Qualified Business Income

Section 199A Qualified Business Income Deduction

The Code Sec. 199A qualified business income (QBI) deduction is another potentially big deduction for clients with a qualified trade or business. The deduction is available to sole proprietors, partners in a partnership, members of an LLC taxed as a partnership, S corporation shareholders, or trusts and estates. Whether a client is eligible for the deduction depends on whether the client has a qualified trade or business and the client’s taxable income.

Qualified trades or businesses include trades or businesses for which the taxpayer is allowed a deduction for ordinary and necessary business expenses under Code Sec. 162. In general, to be engaged in a trade or business under Code Sec. 162, the taxpayer must conduct the activity with continuity and regularity and the primary purpose for engaging in the activity must be for income or profit. If a taxpayer owns an interest in a pass-through entity, the trade or business determination is made at that entity’s level. Material participation under Code Sec. 469 isn’t required for the QBI deduction. Qualified trades or businesses do not include activities conducted by C corporations and the performance of services as an employee.

Additionally, specified service trades or businesses (SSTB) aren’t qualified trades or businesses if the taxpayer has taxable income above a certain threshold (before the QBI deduction). An SSTB is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business. The thresholds above which an SSTB will not fully qualify for the QBI deduction are $160,725 if married filing separately; $321,400 if married filing jointly; $160,700 for all others. Above those thresholds a partial deduction may be available before the deduction is fully phased out.

The first step in determining the QBI deduction is to determine the QBI component, which is generally 20 percent of the taxpayer’s QBI from the taxpayer’s trades or businesses. Where the taxpayer’s taxable income (before the QBI deduction) exceeds the applicable thresholds, a reduction to the QBI deduction is phased in until the deduction is entirely eliminated. In this case, the QBI for each of trade or business may be partially or fully reduced to the greater of 50 percent of W-2 wages paid by the qualified trade or business, or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis immediately after acquisition (UBIA) of qualified property from the qualified trade or business. The partial or full reduction to QBI is determined by the taxpayer’s taxable income. If taxable income (before the QBI deduction) is: (1) at or below the threshold, there is no need to reduce QBI; (2) above the threshold but below the phase-in range (more than $160,725 but below $210,725 if married filing separately; $321,400 and $421,400 if married filing jointly; $160,700 and $210,700 for all others), the reduction is phased in; or (3) above the threshold and phase-in range, the full reduction applies.

If the taxpayer is a patron of an agricultural or horticultural cooperative, the taxpayer must reduce cooperative QBI by the lesser of: 9 percent of the QBI allocable to qualified payments, or 50 percent of W-2 wages from the trade or business allocable to the qualified payments.

With respect to S corporations and partnerships, QBI does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer, or any guaranteed payment (or other payment) to a partner in a partnership for services rendered with respect to the trade or business. Qualified items do not include specified investment-related income, deductions, or losses, such as capital gains and losses, dividends and dividend equivalents, interest income other than that which is properly allocable to a trade or business, and similar items.

If the net amount of QBI from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business to the next tax year (and reduces the QBI for that year).

In the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner in a partnership takes into account the partner’s allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the tax year equal to the partner’s allocable share of W-2 wages of the partnership. Similarly, each shareholder in an S corporation takes into account the shareholder’s pro rata share of each qualified item and W-2 wages.

Compliance Tip: While there was no tax form to file last year with respect to the Code Sec. 199A deduction, there will be forms for 2019 tax returns. In October, the IRS released draft forms (Form 8995, Qualified business Income Deduction Simplified Computation, and Draft Form 8995-A, Qualified Business Income Deduction), as well as draft instructions for the forms.