For tax years 2018 through 2025, individuals, trusts and estates can get a 20% deduction of Qualified Business Income (QBI) from sole proprietorships, S corporations and partnerships subject to certain limitations.
In general, all business income/loss qualifies for the deduction with the following exceptions and limitations:
- It does not include employee wages, capital gains/losses, interest, dividends or partner guaranteed payments.
- The QBI deduction is limited to 20% of taxable income less capital gain/qualified dividends.
- Specified Service Trades/Businesses (SSTB) income qualifies for the 20% deduction if the taxpayer’s taxable income is less than $321,400 for 2019 married filing joint ($160,700 single) and is fully phased out at $421,400 ($210,700 single). SSTB businesses include health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing/investment management, trading, dealing in securities, and any business where the principal asset is the reputation or skill of one or more employees or owners. Engineering and architecture services qualify for the QBI deduction.
- De minimis rule – If the business’ gross receipts are $25 million or less, then less than 10% of gross receipts can be attributable to SSTB. If gross receipts are greater than $25 million, the percentage is reduced to less than 5% of gross receipts can be attributable to SSTB.
- For non-SSTB income over the threshold amounts, the QBI deduction is limited to 50% of wages or 25% of wages plus 2.5% of unadjusted qualified property (tangible property less than 10 years old or the depreciable life and must be owned on the last day of the year). Note: Land doesn’t qualify.
The IRS gave further guidance to aggregate businesses for QBI purposes to combine income and wage and property limitation amounts, which could maximize the QBI deduction at the entity or individual level. To aggregate businesses, the new rules require 50% or more common ownership (for majority of the year including the last day of the year) and at least two of the following factors must be satisfied:
- The businesses provide products, property or services that are the same or customarily offered together.
- They share facilities or significant centralized business elements (personnel, accounting, legal, manufacturing, purchasing, HR or IT services).
- They are operated in coordination with or reliance upon one or more of the businesses in the aggregated group.
The guidance also states that an SSTB cannot be aggregated. Once the election to aggregate is made, it’s irrevocable and a statement must be included with the return each year.
For real estate, there must be a determination that it qualifies as a trade or business. Factors to consider include:
- Type of property
- Number of properties rented
- Owners’ involvement
- Types and significance of ancillary services
- Terms of the lease
The IRS also provided a safe harbor for real estate. To qualify, there must be separate books/records and 250 or more hours of service with contemporaneous records. It cannot be a triple net lease. A statement must be included with the return.
Careful tax planning should be considered to determine if your business qualifies for the 20% deduction and how to maximize it. Some factors may include the type of entity for tax purposes, re-evaluate guaranteed payments, separation of the businesses, the amount of owner salaries, reduction of taxable income (if possible) and aggregation.
Please contact your Clark Nuber professional or Rene Schaefer to help you plan to take advantage of this major new tax incentive.
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