Section 199A (also known as “the qualified business income deduction” or “the 20% passthrough deduction” or “the monster that stalks my dreams”) hit the news again a few weeks back with the publication of final regulations – and related materials – by the IRS. Sure, it might not have hit the news that most people follow, but it was big on the radar of tax geeks. Still is.
Some have tried – with varying levels of success – to put everything important regarding this deduction into one writeup, but that: a) uses a lot of ink (real or virtual); b) sometimes obfuscates the important points; and/or c) can get super-boring. I should know: I’ve tried, and now I avoid myself at parties. With all that said, this two-part series (I tried really hard to make it one part – honest) will present a total of seven important points that all business owners need to know regarding the QBI deduction. Why seven? I like prime numbers – and I got tired. Okay, let’s hit four of them now.
- It may not be long for this world. Since Republicans used budget reconciliation to pass the Tax Cuts & Jobs Act, many of its provisions, including Section 199A, expire after 2025. And while that may seem quick, consider this: with a Democratic House, an election in 2020 that will figure “bigly” into future policy, and some pretty dramatic talk being floated for tax changes (the Ocasio-Cortez proposed 70% marginal tax rate being an easy target), the qualified business income deduction may be more short-lived than we originally thought (and all that after I had the flowchart tattooed on my arm).
- Of primary importance is whether you have a “trade or business.” You may be thinking that a trade or business should be easy to identify. While that is usually true, the issue is that the term has never actually been defined in statute, so it is based on facts, circumstances, and case law. In releasing these regulations, despite requests for more guidance, the IRS continued the grand tradition of leaving the term undefined and beyond the scope of the regulations. Defining a trade or business is also beyond the scope of this discussion (see, I can do it, too), but know that the activity in question needs to rise to the level of an enterprise engaged in with regularity, for profit, etc. There is a whole other series of discussions to be had about the various factors to be considered in determining whether there is a trade or business (with a list of criteria in yet another regulation), but again: scope. Now, if the activity in question is a rental real estate activity, read more in point four.
- It seems simple enough to compute, but don’t be fooled. The upper limit of the QBI deduction is 20% of the qualifying net income of the trade or business (capped at 20% of taxable income if lower), but there are caveats to this, particularly if taxable income is over a certain threshold ($315,000 for a married filing jointly taxpayer; half that for others). At that level, limitations based on W-2 wages from the business and its unadjusted basis of qualifying property immediately after acquisition begin to apply. And, of course, there is the question of whether the business is a specified service trade or business – more on this in Part 2 – which also takes taxable income thresholds into account to determine whether – and to what extent – all this kerfuffle even applies in the first place.
- Rental real estate activities might be trades or businesses – or might not – but sometimes definitely are. Whether a rental real estate activity is a trade or business is a historically unsettled – and previously often unimportant – question, and it is only slightly more settled now for purposes of the QBI deduction. The one piece of additional guidance the IRS rendered is not in the regulations themselves, but rather in an accompanying Notice, in which it lays out a safe harbor test for a rental real estate activity qualifying as a trade or business for purposes of the QBI deduction. This safe harbor, in oversimplified terms, states that the safe harbor is satisfied if separate books and records are maintained, a 250-hour requirement is met, and certain documentation regarding those 250 hours (services rendered, dates, etc.) is kept. But be warned: if your rental activity has a triple net lease arrangement and/or the property is used as a residence for any part of the year, that activity is excluded from the safe harbor, no matter what.
Okay, we’ll round that out next time with an odd number of additional and not unrelated points. But always remember: these little conversations do not do justice to the complexity of these provisions and how they may apply to you…situations are fact dependent…seek the advice of a competent professional…never play cards with a man named after a city…etc. Next time.
Michael A. Carraway, Jr., CPA
Michael A. Carraway, Jr., is a partner with GranthamPoole PLLC and a recognized leader in the field of partnership and corporate taxation, having worked with many clients on entity and transaction structuring matters. He has also written, taught, and spoken on many topics in the area over the years and has served as a technical subject matter expert in several practices. Please contact Mike at firstname.lastname@example.org, www.linkedin.com/in/michaelcarraway, or 601-499-2400. CPA License # R2705
***The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.