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IRS releases FAQs on the Sec. 199A deduction for qualified business income

August 10, 2018

In a frequently asked question (FAQ) format, IRS has issued what it describes as basic guidance on the Code Sec. 199A pass-through deduction, which was enacted in the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017). IRS says that it will be issuing separate guidance for co-ops.

Guidance. IRS explains that under Code Sec. 199A, eligible taxpayers may be entitled to a deduction of up to 20% of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers, the deduction is subject to limitations which are based on the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business. Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.

Eligible taxpayers may also be entitled to a deduction of up to 20% of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. This component of the Code Sec. 199A deduction is not limited by W-2 wages or the UBIA of qualified property. The sum of these amounts and the above amount based on QBI is referred to as the “combined qualified business income amount.” Generally, the deduction is the lesser of the combined qualified business income amount and an amount equal to 20% of the taxable income minus the taxpayer’s net capital gain.

The deduction is available for tax years beginning after Dec. 31, 2017, regardless of whether an individual itemizes their deductions on Schedule A (Itemized Deductions) or takes the standard deduction on Form 1040. Most eligible taxpayers will be able to claim it for the first time when they file their 2018 federal income tax return in 2019. (FAQ No. 1)

Individuals, trusts and estates with QBI, qualified REIT dividends, or qualified PTP income may qualify for the deduction. In some cases, patrons of horticultural or agricultural cooperatives may be required to reduce their deduction. (FAQ No. 2) S corporations and partnerships are generally not taxpayers and cannot take the deduction themselves. However, all S corporations and partnerships report each shareholder’s or partner’s share of QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends and qualified PTP income on Schedule K-1, so the shareholders or partners may determine their deduction. (FAQ No. 3)

Determining the deduction. In the FAQs, IRS explains how to compute the QBI deduction. It also provides a number of definitions needed to understand the computation.

Qualified business income (QBI). QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded. (FAQ No. 4)

Qualified trade or business. A qualified trade or business is any trade or business, with two exceptions:

  1. Specified service trade or business (SSTB), which includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers.
  2. Performing services as an employee.

Computation. The SSTB limitation does not apply if a taxpayer’s taxable income is below $315,000 for a married couple filing a joint return and $157,500 for all other taxpayers. The deduction is the lesser of:

  1. 20% of the taxpayer’s QBI, plus 20% of the taxpayer’s qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or
  2. 20% of the taxpayer’s taxable income minus net capital gains.

If the taxpayer’s taxable income is above the $315,000/$157,500 thresholds, the deduction may be limited based on whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property used by the business. 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. These threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years. (FAQ No. 6)

Examples. In addition, in the FAQs, IRS answers several questions dealing with specific scenarios.

…A taxpayer who has income from an SSTB asks how this affects his deduction. IRS replies that the SSTB limitation does not apply to any taxpayer whose taxable income is below the $315,000/$157,500 threshold amounts. For taxpayers whose taxable income is within the phase-in range, the taxpayer’s share of QBI, W-2 wages and UBIA of qualified property related to the SSTB may be limited. If the taxpayer’s taxable income exceeds the phase-in range, no deduction is allowed with respect to any SSTB. IRS notes that the threshold amounts and phase-in range are for tax year 2018 and will be adjusted for inflation in subsequent years. (FAQ No. 7)

… A taxpayer with taxable income under $315,000 and filing married filing jointly asks if he has to determine if he is in an SSTB to take the deduction? IRS replies: No — if the taxpayer’s 2018 taxable income is below $315,000, if married filing jointly, or $157,500 for all other filing statuses, it doesn’t matter what type of business the taxpayer is in. The taxpayer will be able to deduct the lesser of: (a) 20% of his QBI, plus 20% of his qualified REIT dividends and qualified PTP income, or (b) 20% of his taxable income minus his net capital gains. (FAQ No. 8)

…A taxpayer with taxable income between $157,500 and $207,500 and filing as single who receives QBI asks if it matters if it is from an SSTB. IRS replies: Yes — because his taxable income is above the threshold amount, his Code Sec. 199A deduction with respect to any SSTB will be limited. However, because he is within the phase-in range, he may be allowed some Code Sec. 199A deduction with respect to an SSTB. In addition, for taxpayers above the threshold amount, the Code Sec. 199A deduction with respect to any trade or business, including an SSTB, may be limited by the amount of W-2 wages paid by the trade or business and the UBIA of qualified property held by the trade or business. The phase-in range is $315,000 to $415,000 for joint filers and $157,500 to $207,500 for all other filing statuses. (FAQ No. 9)

…A taxpayer with taxable income over $207,500 and filing as single whose only income is from an SSTB asks if he is entitled to the deduction with respect to the SSTB. IRS replies: No — The same is true for a married couple filing a joint return whose taxable income exceeds $415,000. However, IRS notes that he may be entitled to a deduction for QBI earned from another trade or business that is not an SSTB or from qualified REIT dividends or qualified PTP income. (FAQ No. 10)

…A taxpayer with over $207,500 taxable income and filing as single who is not engaged in an SSTB asks if he is entitled to the deduction. IRS replies: Yes — if he has QBI, qualified REIT dividends or qualified PTP income. For eligible taxpayers with total taxable income in 2018 over $207,500 ($415,000 for married filing joint returns), the deduction for QBI may be limited by the amount of W-2 wages paid by the qualified trade or business and the UBIA of qualified property held by the trade or business. (FAQ No. 11)

References: For the QBI deduction, see FTC 2d/FIN ¶L-4305 et seq; United States Tax Reporter ¶199A4.