One of the most important and complex parts of the Tax Cuts and Jobs Act of 2017 is Section 199A, the new qualified business income (QBI) deduction. The deduction is a 20-percent pass-through for entities such as partnerships, LLCs, S-corps, and some trusts and estates.
The QBI deduction is potentially a big deal for some businesses, but there is plenty of ambiguity about how to interpret and implement it, notes tax expert Vicki L. Mulak. Further muddling things, the Internal Revenue Service is taking its time when it comes to providing meaningful guidance. There is a lot at stake with the QBID, says Mulak in her Eli Financial webinar, “Understand the Mechanics of Section 199A Deduction,” and tax pros need to understand clearly how Section 199A works and what opportunities and advantages it provides.
Advantage: Reduce Income Tax, But Not Self-Employment Tax
The QBI deduction is one of the “most generous” provisions of the tax overhaul, reports Kiplinger. It’s also one of the most complex parts of the law, so taxpayers who think they may qualify will likely look for help securing it.
The provision lets sole proprietors, small business owners, freelancers, and gig workers “pass-through” business profits (or losses) to Schedule C of their individual returns and do so without itemizing.
How it works: “Starting this year, many of these taxpayers will be allowed to deduct up to 20% of their qualified business income—net income after they’ve claimed business deductions—before they calculate their tax bill,” explains Kiplinger. “For example, if you’re self-employed and earn $100,000 in qualified business income this year, you could be eligible to deduct $20,000. If you’re in the 24% tax bracket, that would reduce your tax bill by $4,800.”
One important caveat, notes H&R Block, is that the pass-through reduces federal income tax only, not self-employment taxes or income for the purposes of the alternative minimum tax.
Further, notes the South Carolina Association of Certified Public Accountants, taxpayers are subject to a reduction ratio in their otherwise-available QBI deduction, which limits the deduction to a percentage of W-2 wages paid “and/or a percentage of the cost of assets used in the trade or business producing the QBI.”
Federal Guidance Coming Before 2019?
With the tax year well into its second half, taxpayers and tax pros are still eagerly waiting for clues from the feds as to how to use the QBI deduction.
Guidance was expected in July, Acting IRS Commissioner David Kautter told the American Bar Association at a meeting in May, but never materialized.
“The goal of the guidance is to get things out that are complete,” an IRS spokesperson told Wolters Kluwer. “But, it will not cover every question that taxpayers have.”
Until that happens, many tax pros will be playing a guessing game—one that could have significant ramifications for clients.
“If uncertainty persists, though, taxpayers will eventually have to take a position,” explains Politico. “Practitioners can advise their clients to guess one of two ways–more aggressively or more conservatively–neither of which is optimal.”
For what it’s worth, the IRS lists guidance for Section 199A on its to-do list for 2018.
With lots of details (hopefully) forthcoming, Mulak stresses that tax pros need to act now to be prepared to serve clients with complicated Section 199A questions.
