The Internal Revenue Service (“IRS”) has issued proposed regulations today to further clarify the new provision allowing many owners of sole proprietorships, partnerships, trusts and S corporations a 20 percent qualified business income deduction.
Proposed regs issued on the 199A business income deduction
The new business income deduction—referred to as the Section 199A deduction or the deduction for qualified business income (“QBI”)—was created by the new Tax Cuts and Jobs Act (“TCJA”). The deduction is available starting in 2018. As a result, eligible taxpayers can claim it for the first time on their 2018 federal income tax return.
For recent announcements and updates, check the IRS “Tax Reform” web page.
What is the 20% QBI Deduction?
The TCJA reduced tax rats on C corporations. More specifically, the TCJA reduced the entity-level tax on a C corp from 35% to a flat 21%. To maintain fairness between the taxation of C corps and companies other than corporations (that is, sole proprietorships, S corporations, or partnerships), the TCJA created the new QBI deduction. The business income deduction was created under Sec. 199A for taxpayers other than a corporation.
The mechanics of the QBI deduction are complex. Generally, however, the deduction is equal to the lesser of 20 percent of a taxpayer’s qualified business income plus 20 percent of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20 percent of taxable income minus net capital gains.
The deduction is available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. There are limitations on deductions for taxpayers above the $157,500/$315,000 taxable income thresholds. The proposed regs contain detailed descriptions of the deductions.
What is Qualified Business Income or QBI?
Under Sec. 199A(c), the term “qualified business income” means, for any taxable year, the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer. Such term shall not include any qualified REIT dividends, qualified cooperative dividends, or qualified publicly traded partnership income.
Basically, QBI includes domestic income from a trade or business. Therefore, employee wages, capital gains, interest and dividend income are excluded. Taxpayers may rely on the rules in these proposed regulations until final regulations are published in the Federal Register.
The IRS has also put out Notice 2018-64, which should be read in conjunction with the proposed regulations. The notice clarifies the methods of calculating W-2 wages for purposes of Sec. 199A.
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