New Rules for Taxes on Pass-Through Entities
In a prior post, we discussed how the new tax law reduces taxes for pass-through entities (subchapter S corporations, LLCs, partnerships, and sole proprietors). Under the 2017 TCJA, some pass-through entities received a favorable tax deduction of up to 20% tax on Qualified Business Income (QBI)
The IRS recently issued new regulations related to this tax change in TCJA.
Income Limits for QBI
The authors of the TCJA intended the QBI deduction to aid profitable businesses, which hire employees. The authors did not want to give large tax benefits to high-income professionals who make profits due to their personal labors.
To address this issue, the IRS issued a new IRC Section 199A. This new regulation created a “Specified Service Trade or Business” (SSTB) classification.
Owners of pass-through entities falling under this new classification will face limitations on the QBI deduction if their income is too high. The upper limit on income is $315,000 for a couple (filing jointly) or $157,000 for all other taxpayers.
Taxpayers with incomes above the limits cannot take this deduction. The regulation phases out the QBI deduction as a couple’s or individual’s income approaches each limit.
Entities under the SSTB Classification
The income limitations apply if the pass-through entity is any of the following:
• actuarial science
• performing arts
• consulting, athletics
• financial services
• investing and investment management
• dealing with certain assets, or
• any trade or business where the principal asset is the reputation or skill of one or more of its employees
(Note: the SSTB classification for the qualified business income deduction does NOT include Architecture or Engineering.)
In addition, the new regulation forbids individuals performing services as an employee from taking the QBI deduction.
REIT and PTP Income Eligible for QBI
The regulation also allows up to 20% income deduction for owners of combined qualified real estate investment trusts (REITs) and qualified publicly traded partnerships (PTPs.) Under this regulation, the IRS does not limit the income to W-2 wages or the unadjusted basis immediately after acquisition (UBIA) of qualified properties.
The agency sums these two amounts and refers to the total as combined QBI. In general, the IRS will allow these owners to deduct the lesser of 20% the combined QBI or the amount equal to 20% of the taxable income minus the taxpayer’s net capital gain.
Here is an example of the above scenario:
At the end of 2018, a married and jointly filing taxpayer has $100,000 of QBI, $100,000 of long-term capital gain and $30,000 of deductions, resulting in a taxable income of $170,000. This taxpayer can deduct the lesser of the following:
A. $20,000, computed using the standard 20% QBI deduction, which in this case is $100,000 income * 20%.
B. $14,000, which results from subtracting the taxpayer’s net capital gain from the taxpayer’s income and multiplying the result by 20% ($100,000 – $30,000 * 20%.).
Need Help Determining Your Situation
The QBI issue is a complicated tax situation. If you need end-of-year planning for your taxes, please contact us.