deduction of up to 20% of the “Qualified Business Income” (QBI) from a business operated as a sole proprietorship or through a partnership, S corporation, estate or trust, (the “Pass-Through Deduction”), plus
- 20% of the taxpayer’s aggregate qualified Real Estate Investment Trust (REIT) dividends and publicly traded partnership (PTP) income.
For most of us, that basically means any Income of a “Pass-Thru Entity” (one where the Net Income/(Loss) “Passes Thru” to another entity to be taxed); i.e.: Sole Proprietor, Limited Liability, Partnership, and/or an S-Corporation are allowed a 20% Deduction of its “Qualified Business Income”, or QBI.
What is “Qualified Business Income” (QBI)? In IRS legalese, QBI is “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer”. In essence, if you are involved in a Pass-Thru Entity, you should be allowed a 20% deduction for any Net Income the entity generated. I say should because there are caveats, which are too long/many to review here (247 pages), thus this is where the use of a professional tax preparer may be a good investment. One thing I will say here, if you are involved in more than one “Pass-Thru Entity”, you may aggregate the Income/(Loss) of those entities to qualify for the 20% deduction. If qualified trades or businesses are aggregated, the deduction is equal to 20% of the total QBI attributable to the aggregated businesses.
Now, to muddy the waters a little (Oh our Congress and the IRS), there are “limitations” or a “threshold” which guide the implementation of Section 199A. These limitations are phased in for joint filers with taxable income between $315,000 and $415,000, and all other taxpayers with taxable income between $157,500 and $207,500. The threshold amounts and phase-in ranges in the current bill are for tax-year 2018 and will be adjusted for inflation in subsequent years. This part of the law made it impossible for me to understand the Democrats claims that the Tax Cuts and Jobs Act was “written for the rich” with “crumbs for the middle class”. Anyway, Section 199A is only part of the Act, and I don’t want to get political here.
Finally, there are basically three (3) “Categories” Section 199A will operate under:
- Category I – Determining the Deduction when the Taxpayer’s Taxable Income Is Below the Threshold,
- Category II – Determining the Deduction when the Taxpayer’s Taxable Income Exceeds the Threshold Plus the Phase-Out Range, and
- Category III – Determining the Deduction when the Taxpayer’s Taxable Income Exceeds the Threshold but Is Within the Phase-Out Range.
These “Categories” are somewhat involved; again, an area where the use of a professional tax preparer may be a good investment.
I hope this has been somewhat informative. Please do not hesitate to contact Essential Accounting, LLC for assistance with IRS Section 199A, or any other tax or accounting matter that may be giving you difficulty.