Steve Richardson & Company, Certified Public Accountants
QBI Tax Planning Summary
May 21, 2019
To Our Clients and Friends:
This past tax season was a bit more challenging than most for several reasons.
- Congress initiated a massive tax overhaul that caused a number of unexpected changes in tax practice.
- The IRS was ‘out of work’ for 35 days at the beginning of tax season. Tax season got off to a slow and cranky start.
- The tax withholdings tables issued by the IRS and third party vendors such as QuickBooks and ADP were wrong!
I’m going to try and draft a series of letters about the actual day-to-day impact of the new tax law on our clients. Some of these letters will be simple, short and to the point. Others will be equally as important but a bit more complex.
Qualified Business Income Deduction (QBI)
This year we were surprised by how complex the “qualified business income deduction” would prove to be in practice. The QBI sounds simple. A business may get up to a 20% tax deduction for domestic business operations. It’s not that simple!
LLCs and S-Corps
Most small business entities are now organized as “pass-through” entities such as LLCs and S-Corps. The QBI is one step more difficult when a “pass-through” entity is involved.
Specified service trade or business
Small businesses face complex QBI rules. If a small business is a “specified service trade or business”, then if faces a daunting additional layer of rules.
A “specified service trade or business” is, according to the IRS,
“any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of professionals.”
The additional of rules applied to “specified service trade or businesses” will cause a “phase-out” of the QBI deduction based on income, which is $157,500 for individuals and $315,000 for married couples. Splitting income from a “specified service trade or businesses” to a non-“specified service trade or businesses” is subject to tight rules. Also, self-rentals tied to “specified service trade or businesses” are treated as if they too are “specified service trade or businesses”.
There are planning opportunities. These planning opportunities are narrow and require substantial lead time.
Rental Real Estate
Under the proposed safe harbor, a “rental real estate enterprise” would be treated as a trade or business for purposes of Sec. 199A if at least 250 hours of services are performed each tax year with respect to the enterprise.
Under limited circumstances, rental activities can be treated as subject to the Section 199A QBI Deduction.
But should your rental property be treated as Section 199A property?
There are a few problems with treating rental real estate as subject to the QBI rules.
- If the properties lose money (not uncommon in
rental real estate) one can have a “Negative QBI”. A negative QBI does nothing
good. It is a direct reduction in the amount of available QBI deduction. If you
have a pass-through entity making a profit (as LLC or S-Corp) a negative QBI
adjustment reduces the value of the QBI deduction.
- This “negative QBI through some of our younger staff people a curve ball this past tax season.
- The record keeping requirements for the 250-hours of personal services are onerous.
The QBI only helps a taxpayer if they are profitable.
Some rental properties are automatically subject to the 199A rules.
If you have an active trade or business that is not a -“specified service trade or businesses” and this active trade or business is engaged in a self-rental activity, then the rental property is subject to the 199A rules. Tax Planning: if you rent your own property for your business, make sure that the rents paid are high enough to show a rental profit.
QBI is complicated
These rules are complicated and frankly, I’m still learning the rules. The IRS has been slow to provide guidance for the same reasons; the IRS is still trying to understand the QBI rules and the implications of the QBI rules. We will be hearing more on this topic.
Conclusion
As always, we deeply appreciate all of our clients and friends.
Sincerely,