section 199a qualified business income deduction•introduced in the tax cuts and jobs act (dec 22,...

Presented by:Kasey Pittman, CPA, MSA, Tax Senior Manager

Section 199AQualified Business

Income DeductionNovember 13, 2019

What is Section 199A?

• Section 199A– A provision in the Tax Cuts

and Jobs Act – A deduction for “Main

Street”• Sole proprietorships• Partnerships• S Corporations• Estates and Trusts• PTPs & REITS

• Introduced in the Tax Cuts and Jobs Act (Dec 22, 2017)– 23 pages of a 503 page law

• Proposed Section 199A Regulations (Aug 8, 2018)– 80 pages of Regulations and over 100 pages of commentary

• Final Section 199A Regulations (Jan 18, 2019)– Almost 100 pages of Regulations and almost 150 pages of NEW

Commentary

History of Section 199A

How Much is the Deduction?

• How Much is the Deduction?– Up to 20% of your Qualified Business Income (QBI)

• What Taxpayers Hear/Understand:– “I only have to pay tax on 80% of my income!”

• Not so fast! – As we all know it depends!

• Also!– Sunsets on January 1, 2026 (as of right now)

The Red Tape

• Entity Limitations/Calculations– Legitimate Business– Qualified Business Income (“QBI”)– Type of Business (Specified Service?)– W‐2 Wages Paid– Basis of Property Owned

• Individual Limitations/Calculations– Adjusted Gross Income

What is Considered a Legitimate Business?• A Section 162 Trade or Business

– Sec. 162 Trades or Businesses are eligible for the QBI deduction– What do I need to have a Section 162 Trade or Business?

• A clear profit motive• Regular and continuous activity

• You CAN have more than one Trade or Business within an Entity

• What About Rental Real Estate?

What is QBI?

• What is QBI?– Qualified Trade or Business:

INCOME + GAIN – DEDUCTION – LOSS = QBI– What is NOT QBI?

• Income not related to the business:– Captial Gains/Losses (ST or LT)– Sec 1231– Dividends– Interest or Annuity Income

• Guaranteed payments or S Corp Owner Wages

Qualified Business Income –Negative QBI• What if I have Negative QBI?

– With more than one business? You must NET• If an individual’s QBI from at least one trade or business is less than zero, the individual must offset the QBI attributable to each trade or business that produced net positive QBI with the QBI from each trade or business that produced a negative QBI

• If netting still results in a negative total, that total is carried forward

– With one business? You carry forward the negative amount to net with future positive QBI

– Only work with QBI (no change to Wages or UBIA)

Qualified Business Income -SSTBs• What is a Specified Service Trade or Business?

– “Any trade or business involving the performance of services of one or more of the following fields: Health, Law, Engineering, Architecture, Accounting, Actuarial Science, Performing Arts, Consulting, Athletics, Financial Services, Brokerage Services, Investing and Investment Management, Trading, Dealing in Securities/Partnership Interests/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 or owners”

Qualified Business Income –W-2 Wages• Two More Items to Determine for Each Business• W‐2 Wages

– W‐2 Wages paid by each trade or business– Wages must be for work in the trade or business

• 3 Methods– (1) Unmodified Box Method– (2) Modified Box 1 Method– (3) Tracking Wages Method

Qualified Business Income –UBIA of Property• Unadjusted Basis Immediately after Acquisition (UBIA) of

Qualified Property– Each business must determine the UBIA of Qualified Property as

of the last date of the year

• What is Qualified Property?• 199A Asset Life

– Greater of:• MACRS Asset Life, or• 10 years

Qualified Business Income –UBIA of Property• A Few Stipulations

– Must be held and available for use in the trade or business as of the last day of the taxable year

– Be used for production of QBI– Anti‐Abuse for some assets within 60 days of year end and

disposed of within 120 days

• Bonus and 179 – No Effect• Special Rules

– Excess 743(b) Basis Adjustment– Like‐Kind Exchanges

Qualified Business Income -Individual Income Limitations

Individual Taxable Income Before The QBI Deduction

Sectoin 199A Deduction Overview• How it Works:

QBI Deduction + PTP/REIT Deduction =Section 199A Deduction

(Subject to Taxable Income Limitation)

Our Flow Chart

Non-SSTB Under Threshold

Non-SSTB Under Threshold

A, an unmarried individual, owns and operates a computer repair shop as a sole proprietorship. The business generated QBI of $100,000 in 2018. A has no capital gains or losses. After allowable deductions not relating to the business, A’s total taxable income for 2018 is $131,000.

Potential QBI Deduction$100,000 x 20% = $20,000

Non-SSTB Above Phase-In Range

Non-SSTB Above Phase-In RangeB and C are married and file a joint individual income tax return. B is a shareholder in M, an entity taxed as an S corporation that conducts a single trade or business, which is not an SSTB. B’s share of the M’s QBI is $300,000 and share of the W‐2 Wages is $40,000. M has no qualified property. C also earns a salary with an unrelated company. After allowable deductions unrelated to M, B and C have a 2018 taxable income of $500,000.

Non-SSTB Above Phase-In Range

Calculate QBI Component FactorsStep 1 – QBI of $300,000 x 20% = $60,000Step 2 –Wages of $40,000 x 50% = $20,000

Step 3 –Wages of $40,000 x 25% and UBIA of $0 x 2.5% = $10,000

Step 4 – Greater of Step 2 or 3 = $20,000Step 5 – Lesser of Step 1 or 4 = $20,000

Potential QBI DeductionStep 6 – Take Step 5 = $20,000

Non-SSTB in Phase-In Range


Does the greater of the following exceed 20% of QBI for a trade or business?:

50% of Wages, OR 25% of Wages + 2.5% UBIA of Property

If YES – The trade or business has all it needs to take maximum deduction. (Skipping Example)

If NO – Amount allowable is between the limit above and 20% of QBI, depending on how far the taxpayer is into the Phase‐In Range


B and C are married and file a joint individual income tax return. B is a shareholder in M, an entity taxed as an S corporation that conducts a single trade or business, which is not an SSTB. B’s share of the M’s QBI is $300,000 and share of the W‐2 Wages is $40,000. M has no qualified property. C also earns a salary with an unrelated company. After allowable deductions unrelated to M, B and C have a 2018 taxable income of $375,000.

Non-SSTB in Phase-In RangeCalculate QBI Component Factors

Step 1 – QBI of $300,000 x 20% = $60,000Step 2 –Wages of $40,000 x 50% = $20,000


Step 4 – Greater of Step 2 or 3 = $20,000Step 5 – Lesser of Step 1 or 4 = $20,000

Calculate Excess AmountStep 6 – Is Step 1 > Step 5? If Yes:

Step 7 – Step 1 – Step 4 = $60,000 ‐ $20,000 = $40,000


Potential QBI DeductionStep 10 – Step 1 – Step 9= $60,000 ‐ $24,000 =

$36,000

Calculate Reduction PercentageStep 8 – ($375,000 ‐ $315,000)/$100,000 =

$60,000/$100,000 = 60%

Calculate Reduction AmountStep 9 – Step 7 x Step 8 = $40,000 x 60% = $24,000

SSTB Under Threshold

SSTB Under Threshold

R, an unmarried individual, operates a consulting business (an SSTB) as a sole proprietorship. The business generated $140,000 of net taxable income from operations in 2018, all of which is QBI. R’s overall taxable income for the year is $147,000.

Potential QBI Deduction$140,000 x 20% = $28,000

SSTB Above Phase-In Range

SSTB Above Phase-In Range

R, an unmarried individual, operates a consulting business (an SSTB) as a sole proprietorship. The business generated $140,000 of net taxable income from operations in 2018, all of which is QBI. R also has significant income from a family partnership in which she is a passive partner. R’s overall taxable income for the year is $347,000

Potential QBI DeductionOver Threshold = $0

SSTB in Phase-In Range


B and C are married and file a joint individual income tax return. B is a shareholder in M, an entity taxed as an S corporation that conducts a single trade or business, which happens to be an SSTB. B’s share of the M’s QBI is $300,000 and share of the W‐2 Wages is $40,000. M has no qualified property. C also earns a salary with an unrelated company. After allowable deductions unrelated to M, B and C have a 2018 taxable income of $375,000.

SSTB in Phase-In RangeCalculate QBI Component Factors

Step 1 – QBI of $300,000 x 20% = $60,000Step 2 –Wages of $40,000 x 50% = $20,000


Step 4 – Greater of Step 2 or 3 = $20,000

Calculate Applicable PercentageStep 5 – ($375,000 ‐ $315,000)/$100,000 =

$60,000/$100,000 = 60%Step 6 – 100% ‐ 60% = 40%


Potential QBI DeductionStep 10 – Step 7 – Step 9 = $24,000 ‐ $9,600 =

$14,400

Step 7 – Step 1 x Step 6 = $60,000 x 40% = $24,000Step 8 – Step 4 x Step 6 = $20,000 x 40% = $8,000

Step 9 – (Step 7 – Step 8) x Step 5 = ($24,000 ‐ $8,000) x 60% = $16,000 x 60% = $9,600

Combined Qualified Business Income Amount (“CQBIA”)• Once the Calculation is Done for Each Trade or Business

we Combine– Combine Potential QBI Deductions Calculated for each Trade or

Business or Aggregated Group– Result is “Combined Qualified Business Income Amount”

PTP Income & REIT Dividends

• Treated separately from QBI when calculating the QBI deduction

• Much Simpler Calculation– 20% of Qualified PTP Income and 20% of Qualified REIT Dividends

• PTP & REIT K‐1s will disclose necessary information• Negative Combined Qualified PTP Income and REIT

Dividends?– The negative amount is carried over to the following tax year and

will offset and positive Qualified PTP income and Qualified REIT dividends for that tax year.

– Does not effect QBI from a trade or business


An Example: On the K‐1 for a PTP, a client has $100 of qualified PTP income. In addition, he has $200,000 of QBI from a manufacturing business that he owns. The client is married with taxable income below the threshold amount.

Potential 199A Deduction($200,000 x 20%) + ($100 x 20%) =

$40,000 + $20 = $40,020


An Example: On the K‐1 for a PTP, a client has ‐$100 of qualified PTP loss. In addition, he has $200,000 of QBI from a manufacturing business that he owns. The client is married with taxable income below the threshold amount.

Potential 199A Deduction($200,000 x 20%) + ($0 x 20%) =

$40,000 + $0 = $40,000

$100 PTP/REIT Loss Carried forward to Next Year

Overall Taxable Income Limitation• Overall Taxable Income Limitation

– Amount equal to 20% of the excess (if any) of Taxable Income over Net Capital Gain

• What is Net Capital Gain?– Defined in Section 1(h)– Includes Qualified Dividends (Sec 1(h)(11))

The Income Limitation

• An Example:

Application to Trusts & Estates

• Trusts & Estates are 199A “Individuals”– Aside from grantor trusts

• Basic Premise:– To extent income remains in Trust/Estate, eligible for QBI and

Trust/Estate treated as Individual– To extent income is distributed, not eligible for QBI and

Trust/Estate is treated as an RPE.

A Few Additional Notes

• Section 481(a) Adjustments– Are taken into account for QBI if Jan 1, 2018 or after– See Section 2 for more detailed discussion

• No Effect on: Basis, SE Tax, S Corporation AAA, etc• 199A = AMT 199A• Change to Sec 6662 Accuracy Related Penalty

– Reduced to lesser of 5% or $5,000 (from 10% or $5,000)

Quick Break

Common Discussions Re: 199A

Section 162 T or B?

• Does a Section 162 Trade or Business Need to be the taxpayer’s primary occupation to qualify?

NO!

See: Rev. Rul. 77‐356Facts:Member of Congress who gave 10 speeches for $1,500 comp over a one year periodNeed: Regular and continuous activity

Rental Real Estate

• Does Rental Real Estate Qualify for 199A?– Yes in many circumstances

• How does a Business Qualify?– As a Section 162 T or B– Using the Safe Harbor

Rental Real Estate –Safe Harbor• For 2018 – Notice 2019‐07

– Separate books and records– 250 or more hours– Signed Statement

• For 2019 – Rev. Proc. 2019‐38– Similar requirements to Notice 2019‐07, plus

• Contemporaneous log• Statement (unsigned)

• Additional Stipulations– NNN Leases, 280A, Related Rental, etc.

Rental Real Estate –Qualifying as a 162 T or B• Good Facts

– Time spent in management/maintenance – Obligation to repair/maintain, pay taxes, etc.– Efforts to rent or re‐rent the property– Held for income generation

• Bad Facts– Minimal rental activity, including renting or re‐renting,

maintenance, etc. – Held for appreciation– Triple net lease

Rental Real Estate –A Game!• Interest in 8 buildings containing stores and apartments.

No management activities by taxpayer but considerable amount of time spent by agent– Yes!– Gilford v. Commissioner, 201 F.ed 735

• Taxpayer purchased and rented 25 properties. Properties generated substantial income. 3 sold in year of question due to deterioration of neighborhoods. Initially purchased as investments– No– Chicago Title & Trust Co. v. United States, 209 F.2nd 773

Rental Real Estate –A Game!• Full time lawyer owns 6 story apartment building fully

rented when purchased. Visited 1 – 2 times and devoted 1‐2 hours/month. Uninvolved other than lease negotiations. Hired labor for repairs, etc. – Yes!– Frackler v. Commissioner, 45 B.T.A. 708

• Single‐family home inherited with tenant in place. Tenant remained for 14 years, until time of sale. Taxpayer provided for repairs, upkeep, etc. – No– Grier v. United States, 218 F.2nd 603

Rental Real Estate –A Game!• Taxpayer had residence in Austria. Fled in 1938.

Property manager rented to several tenants but no payments made it to taxpayer. Destroyed in bombing.– Yes!– Reiner v. United States, 222 F.2nd 770

• Taxpayer purchased and rented 2 timeshares. Location based on income potential. Agent engaged to manage units, which took significant time. No separate bank account. No books maintained.– Yes!– Murtaugh v. Commissioner, TC Memo 1997‐319

Rental Real Estate – Rented to Related Pass-through Entity• Self‐Rentals MUST be included in 199A

– Common control – Direct or indirect ownership of 50% or more• Spouse, children, grandchildren, parents

• NOT a benefit!– Anti‐abuse provision

• SSTB Status of Related Pass‐through Entity Determines SSTB Status of Rental– Dentist owns building? Rental is also SSTB

SSTB Considerations

• De Minimis Rule for SSTBs– If 10% (or 5%) of gross receipts are attributable to SSTB income,

business is not considered SSTB• 10% for $25 million average gross receipts or less• 5% for over $25 million average gross receipts

• “Crack and Pack” Not Allowed– Services or Property provided to commonly controlled SSTB will also be

considered SSTB Income

• Cr

Consulting as SSTB Income

• What is Consulting?– “the provision of professional advice and counsel to the client to

assist the client in achieving goals and solving problems”

• What is NOT Consulting?– Services other than advice and counsel– Sales (or economically similar)– The provision of training or educational courses– “The performance of consulting services embedded in, or

ancillary to, the sale of goods or performance of services on behalf of a trade or business that is not otherwise an SSTB if there is no separate payment for the consulting services”

Choosing an Entity

39.8%

29.6%

37.0%

33.4%

40.8%

Passive Passthrough w/ QBI (37% x 80% + 3.8%)

Passive Passthrough w/o QBI (37% + 3.8%)

Maximum Tax Rates

Active Passthrough w/ QBI (37% x 80%)

C Corporation (21%, then net at 20% + 3.8% NIIT)

Active Passthrough w/o QBI

Choosing an Entity

• Items to consider:– Yearly distribution or dividend requirement?– Active or Passive? NIIT?– Growth mode? Planned acquisitions?– Time horizon to sale?– Sale or transition plan? Sell stock? (1202 QSBS?) Sell assets?

Next generation inheriting?– States – higher or lower income tax?– Tax situation of individual owners? AMT?

Bifurcation of Income• What if you have more than one trade or business inside

an entity?– Bifurcate!

• “If an individual or RPE directly conducts multiple trades or businesses, and has items of QBI that are properly attributable to more than one trade or business, the individual or RPE must allocate those items among several trades or business to which they are attributable using a reasonable method based on all the facts and circumstances”

• How?– Reasonable method that “must clearly reflect the income and

expenses of each trade or business” – Different methods Ok. But consistent year to year.

Bifurcation of Income

• It’s not quite that easy– The taxpayer has the burden of proving more than one trade or

business is being carried on • Campbell, TC Memo 1992‐66 & Groder, TC Memo 1960‐208

• Requirements– Complete and separable set of books and records (1.1446‐1(d)(2))– Income clearly reflected

• Other Important Commentary– Per commentary – “factual determination” and “court decisions

that help define meaning of trade or business provide guidance”– Believe separate T or B will not exist within an entity unless

separate methods of accounting could be used under 446

Bifurcation of Income

• Case Law – More often than not, conclusion is no separate T or B

• 2 Court Cases– Facts: Poultry Industry. Taxpayers wanted to use accrual method

for feed and hatchery and cash method for broiler division. Feed and hatchery had some 3rd party customers but bulk went to broiler division. • Peterson Produce Co.

– No! Not a separate and distinct business

• Rocco, Inc.– Difference – New Corp formed to run broiler operations– Yes! Conducted through separate and individual corp entities

QBI Aggregation

• Can Group Multiple Trades or Businesses Treat as One– Combine: QBI, Wages, UBIA

• Elect In– At individual level, with statement, by return due date

• One aggregation does not force others– Not all or nothing – Can choose– Effectively, a permanent election

• unless change in facts and circumstances

QBI Aggregation

• Requirements to Meet:– (1) 50%+ common ownership

• With linear family attribution• Pass‐throughs – someone (or group) owns 50%+ entities

– (2) Same taxable year– (3) No SSTBs– (4) Meet 2 of the following 3:

• (A) Provide products/services that are the same or customarily offered together

• (B) Shared facilities or significant business elements• (C) Coordination/rely upon each other (ex – supply chain)

S Corporation Reasonable Wages • Does not matter whether you pay

– “Sec 1.199A‐3(b)(2)(ii)(H) provides that QBI does not invludereasonable compensation paid by an S corporation…The rule for reasonable compensation is merely a clarification that, even if an S Corporation fails to pay a reasonable wage to its shareholder‐employees, the shareholder‐employees are nonetheless prevented from including an amount equal to reasonable compensation in QBI”

What is a Guaranteed Payment?• A payment that is made (1) to a partner acting the capacity

as a partner in exchange for services performed for the partnership or for the use of capital by the partnership that (2) is not dependent on partnership income.

• Guaranteed Payment FAQs:– Doesn’t need to be a fixed amount, but not based on pship income– Based on gross income? Could be a GP (it depends)– Based on net income? Likely not a GP– Payable in all events, even if exceeds pship net income– Best practice to be in pship agreement– See 1.707‐1(c)

Tied to Taxable Income!

• Taxable Income!• Altered by:

– Income, of course• General tax planning• Harvesting losses

– Above the Line Deductions, of course• SE Items including SEP Contributions• HSA Deductions

– ALSO Itemized Deductions• Including Charitable Contributions

Tied to Taxable Income!Without Planning Without Planning

Year 1 Year 2 Year 1 Year 2

QBI Deduction ‐ ‐ 27,432 ‐

Child Tax Credit 1,500 1,500 4,000 ‐

Total Standard and Itemized Deductions

30,000 30,000 44,000 24,000

Increase in Cash Flow from PlanningAdditional QBI 27,432

Additional Deductions 8,000

Reduction in Taxable Income 35,432

Reduction in Tax (at 35%) 12,401

Increase in Credits 1,000

Additional Cash to Taxpayer 13,401

Questions

Contact

Kasey Pittman, CPA, MSA TaxTax Senior Manager

PBMares, LLP434 McLaws Circle, Suite 201Williamsburg, VA [email protected]

section 199a qualified business income deduction•introduced in the tax cuts and jobs act (dec 22,...

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