By Stephen J. Slade, CPA
Of all the changes made to federal tax law over the past several years, the Section 199A qualified business income (QBI) deduction potentially will have the biggest impact on business owners over the next eight years. Are you having this conversation
with your clients?
For those who may not be up to speed, the QBI deduction is a 20% deduction that can be used by owners of partnerships, S corporations, sole proprietorships, and trust entities – just about any business entity other than a C corporation. The deduction
is 20% of a taxpayer’s QBI, subject to numerous limitations and phase outs. So, a taxpayer with $1 million of QBI could receive a tax deduction of up to $200,000.
CPAs should be talking to their clients who are business owners about this deduction. There are specific guidelines the IRS included in the new regulation regarding what income qualifies, how business owners are paid, how losses are
considered, and stipulations meant to level the playing field between various entity types.
What follows are my key takeaways and some advice regarding this incredibly important tax law change that your clients must understand.
- Be cognizant of taxable income and the QBI restrictions since your clients may face deduction limitations based upon their taxable income reported. There could be instances in which filing separable returns could maximize QBI for your clients. If
married, the lower-earning spouse is the business owner, and the couple has under $207,500 of taxable income, it may make sense to file separable returns.
- Keep in mind that W-2 wages or guaranteed payments paid to business owners could have a direct impact on the calculation of the QBI deduction. In some instances, W-2 wages paid to an S corporation shareholder can maximize the deduction; in other instances,
the wages can reduce the deduction. Help your clients understand how the owner’s compensation impacts the deduction.
- Carefully determine whether or not your client owns a specified service business. If so, there is a risk of the client earning above the maximum-allowed threshold, and they would no longer qualify for the deduction.
- Be aware that the IRS has employed several blocking rules. For example, if your client is a taxpayer that has multiple businesses in one entity, and 10% or more of gross receipts are attributable to specified services, the classification of your client’s
entire business may be as a specified service. The IRS’s view is that if there are multiple businesses within an entity, your client may be permitted to report separable QBI attributes on each business. However, they would have to maintain
complete and separable sets of books.
- The IRS allows for some aggregation rules that are available only to nonservice businesses. Assuming your client meets several qualifications and owns multiple businesses, they will be allowed to use W-2 wages from one business across multiple businesses,
potentially maximizing their QBI deduction. This was generous of the IRS since this concept did not appear in the tax law as drafted by Congress.
- In an unexpected move, the IRS final regulations do not permit aggregation of commercial and residential rental businesses.
- For business owners who own rental real estate properties, the IRS has created a Rental Real Estate Safe Harbor Rule. Owners can claim that their real estate enterprise rises to the level of a trade or business, thus qualifying for the QBI deduction.
To satisfy this safe harbor, your client must demonstrate the following:
- Spends at least 250 hours annually maintaining or managing the properties.
- Keeps separable books and records for the properties.
- The properties are not subject to triple-net-leases or any personal use (i.e., vacation properties).
If your client satisfies the safe harbor rules and attaches a signed affidavit with their tax return, they can receive IRS
The QBI deduction is the tax law change that ultimately will impact business owners the most over the next eight years. But there are many other changes, too. My advice is to proactively talk to your clients about QBI to ensure they understand the new
rules and maximize their personal income tax situation.
Stephen J. Slade, CPA, is tax director with Wouch Maloney & Co. LLP in Philadelphia. He is responsible for creating the firm’s tax policy and ensuring that all staff are properly informed of the ever-changing tax laws.
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