July 9, 2019
Taxpayers first had the opportunity to use the 20% qualified business income deduction this past April 15th, and their tax returns fared a bit better because of it. This unique deduction was created at the end of 2017 as part of the Republican tax overhaul called the Tax Cuts and Jobs Act, and it gave taxpayers the unprecedented opportunity to reduce their taxable income by up to 20%. The 2019 tax season (when we filed 2018’s tax returns) was the first season taxpayers were eligible to take the deduction. Now that we have one year of experience with the deduction under our belts, what did we learn?
In January, just a few months before the April 15th deadline, the US Department of Treasury released final regulations for the qualified business income deduction (“QBI deduction”). These final regulations provided much-needed insight about important items like: calculating the deduction when you have multiple businesses; valuing property and calculating wages to determine your limitations; and how rental real estate businesses are treated under the law. These final regulations, along with the proposed regulations that were simultaneously released, gave tax professionals confidence that they were claiming these deductions correctly, and that their decisions were in the best interests of their clients.
Single and joint filers whose income thresholds exceeded $157,500 and $315,000, respectively, had more complex calculations than those whose incomes were lower. At these income thresholds, the QBI limitations kicked in, which required:
These tasks were not necessarily difficult, but high earners were required to spend more time and money on tax preparation than their low-income counterparts, which was a hard pill to swallow.
The QBI deduction limitations were often mentioned only as afterthoughts, but truthfully, the limitations were very impactful for many. The W-2 wage limitation (which you can read more about here) tripped some taxpayers up, especially those in closely-held businesses who chose to take distributions rather than pay themselves a salary. Ideally, W-2 wages should have been high enough so as not to limit the deduction, but not so high that it reduced the deduction’s benefit. Determining this perfect mix required us to modeling different decisions so that we could see which ones resulted in the largest deduction.
Lawmakers are not tax experts; most new tax laws need to be interpreted by the IRS before the public can implement them. The IRS released two sets of regulations in preparation of this year’s tax season, but not all questions were answered. For example, the law is not clear how [or if] taxpayers can segregate their SSTB activities from their non-SSTB activities. There are anti-abuse policies in place to prevent activity separation for the sole purpose of circumventing the limitations, but there may be some legitimate reasons taxpayers can separate their activities. We hope that the next round of the final regulations provides some answers.
Changes ushered in through tax reform and their implications are still being determined. While 199a deduction remains a powerful tax planning opportunity, there are unknowns which should be answered by the IRS as more guidance is released. If you have questions about the QBI deduction or need assistance with a tax planning or compliance issue, Wilson Lewis can help! For additional information please call us at 770-476-1004 or click here to contact us. We look forward to speaking with you soon.