The Tax Cuts and Jobs Act of 2017 is the biggest change to the Internal Revenue Code in over 30 years. One of the biggest changes is the introduction of the Qualified Business Income Deduction. Now that the dust has settled, we are facing our first tax filing season with this new law in place. We have received many questions about this deduction and hope that the following FAQ section provides clarity.
What is the Qualified Business Income Deduction?
It is a deduction available to an individual business owner equal to a maximum 20% of qualified business income. The deduction is claimed on an individual owner’s tax return (Form 1040) and is available whether the individual itemizes deductions on Schedule A or takes the standard deduction. The deduction is calculated for each business the individual has, and the cumulative deduction is limited to 20% of the individual’s taxable income from all sources. The deduction is also available to some trusts and estates.
What is Qualified Business Income?
In order to take the Qualified Business Income Deduction, a taxpayer must first have Qualified Business Income. We liken Qualified Business Income to the normal, operating income the business was formed to generate. The income must be from a U.S. trade or business and does not include investment income (such as capital gains and losses and certain dividend and interest income). It also does not include guaranteed payments or wages received as an employee of the business.
Are there any limitations?
Are you kidding? It’s the IRS; of course there are limitations. Once taxable income on an individual Form 1040 exceeds $315,000 for a married couple filing jointly (or $157,500 for other filers), the deduction is subject to multiple limitations based on the type of business, amount of W-2 wages paid by the business, and the property owned by the business.
Does this deduction affect business tax returns?
As mentioned above, this deduction is taken on an individual tax return. However, business returns, such as those filed by partnerships and S corporations must provide their partners and shareholders with the information necessary to calculate the Qualified Business Income Deduction on their personal returns. Therefore, the business entity must answer several important questions:
- Is it the type of business that qualifies for the deduction?
- What income qualifies for the deduction?
- What is the correct amount of wages and property?
The business is responsible for reporting this information to each of its partners or shareholders on a Schedule K-1. So, yes, business returns are greatly affected.
Summary
Despite its complications, the Qualified Business Income Deduction can be a powerful tool in minimizing a taxpayer’s effective tax rate. Effective planning, though, really starts at the business level. Treasury released the final regulations in January so tax practitioners (and their software providers) have spent countless hours analyzing every provision. Needless to say, this tax filing season should be the most interesting in a very long time.
If you have questions or are interested in having ATKG do a more in-depth presentation to you or your firm, give us a call at (210) 733-6611 or email us at office@atkgcpa.com.
