New Qualified Business Income Deduction

Headlines about the new tax law and its impacts are daily news. Some of the tax law changes are clear and easy to understand. Other changes are incredibly unclear and difficult to interpret. One particularly ambiguous tax law change is the new deduction for “qualified business income” contained in the 2017 Tax Cuts and Jobs Act. It’s so confusing that the AICPA requested “immediate guidance” from the IRS last month.

 

The new deduction is the lesser of 20% of qualified business income or 50% of W-2 wages paid by pass-through businesses that operate as a sole proprietor (reported on Schedule C), partnership, Subchapter S Corporation, or owner of rental property (reported on Schedule E). Sounds pretty simple, but it’s really not.

 

More guidance will be coming at some point, but business owners often can’t wait to make decisions. Based on what is now known, businesses need to look closely at three considerations to know whether they are eligible to take the new qualified business income deduction:

 

  1. Excluded Businesses

Right off the bat, specified businesses are excluded from taking this new deduction. Businesses providing accounting, legal, consulting, and architect services are specifically excluded. Businesses that “rely on the skills and expertise of the owner or employees” are also excluded. That last part is certainly open to interpretation, and one of the reasons the AICPA’s requested IRS guidance.

 

  1. Income Level

The deduction of 20% of qualified business income is subject to a dollar limit, based on the owner’s filing status. For example, the dollar limit for a single individual is $157,500 and $315,000 for married couples filing a joint tax return. At first glance, this sounds pretty awesome, but required adjustments could reduce the limit.

 

  1. Wages Paid

After calculating 20% of qualified business income, compare it to 50% of total wages paid to employees. Sole proprietors don’t pay themselves wages, so this deduction is not available to them unless they pay wages to employees. Remember, it’s a “lesser of” situation, so if one option is zero, no deduction. Understanding the type of business entity and how workers are paid is essential to getting this right.

 

The number of complexities and variables to consider about qualified business income and the new tax deduction for pass-throughs are too long and dense to cover here. Plus, the IRS still needs to issue guidance to help business owners — and their accountants – make informed decisions and file their taxes next year. So stay tuned!

Are Legal Fees Tax Deductible?

The answer is—it depends! Generally, it depends on the nature of the expense. Legal expenses incurred for business purposes are generally deductible as ‘ordinary and necessary’ expenses of the business entity. Most legal fees paid for personal reasons are not deductible, but some exceptions exist.

 

Some relatively common situations exist where non-business legal fees may be deductible. These situations relate to doing or keeping a job, collecting taxable income, or getting tax advice. As always, details matter. The rules that apply and how to report can get pretty complicated.

 

Legal Expenses that May be Deducted are generally related to business, employment/income, and income taxes, such as:

  1. Legal expenses incurred in attempting to produce or collect taxable income, or paid in connection with the determination, collection, or refund of any tax.
  2. Related to either doing or keeping a job, such as legal fees paid related to a claim of unlawful discrimination.
  3. Tax advice related to a divorce if the fees are billed specifically for tax advice, determined in a reasonable way.
  4. To collect taxable alimony.
  5. To resolve individual tax issues relating to profit or loss from business, rentals or royalties, or farm income.

 

Legal Expenses that May Not be Deducted are generally related to personal legal needs, such as:

  1. Preparation of a will.
  2. Property claims or property settlement in a divorce.
  3. Custody of children.
  4. Civil or criminal charges resulting from a personal relationship.
  5. Damages for personal injury, other than for certain whistleblower and unlawful discrimination claims.

 

This list of situations highlights the importance of understanding the rules about which legal fees are tax deductible and which are not.  While the details of what’s going on aren’t under your control, you can control obtaining the documentation needed for those tax deductible legal fees.

 

Want to know more? This topic is so complicated, it’s addressed in four separate IRS publications: Tax Guide for Small Business, Publication 334, http://bit.ly/2sCks0Z; Miscellaneous Deductions, Publication 529, http://bit.ly/2tHPiom; Business Expenses, Publication 535, http://bit.ly/2pkyRwT; and Basis of Assets, Publication 551, http://bit.ly/2tF2c6X.