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New IRS Proposed Regulations Are Announced

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When the Tax Cuts and Jobs Act was signed into law in December 2017, unanswered questions regarding how to execute some key components of the Act remained.

One of the most pressing questions raised at the time of the Act’s passage was in Section 199A regarding the impact of lowering the tax rate for corporations to 21%, while keeping individual tax payer rates at a higher level.

Why is This a Big Deal?  

It matters becasue entities such as sole proprietorships, “S” Corporations, partnerships, limited liabilities companies (LLCs) and some trusts and estates would not benefit at all from the new the corporate tax deduction.

This is because income taxes are only levied at the individual owners' rate for sole proprietors and owners of ‘pass through’ businesses (i.e., companies that don't pay income taxes at the corporate level, passing income and expenses through directly to the owners to record on their own tax returns).

As such, the advantages of the new corporate deduction would not be available to them. After months of grappling with this, Congress has now issued proposed regulations to assist sole proprietors and owners of pass-through businesses.

Defining the Scope of Section 199A – the Deduction for Solos and Pass-Through Businesses

  • For years beginning after December 31, 2017, a deduction will be available for taxpayers whose taxable income falls below $315,000 for those filing joint returns and $157,500 for remaining taxpayers.
  • If your taxable income is below these threshold amounts, you can just deduct 20% of your qualified business income (called QBI) and there is no need for further complicated calculations.
  • If your taxable income exceeds the threshold, then you will use the following formula to calculate the deduction, which is generally equal to the lesser of either:
      • 20% of your QBI, plus 20% of your qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income OR
      • 20% of your taxable income less any net capital gains
  • On the new draft 1040 Form, line 9 has been added for tax payers to claim the deduction (as calculated above), thus lowering the taxable income that is attributed to their business and reducing their tax obligation.

How is Qualified Business Income (QBI) Determined?

The definition is pretty straightforward: your company’s Qualified Business Income is the net amount of the income, gain, deduction and loss from your “qualified trade or business.”

For purposes of this tax deduction, a qualified business or trade is any business or trade - with two exceptions:

  1. A specified service trade or business (SSTB) which involves providing services in healthcare, law, consulting, athletics, financial services, brokerage services, or any trade or business that depends on the reputation or skill of the owners or one or more of its employees.
  2. Performing services as an employee.

What Happens When a Qualified Business Exceeds the Taxable Income Threshold Amount?

Here is where the nearly 200 pages of proposed regulations and explanations becomes even more complex.

We will offer an overview here, but we suggest that those solos and owners of pass-through entities with income over the threshold amounts consult with experts – including your CPA – who can ensure that you remain compliant with the tax law.

In a nutshell, if your earnings are over the taxable income threshold, your deduction may be limited based on:

  • If your company is one of the two exceptions named above
  • W-2 wages paid by the business
  • Unadjusted basis of certain property used by the business (UBIA)

The limitations on your deductions (based on the above qualifiers) are phased-in for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income falling between $157,500 and $207,500.In this situation the tax benefit decreases as the income reported increases.

SSTBs Over the Taxable Income Threshold May Lose the New Deduction 

If you fall into the SSTB category, and your taxable income is above both the threshold limits and the phase-in range as described above ($415,000 for joint filers and $207,500 for other taxpayers), then you lose the deduction completely. In this circumstance, you will be required to revert to paying taxes under the previous pass-through rules at your individual tax rate.

Proposed Regulations Can Evolve!

This brief synopsis was not intended to address all of the multi-faceted issues that the Section 199A deduction encompasses.Our goal is to keep you aware and informed as quickly as possible of any tax law changes that occur. At the same time, we encourage you to contact us if you have any concerns regarding your specific situation.

We also want to remind you that this recent announcement is for regulations proposed by the Internal Revenue Service (IRS) that have not yet been enacted as law.

Ken Bagner, CPA, MST, CGMA, is the Member in Charge of the Sobel & Co. Tax Practice. He can be reached at 973-994-9494 or by email at Kenneth.bagner@SobelCoLLC.com.

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