2020 NATIONAL INCOME TAX WORKBOOK CHAPTER 3 QUALIFIED
2020 NATIONAL INCOME TAX WORKBOOK CHAPTER 3: QUALIFIED BUSINESS INCOME DEDUCTION ISSUES
Chapter 3 Intro P. 73 1. Calculating – The basics 2. Aggregating – Why? When? How? 3. QBI Losses – what now? 4. Partnerships and S corps – allocating and reporting 5. Real estate – qualify for QBI? 2
Taxable Income Limit QBI P. 74 Taxable Income x 20% Lesser (W-2 Limit and SSTB Limit discussed later) 3
Definition of QBI P. 74 QBI, generally: Qualified items of income, gain, deduction, and loss with respect to any qualified trade or business Trade or business: Reference to I. R. C. 162 and certain self-rentals Effectively connected with US trade or business 4
Services as an Employee P. 74 Services as an employee = NOT QBI Remember last year? (page 77 - 80) W-2 vs 1099? • Presumed employee for 3 years • Rebuttal possible 5
Effectively Connected with a US Trade or Business QBI “effectively connected” P. 74 T or B in US Per I. R. C. 864(c) Office / fixed place Material factor in realization of income Substantial activities 6
Excluded from QBI P. 74 QBI excludes: Dividends Interest Income (unless allocated to T or B) Capital gains and losses Foreign personal holding companies Annuities (unless in connection w/ T or B) 7
REITs and PTPs – Separate! P. 75 *QBI component REITs and PTPs Schedule C REIT #1 Schedule E REIT #2 Partnership PTP #1 1120 S Net 20% combined *If above threshold, QBI component calculated on or B separately, with W-2 and SSTB limits each T 8
Reasonable Compensation to S Corp Shareholders Distribution S Corp (does not reduce QBID) P. 75 Salary (reduces QBID) Shareholder If salary not reasonable, IRS can recharacterize, up to reasonable compensation 9
Guaranteed Payments to Partners P. 75 Partnership I. R. C. 707(a) and (c) Distribution (does not Guaranteed Payment (reduce QBID) (reduces QBID) Partner 10
Example 3. 2 – Guaranteed Payments – for Services 50% Dan D&D Sporting Goods QBI Guar pay QBI P. 75 50% 550, 000 (125, 000) Guar 300, 000 pay (150, 000) QBI 0 Dave 11
Example 3. 3 – Guaranteed Payments for Services – P. 75 D&D Sporting Goods 50% QBI 550, 000 Guar (0) Guar Dan Dave pay (0) pay 550, 000 QBI (225, 000) 0 12
Other Deductions Reduce QBI? P. 76 The following other deductions reduce QBI: • Deductible portion of SE tax • Self employment health insurance • Contribution to qualified 404 retirement plans If the individual’s gross income from the trade or business is taken into account in calculating the allowable QBI deduction 13
Example 3. 4 – Effect of SE Tax on QBID P. 76 John – single. TI below threshold Sole proprietorship – net income SE tax deduction: 140, 000 x. 9235 = 129, 290 x. 153 = 19, 781 x. 50 = QBID 140, 000 (9, 891) 130, 109 x. 20 26, 022 14
S Corp Shareholders S Corp Included in S/H W-2 >2% S/H P. 76 Paid S/H health ins premiums QBI flow thru reduced by the deduction FAQ 33 states self employed health insurance will still be deducted from QBI, so it may actually reduce QBI at both levels! 15
Limitations on QBI P. 76 QBI x 20% = preliminary QBI deduction limitations: Everyone: Taxable income limit Above the Threshold: W-2 wage and capital limit SSTB limit 16
Taxable Income Limit P. 76 Taxable income, before QBI deduction Less: net capital gains = Adjusted taxable income x 20% = limitation Net capital gains include: • Long-term capital gain • Unrecaptured 1250 gain • Collectibles gain • 1202 gain • Qualified dividends 17
W-2 Wage and Capital Limit P. 76 1. QBI x 20% 2. Taxable income x 20% NOW a 3 rd limit, if above threshold: 3. W-2 wage and capital limit: Greater of: 50% of W-2 wages, or 25% of W-2 wages, plus 2. 5% of the UBIA (W-2 wages? UBIA? Last year = pages 17 -23) 18
2020 Phasein Ranges Single, MFS, Ho. H 213, 300 Full W-2 Limit P. 77 Joint 426, 600 Partial W-2 Limit 50, 000 163, 300 No W-2 Limit 100, 000 326, 600 19
Example 3. 5 - Below Phasein P. 77 Facts: Single, wages paid 15, 000, UBIA 10, 000 Wages S Corp – QBI Standard ded Taxable income 100, 000 75, 000 x 20% = 15, 000 QBID (12, 400) 162, 600 x 20% = 32, 520 TI limit What is the lower limit for single? 20
Example 3. 6 - Above Phasein P. 77 Facts: Single, wages paid 15, 000, UBIA 10, 000 Other Income Wages S Corp – QBI Standard deduc Taxable income 112, 400 100, 000 75, 000 (12, 400) 275, 000 What is the upper limit for single? 275, 000 x 20% = 55, 000 15, 000 x 50% = 7, 500 or 15, 000 x 25% = 3, 750 + 10, 000 x 2. 5% = 250 4, 000 21
Taxable Income in the Phasein Range P. 78 How far through the phasein range? Taxable Income 394, 600 326, 600 426, 600 68, 000 100, 000 68% 22
Example 3. 7 TI in Phasein - TEST If TI below 326, 600 QBI x 20% 175, 000 x 20% 35, 000 If lesser, no limit! TI 394, 600 P. 78 If TI above 426, 600 wages compare 50, 000 x 50% = 25, 000 If lesser, limit applies 23
Example 3. 7 TI in Phasein - Calculation If TI below 326, 600 QBI x 20% 175, 000 x 20% 35, 000 TI 394, 600 68% P. 78 If TI above 426, 600 wages at risk 10, 000 50, 000 x 50% = 25, 000 lose 68% of the 10, 000 = 6, 800 35, 000 – 6, 800 = 28, 200 24
Specified Service T or B Limitation P. 81 The SSTB limitation may reduce or eliminate the QBI deduction for an SSTB owner with taxable income above threshold. Above - NO QBI, W-2 Wages, UBIA can be used Within - Limitation partially applies Below - Limitation has no effect 25
SSTB Limitation (using joint) 3 different calculations, depending on income: P. 81 426, 600 W-2 & SSTB limitations Phase in period: Partial W-2 and SSTB limitations 326, 600 Only limit is taxable income 26
Definition of SSTB – I. R. C. 199 A(d)(2) Health Performing Arts Principle asset. Reputation Law P. 81 Accounting Consulting Actuarial Financial Athletics Brokerage 27
Definition of SSTB – I. R. C. 199 A(d)(2)(B) Added and P. 81 Subtracted Investing Investment Management Trading Dealing in Securities, Partnership Interests, Commodities Engineers Architecture 28
Taxable Income within the Phasein Range – Applicable % Taxable Income 163, 300 173, 300 P. 82 213, 300 20% 80% used for W-2 limitation used for SSTB limitation 29
Example 3. 8 TI in Phasein SSTB- Calc If TI below 326, 600 TI 394, 600 68% QBI 175, 000 x 32% 56, 000 x 20% 11, 200 P. 82 If TI above 426, 600 32% wages at risk 3, 200 lose 68% of the 3, 200 = 2, 176 11, 200 – 2, 176 = 9, 024 50, 000 x 32% 16, 000 x 50% 8, 000 30
Example 3. 9 Threshold - SSTB P. 86 Kalinda – single Sole income – accounting practice Taxable income - 220, 000 Wages – 200, 000 UBIA - 55, 000 Above the upper threshold No QBID 31
De Minimis Rule – Not Treated as an SSTB Gross Receipts 25, 000 or less >90% e or n g i <10% P. 86 Gross Receipts over 25, 000 Not SSTB income >95% < 5% Not SSTB income 32
Example 3. 10 - De Minimis Rule P. 86 Landscaper – sells equipment and design (consulting) Does not sell the trees, shrubs, flowers it recommends Invoices separately One set of books - single trade or business e h t e s u 2, 000 Total gross Beca g n i p a c s receipts Land e r a s t p i e c e r s s gro e r i t n e e th , % !! 5. B 2 consulting T 1 S S n a s i 250, 000 s s gross receipts busine 33
De Minimis Rule – Example 3. 11 PP. 86 -87 Veterinarian services & develops and sells organic dog food at clinics and online. Maintains separate set of books, separate employees. Treats as separate trades or businesses for 162 &199 A 3, 000 Gross Receipts 1, 000 Vet - SSTB T O N t u B , % 0 1 r ve d o n a R t G e t v e V se u a c e r b o T e B d S a r S t e t an a r a p se d o o 2 f 6 1 r dog e d n u s e s s busine 34
Multiple Trades or Businesses P. 86 Individual or RPE Business #1 Business #2 Business #3 Business #4 Each business separately tested to determine whether that business is an SSTB. The de minimis threshold is applied to each business separately. 35
Services or Property provided to SSTB – Antiabuse Rule P. 87 SSTB products or services ≥ 50% ownership T or B Portion provided to SSTB must be treated as a separate SSTB. Portion not provided to SSTB, eligible for 199 A 36
Example 3. 12 – Leasing to SSTB P. 87 Patterson Dental – Owns a building in which it conducts a dental practice Dental Practice Pays rent Building Income from leasing the building to the dental practice is SSTB income 37
Example 3. 13 – Leasing to SSTB and Non-SSTB P. 87 Patterson Dental – Owns a building in which it conducts a dental practice and rents to a coffee shop Dental Practice Pays rent Dentist Office Coffee shop Income from leasing the building to the coffee shop is NOT SSTB income 38
Example 3. 14 – Related SSTB P. 87 Brown and Buckley partnership divides into 3 partnerships: B&B Law B&B Rentals All property B&B Staffing All Services Each partnership will be treated as an SSTB 39
Allocations of Expenses shared expenses 1/3 Direct Tracing T or B PP. 87 -88 T or B 2/3 T or B Gross Income 100, 000 Gross Income 200, 000 40
Issue #2 Aggregation of Activities Entity #1 High QBI Low Wages & UBIA Aggregate to maximize W-2 limitation P. 88 Entity #2 Low QBI High Wages/ UBIA (also look for loss entities with wages) 41
Aggregation Requirements P. 88 • NOT an SSTB • Business relationship • Common ownership See flow chart on page 89 42
Business Relationship Business #1 Need connection P. 89 Business #2 2 of 3 required: 1. Provide products, property or services that are the same or customarily offered together 2. Share facility or business function: personnel, accounting, legal, manufacturing, etc. 3. Coordination or interdependence between businesses 43
Common Ownership P. 90 Business #1 others Business #2 >50% others > ½ tax year #1 #2 #3 44
Section 469 Groupings vs 199 A Aggregation Groupings P. 90 469 NOT NECESSARILY THE SAME!! 199 A Limit deduction of certain passive losses Activities constitute an appropriate economic unit Facts and circumstances Allowance of deduction TESTS: Not an SSTB Business relationship Common ownership 45
Example 3. 15 Similar Products, Shared Facilities P. 90 share Restaurant Entity own staff equipment kitchen purchasing accounting advertising Catering Entity own staff equipment Common Ownership Owner may elect to aggregate 46
Example 3. 16 Dissimilar Products, Shared Functions Clothing Manufacturer Common Management P. 90 Pet Food Only shared function Owners cannot elect to aggregate the businesses. Need to meet 2 tests 47
Example 3. 17 Residential and Commercial are P. 90 dissimilar Stonefly Corp 100% Residential condominium Share: accounting legal human resources 100% Commercial office building NOT the same type of property, and do NOT provide similar services! 48
Example 3. 18 Aggregation to Increase QBID Wanda Howard Aggregate Net Income 1, 000, 000 2, 000 W-2 wages 600, 000 150, 000 750, 000 UBIA 3, 000 0 3, 000 Tentative 50% W-2 25% W-2 + 2. 5% UBIA 200, 000 300, 000 200, 000 problem! 75, 000 P. 91 400, 000 lesser 375, 000 greater 225, 000 37, 500 262, 500 49
RPE and Aggregation T or B RPE can aggregate its activities at the entity level P. 92 T or B RPE S/H or Partner Binding on all owners S/H or Partner 50
Consistency and Reporting 2019 Aggregate T or B #1 T or B #2 P. 92 All future years consistent + T or B #3 Newly created or newly acquired B can be added, if all tests met T or Significant change in facts, no longer aggregate a T or B 51
Individual Disclosure P. 92 Disclose: • Description • Name and EIN • During tax year: • formed, ceased, acquired, or disposed of • Any aggregated T or B of an RPE in which the individual holds an ownership interest • Other information required in forms, instructions, public guidance 52
Failure to Disclose – individual T or B #1 No disclosure P. 92 T or B #2 Aggregated T or B IRS disaggregate Cannot aggregate for 3 years 53
Qualified Business Loss P. 93 QBI loss offsets positive QBI Problem: No W-2 wages or UBIA taken into account from loss T or B 54
Qualified Business Loss Carryover 2020 P. 93 2021 Loss carries over to 2021 Negative QBI from a separate T or B No 199 A Deduction 55
Example 3. 19 - Loss from Qualified Business farm QBI income 150, 000 (10, 000) 140, 000 x 20% 28, 000 Wages 40, 000 x 50% 20, 000 + restaurant QBI income 150, 000 (10, 000) 140, 000 x 20% 28, 000 Wages 30, 000 x 50% 15, 000 furniture QBI loss (20, 000) allocate Based on QBI P. 93 Wages 20, 000 lost! Lesser 35, 000 or TI 417, 800 x 20% = 83, 560 56
Example 3. 20 – QBI Loss Carryover farm QBI income 150, 000 restaurant QBI income 150, 000 p. 94 furniture QBI loss (400, 000) Net QBI loss (100, 000) The (100, 000) is carried forward and treated as a separate trade or business for purposes of computing 199 A deduction in subsequent year. NOTE: for income tax purposes, the (100, 000) loss may offset Sandra’s salary income. 57
Previously Disallowed Losses 2017 N/A 2018 Loss disallowed, suspended, or reduced: At risk Basis Passive does not affect QBI in 2018 P. 94 2019 Loss allowed (FIFO): if a loss from 2018 or later reduces taxable income then is a qualified item of deduction or loss does reduce QBI in 2019 or later 58
Previously Disallowed Losses P. 94 Special Rules • 469 groupings may differ from 199 A aggregations – allocate • Previously disallowed loss may relate to a trade or business no longer in existence – loss from a separate trade or business • Loss attributable to a trade or business determined in year loss incurred • SSTB determinations made in year loss incurred 59
Example 3. 21 Suspended Losses Rental Property P. 94 162 trade or business. 2019 Passive loss suspended (20, 000) 2020 Can use the loss against taxable income. Treated as a QBI loss carryover from a separate trade or business 60
Net Operating Losses P. 95 Generally, an NOL is not included in calculating QBI. However, an excess business loss under 461(l) is treated as an NOL carryover to the following tax year and is taken into account for purposes of computing QBI in the subsequent tax year that it is deducted. 61
NOLs from 2017 and Earlier P. 95 Pre-2018 NOL carryover does not directly affect QBI. But the reduction in taxable income may have other impacts on the calculation: For taxpayers in phasein range, the lower TI may increase the deduction QBID However, the lower TI will reduce the taxable income limitation and may reduce the deduction 62
ISSUE #4 PARTNERSHIPS AND S CORPS P. 95 4 steps: 1. One or more trades or businesses? 2. QBI for each trade or business? 3. W-2 wages and UBIA for each trade or business 4. REIT dividends & PTP income 63
ALLOCATING QBI ITEMS - PARTNERSHIPS P. 95 • Each partner’s share is determined by the partnership agreement • 704 gives some discretion • Special allocations must have substantial economic effect • If partnership agreement silent, use partner’s interest in the partnership 64
ALLOCATION OF QBI ITEMS – S CORPORATIONS P. 96 • Pro-rata share of each qualified item of: • income, loss, deduction, credit • One class of stock • Allocate based on number of shares owned, on a daily basis 67
EXAMPLE 3. 22 QBI AND WAGES TO S CORP S/H’S Riders Inc. Juan 40% 100, 000 salary P. 96 QBI – 350, 000 Wages - 140, 000 salary Jennifer 60% QBI – 140, 000 (350, 000 x 40%) QBI – 210, 000 (350, 000 x 60%) Wages – 56, 000 (140, 000 x 40%) Wages – 84, 000 (140, 000 x 60%) 68
REPORTING P. 96 1065 K-1 Z STMT A QBI W-2 wages UBIA Whether SSTB Also, statements for pass thru info from RPEs and aggregations 69
REPORTING P. 96 1120 S K-1 V STMT Z STMT A QBI W-2 wages UBIA Whether SSTB Also, statements for pass thru info from RPEs and aggregations 70
FAILURE TO REPORT QBI ITEMS ON K-1 P. 96 Warning! If W-2 wages and UBIA are not determined and reported separately for each trade or business, they are presumed to be zero. 71
ISSUE #5 QBI DEDUCTION FOR REAL ESTATE RENTALS P. 97 Is a rental activity a trade or business under 162? Factors: 1. Type of property – commercial vs residential 2. Number of properties 3. Other services provided 4. Type of lease: Net lease vs traditional lease short-term vs long-term 72
SELF RENTALS P. 97 “solely for purposes of section 199 A, the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business. . ” NEED COMMON CONTROL 73
SELF RENTALS P. 97 Commonly Controlled Trade or Business (Not C corp) tenant can be an individual or RPE Rents to Rental Property Solely for 199 A, treated as a trade or business (gain QBI, loss passive) 74
COMMON CONTROL – FOR SELF RENTALS P. 97 Same person or group of persons directly or by attribution own 50% or more of each trade or business S corporation Partnership I. R. C. 267(b) I. R. C. 707(b) ≥ 50% of issued ≥ 50% capital or and outstanding profits in the stock partnership 75
SELF RENTALS P. 97 + Trade or Business Rental Property Can aggregate regardless of whether they could otherwise aggregate - Whether the rental property has a profit or loss could impact the overall QBI calculation. 76
SAFE HARBOR P. 97 Rev Proc 2019 -38 Safe harbor under which a “rental real estate enterprise” may be treated as a trade or business solely for purposes of 199 A A real estate rental enterprise may consist of an interest in multiple properties 77
SAFE HARBOR PP. 97 - 98 Real Estate Enterprise 1 or 2 or 3 Etc. Similar (commercial / residential not similar) Special rules for mixed use property Separate books and records Same from year to year No vacation homes or triple net leases 78
TRIPLE NET LEASES P. 98 Requires tenant to pay taxes, insurance, maintenance – excluded from safe harbor NO QBI One triple net rental generally not a T or B May qualify for QBI If otherwise treated as a T or B may qualify 79
SAFE HARBOR TEST P. 98 In existence less than 4 years: In existence for at least 4 years: 250 hours of service performed each year 250 hours of service performed per year for 3 out of 5 years 80
SAFE HARBOR TEST – SERVICES INCLUDE: • • Advertising Executing leases Verifying information Collecting rent Daily operations Management Supervision p. 98 Performed by owner, employees, and independent contractors 81
SAFE HARBOR TEST - RECORDS P. 99 For each rental enterprise: • Must keep separate books records • Must keep separate bank accounts Failure to meet the safe harbor, does not necessarily preclude rental real estate activities from being a section 162 trade or business based on facts and circumstances 82
RECORDKEEPING P. 99 • Separate books and records for each enterprise • Contemporaneous records: time reports, logs: • Hours of service • Description of services • Dates • Who performed services NOTE: Contemporaneous record requirement will not apply to tax years beginning before 1/1/20 83
RECORDKEEPING P. 99 • What if services performed by an employee or independent contractor? Taxpayer can provide: • A description of services performed • Amount of time generally spent on services • Time, wage, or payment for such services NOTE: Taxpayer must make records available for inspection at the request of IRS 84
REPORTING P. 99 If using the safe harbor, the taxpayer or RPE must include a statement: • Must include: • Description of properties in enterprise • Address • Rental category • Properties acquired or disposed of during year • A representation that requirements of the revenue procedures have been met 85
SE TAX P. 99 Rental Real Estate Schedule E Schedule C Normal rental, If substantial services even if trade or performed (boarding business for 199 A house, hotel, motel, B and B) NOT subject to SE tax Subject to SE tax 86
QUESTIONS? 87
- Slides: 85