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:
- 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.
- 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.
- 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!