On February 11, the House Ways and Means Committee finished marking up draft legislative text in the Fiscal 2021 budget resolution reconciliation, which contains tax law proposals based on President J...
The IRS urges taxpayers who receive Forms 1099-G, Certain Government Payments, for unemployment benefits they did not actually get because of identity theft to contact their appropriate state agency f...
The IRS has reminded taxpayers to avoid "ghost" tax return preparers whose refusal to sign returns can cause an array of problems. Filing a valid and accurate tax return is important because the taxpa...
The IRS has reminded taxpayers that they can securely access their IRS account information through their individual online account.Information that taxpayers can view online includes:the amount they o...
The IRS has warned individuals who live outside of the United States and receive Social Security benefits that they may not receive Form SSA-1099, due to the temporary suspension of international mail...
A California trial court’s postjudgment order awarding attorney fees to a taxpayer who successfully contested the property tax valuation of his property was reversed because the trial court had rema...
The IRS has released new Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals. The form allows eligible self-employed individuals to calculate the amount to claim for qualified sick and family leave tax credits under the Families First Coronavirus Response Act (FFCRA) ( P.L. 116-127). They can claim the credits on their 2020 Form 1040 for leave taken between April 1, 2020, and December 31, 2020, and on their 2021 Form 1040 for leave taken between January 1, 2021, and March 31, 2021.
The IRS has released new Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals. The form allows eligible self-employed individuals to calculate the amount to claim for qualified sick and family leave tax credits under the Families First Coronavirus Response Act (FFCRA) ( P.L. 116-127). They can claim the credits on their 2020 Form 1040 for leave taken between April 1, 2020, and December 31, 2020, and on their 2021 Form 1040 for leave taken between January 1, 2021, and March 31, 2021.
The FFCRA allows eligible self-employed individuals who, due to COVID-19, are unable to work or telework for reasons relating to their own health or to care for a family member, to claim the refundable tax credits. The credits are equal to either a qualified sick leave or family leave equivalent amount, depending on circumstances. To be eligible for the credits, self-employed individuals must:
- conduct a trade or business that qualifies as self-employment income; and
- be eligible to receive qualified sick or family leave wages under the Emergency Paid Sick Leave Act as if the taxpayer was an employee.
For IRS frequently asked questions on the credits, go to https://www.irs.gov/newsroom/covid-19-related-tax-credits-for-required-paid-leave-provided-by-small-and-midsize-businesses-faqs. The FAQs include a special section on provisions related to self-employed individuals.
The IRS is urging employers to take advantage of the newly-extended employee retention credit (ERC), which makes it easier for businesses that have chosen to keep their employees on the payroll despite challenges posed by COVID-19. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Division EE of P.L. 116-260), which was enacted December 27, 2020, made a number of changes to the ERC previously made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ( P.L. 116-136), including modifying and extending the ERC, for six months through June 30, 2021.
The IRS is urging employers to take advantage of the newly-extended employee retention credit (ERC), which makes it easier for businesses that have chosen to keep their employees on the payroll despite challenges posed by COVID-19. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Division EE of P.L. 116-260), which was enacted December 27, 2020, made a number of changes to the ERC previously made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ( P.L. 116-136), including modifying and extending the ERC, for six months through June 30, 2021.
Eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70-percent of the qualified wages they pay to employees after December 31, 2020, through June 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. Thus, the maximum ERC amount available is $7,000 per employee per calendar quarter, for a total of $14,000 in 2021.
Effective January 1, 2021, employers are eligible if they operate a trade or business during January 1, 2021, through June 30, 2021, and experience either:
- a full or partial suspension of the operation of their trade or business during this period because of governmental orders limiting commerce, travel or group meetings due to COVID-19; or
- a decline in gross receipts in a calendar quarter in 2021 where the gross receipts for that calendar quarter are less than 80% of the gross receipts in the same calendar quarter in 2019 (to be eligible based on a decline in gross receipts in 2020, the gross receipts were required to be less than 50-percent of those in the same 2019 calendar quarter).
In addition, effective January 1, 2021, the definition of "qualified wages" for the ERC has been changed:
- For an employer that averaged more than 500 full-time employees in 2019, qualified wages are generally those wages paid to employees that are not providing services because operations were fully or partially suspended or due to the decline in gross receipts.
- For an employer that averaged 500 or fewer full-time employees in 2019, qualified wages are generally those wages paid to all employees during a period that operations were fully or partially suspended or during the quarter that the employer had a decline in gross receipts, regardless of whether the employees are providing services.
The IRS points out that, retroactive to the enactment of the CARES Act on March 27, 2020, the law now allows employers who received Paycheck Protection Program (PPP) loans to claim the ERC for qualified wages that are not treated as payroll costs in obtaining forgiveness of the PPP loan.
PPP Loan Forgiveness
In a recent posting on its webpage (see "Didn’t Get Requested PPP Loan Forgiveness? You Can Claim the Employee Retention Credit for 2020 on the 4th Quarter Form 941"), the IRS has clarified that, under section 206(c) of the 2020 Taxpayer Certainty Act, an employer that is eligible for the ERC can claim the credit even if the employer received a Small Business Interruption Loan under the PPP. Accordingly, eligible employers can claim ERS on any qualified wages that are not counted as payroll costs in obtaining PPP loan forgiveness. Note, however, that any wages that could count toward eligibility for ERC or PPP loan forgiveness can be applied to either program, but not to both programs.
If an employer received a PPP loan and included wages paid in the 2nd and/or 3rd quarter of 2020 as payroll costs in support of an application to obtain forgiveness of the loan (rather than claiming ERC for those wages), and the employer's request for forgiveness was denied, the employer an claim the ERC related to those qualified wages on its 4th quarter 2020 Form 941, Employer's Quarterly Federal Tax Return. An employer can could report on its 4th quarter Form 941 any ERC attributable to health expenses that are qualified wages that it did not include in its 2nd and/or 3rd quarter Form 941.
Employers that choose to use this limited 4th quarter procedure must:
- Add the ERC attributable to these 2nd and/or 3rd quarter qualified wages and health expenses on line 11c or line 13d (as relevant) of their original 4th quarter Form 941 (along with any other ERC for qualified wages paid in the 4th quarter).
- Include the amount of these qualified wages paid during the 2nd and/or 3rd quarter (excluding health plan expenses) on line 21 of its original 4th quarter Form 941 (along with any qualified wages paid in the 4th quarter).
- Enter the same amount on Worksheet 1, Step 3, line 3a (in the 941 Instructions).
- Include the amount of these health plan expenses from the 2nd and/or 3rd quarter on line 22 of the 4th quarter Form 941 (along with any health expenses for the 4th quarter).
- Enter the same amount on Worksheet 1, Step 3, line 3b.
The IRS recognized that it might be difficult to implement these special procedures so late in the timeframe to file 4th quarter returns. Therefore, employers can instead choose the regular process of filing an adjusted return or claim for refund for the appropriate quarter to which the additional ERC relates using Form 941-X.
More Information
For more information on the employee retention credit, the IRS urges taxpayers to visit its "COVID-19-Related Employee Retention Credits: How to Claim the Employee Retention Credit FAQs" webpage (at https://www.irs.gov/newsroom/covid-19-related-employee-retention-credits-how-to-claim-the-employee-retention-credit-faqs).
The IRS has announced that lenders who had filed or furnished Form 1099-MISC, Miscellaneous Information, to a borrower, reporting certain payments on loans subsidized by the Administrator of the U.S. Small Business Administration (Administrator) as income of the borrower, must file and furnish corrected Forms 1099-MISC that exclude these subsidized loan payments.
The IRS has announced that lenders who had filed or furnished Form 1099-MISC, Miscellaneous Information, to a borrower, reporting certain payments on loans subsidized by the Administrator of the U.S. Small Business Administration (Administrator) as income of the borrower, must file and furnish corrected Forms 1099-MISC that exclude these subsidized loan payments.
On January 19, 2021, the Department of the Treasury and the IRS issued, Notice 2021-6, I.R.B. 2021-6, pursuant to section 279 of the COVID Relief Act, to waive the requirement for lenders to file with the IRS, or furnish to a borrower, a Form 1099-MISC reporting the payment of principal, interest, and any associated fees subsidized by the Administrator under section 1112(c) of the CARES Act ( P.L. 116-136). The filing of information returns that include these loan payments could result in IRS correspondence to borrowers regarding underreported income, and the furnishing of payee statements that include these loan payments to borrowers could cause confusion.
The Service further announced that if a lender has already furnished to borrowers Forms 1099-MISC that report these loan payments, whether before, on, or after December 27, 2020, the lender must furnish to the borrowers corrected Forms 1099-MISC that exclude these loan payments. In addition, if a lender has already filed with the IRS Forms 1099-MISC that report these loan payments, whether before, on, or after December 27, 2020, the lender must file with the IRS corrected Forms 1099-MISC that exclude these loan payments. Directions for how to file corrected Forms 1099-MISC are included in the 2020 Instructions for Forms 1099-MISC and 1099-NEC and the 2020 General Instructions for Certain Information Returns. If a lender described in this announcement furnishes corrected payee statements within 30 days of the furnishing deadline, it will have reasonable cause for any failure-to-furnish penalty imposed under Code Sec. 6722. A lender described in this announcement must file corrected information returns by the filing deadline in order to avoid Code Sec. 6721 failure-to-file penalties.
The IRS is providing a safe harbor for eligible educators to deduct certain unreimbursed COVID-19-related expenses. The safe harbor applies to expenses for personal protective equipment, disinfectant, and other supplies used for the prevention of the spread of COVID-19 in the classroom, paid or incurred after March 12, 2020. All amounts remain subject to the $250 educator expense deduction limitation.
The IRS is providing a safe harbor for eligible educators to deduct certain unreimbursed COVID-19-related expenses. The safe harbor applies to expenses for personal protective equipment, disinfectant, and other supplies used for the prevention of the spread of COVID-19 in the classroom, paid or incurred after March 12, 2020. All amounts remain subject to the $250 educator expense deduction limitation.
Deduction for Educator Classroom Expenses
Employees generally cannot deduct unreimbursed business expenses as miscellaneous itemized deductions in tax years 2018 through 2025. Despite this general rule, teachers may be able to treat some of their unreimbursed classroom expenses as an "above the line" deduction and deduct them from gross income. An eligible educator can deduct up to $250 each year for classroom expenses ( Code Sec. 62(a)(2)(D)). Deductible expenses include those for books, supplies, and computer equipment used in the classroom.
An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in a school for at least 900 hours during a school year.
COVID Act Expands Eligible Expenses
The COVID Tax Relief Act of 2020 ( P.L. 116-260) requires the Secretary of the Treasury to clarify that COVID-19 protective items used for the prevention of the spread of COVID-19 paid or incurred after March 12, 2020 are eligible educator classroom expenses. As a result, the IRS has issued a safe harbor revenue procedure.
Under the revenue procedure, COVID-19 protective items include face masks; disinfectant for use against COVID-19; hand soap; hand sanitizer; disposable gloves; tape, paint, or chalk used to guide social distancing; physical barriers (such as clear plexiglass); air purifiers; and other items recommended by the Centers for Disease Control and Prevention (CDC) to be used for the prevention of the spread of COVID-19.
The revenue procedure applies to such unreimbursed expenses paid or incurred after March 12, 2020. All amounts remain subject to the $250 educator expense deduction limitation.
With some areas seeing mail delays, the IRS has reminded taxpayers to double-check before filing a tax return to make sure they have all their tax documents, including Form W-2, Wage and Tax Statement, and Forms 1099. Many of these forms may be available online. However, when other options are not available, taxpayers who have not received a W-2 or Form 1099, or who received an incorrect W-2 or 1099, should contact the employer, payer, or issuing agency directly to request the documents before filing their 2020 tax returns.
With some areas seeing mail delays, the IRS has reminded taxpayers to double-check before filing a tax return to make sure they have all their tax documents, including Form W-2, Wage and Tax Statement, and Forms 1099. Many of these forms may be available online. However, when other options are not available, taxpayers who have not received a W-2 or Form 1099, or who received an incorrect W-2 or 1099, should contact the employer, payer, or issuing agency directly to request the documents before filing their 2020 tax returns.
Taxpayers who are unable to reach the employer, payer, or issuing agency, or who cannot otherwise get copies or corrected copies of their Forms W-2 or 1099, must still file their tax return on time by the April 15 deadline (or October 15, if requesting an automatic extension). They may need to use Form 4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. to avoid filing an incomplete or amended return. If the taxpayer does not receive the missing or corrected form in time to file their return by the April 15 deadline, they can estimate their wages or payments made to them, as well as any taxes withheld.
If the taxpayer receives the missing or corrected form after filing and the information differs from their previous estimate, the taxpayer must file Form 1040-X, Amended U.S. Individual Income Tax Return.
Unemployment Benefits
Taxpayers who receive an incorrect Form 1099-G, Certain Government Payments, for unemployment benefits they did not receive should contact the issuing state agency to request a revised Form 1099-G showing they did not receive these benefits. Taxpayers who are unable to obtain a timely, corrected form should still file an accurate tax return, reporting only the income they received.
The IRS has highlighted how corporations may qualify for the new 100-percent limit for disaster relief contributions, and has offered a temporary waiver of the recordkeeping requirement for corporations otherwise qualifying for the increased limit. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 ( P.L. 116-260) temporarily increased the limit, to up to 100 percent of a corporation’s taxable income, for contributions paid in cash for relief efforts in qualified disaster areas.
The IRS has highlighted how corporations may qualify for the new 100-percent limit for disaster relief contributions, and has offered a temporary waiver of the recordkeeping requirement for corporations otherwise qualifying for the increased limit. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (P.L. 116-260) temporarily increased the limit, to up to 100 percent of a corporation’s taxable income, for contributions paid in cash for relief efforts in qualified disaster areas.
Qualified Disaster Areas
Under the new law, qualified disaster areas are those in which a major disaster has been declared under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act. This does not include any disaster declaration related to COVID-19. Otherwise, it includes any major disaster declaration made by the President during the period beginning on January 1, 2020, and ending on February 25, 2021, as long as it is for an occurrence specified by the Federal Emergency Management Agency as beginning after December 27, 2019, and no later than December 27, 2020. See FEMA.gov for a list of disaster declarations.
The corporation must pay qualified contribution during the period beginning on January 1, 2020, and ending on February 25, 2021. Cash contributions to most charitable organizations qualify for this increased limit, but contributions made to a supporting organization or to establish or maintain a donor advised fund do not qualify. A corporation elects the increased limit by computing its deductible amount of qualified contributions using the increased limi,t and by claiming the amount on its return for the tax year in which the contribution was made.
Substantiation
The 2020 Taxpayer Certainty Act, which was enacted December 27, 2020, added an additional substantiation requirement for qualified contributions. For corporations electing the increased limit, a corporation's contemporaneous written acknowledgment (CWA) from the charity must include a disaster relief statement, stating that the contribution was used, or is to be used, by the eligible charity for relief efforts in one or more qualified disaster areas.
Because of the timing of the new law, the IRS recognizes that some corporations may have obtained a CWA that lacks the disaster relief statement. Accordingly, the IRS will not challenge a corporation's deduction of any qualified contribution made before February 1, 2021, solely on the grounds that the corporation's CWA does not include the disaster relief statement.
The IRS has announced that tax professionals can use a new online tool to upload authorization forms with either electronic or handwritten signatures. The new Submit Forms 2848 and 8821 Online tool is now available at the IRS.gov/TaxPros page. The new tool is part of the IRS's efforts to develop remote transaction options that help tax practitioners and their individual and business clients reduce face-to-face contact.
The IRS has announced that tax professionals can use a new online tool to upload authorization forms with either electronic or handwritten signatures. The new Submit Forms 2848 and 8821 Online tool is now available at the IRS.gov/TaxPros page. The new tool is part of the IRS's efforts to develop remote transaction options that help tax practitioners and their individual and business clients reduce face-to-face contact.
Here are a few highlights related to the new online tool:
- The Submit Forms 2848 and 8821 Online has "friendly" web addresses that can be bookmarked: IRS.gov/submit2848 and IRS.gov/submit8821.
- Authorization forms uploaded through this tool will be worked on a first-in, first-out basis along with mailed or faxed forms.
- To access the tool, tax professionals must have a Secure Access username and password from an IRS account such as e-Services. Tax professionals without a Secure Access username and password should see IRS.gov/SecureAccess for information they need to successfully authenticate their identity and create an account.
- Forms 2848 and 8821 and the instructions are being revised. Versions dated January 2021 are available. The prior version of both forms will be accepted for a period of time.
- Tax professionals may use handwritten or any form of an electronic signature for the client or themselves on authorization forms submitted through the new online tool. Authorization forms that are mailed or faxed must still have handwritten signatures.
- Tax professionals must authenticate the identities of unknown clients who signed the authorization form with an electronic signature in a remote transaction. IRS Frequently Asked Questions (at https://www.irs.gov/tax-professionals/submit-forms-2848-and-8821-online#2848-8821-faqs) provide authentication options for individual and business clients.
- For business clients, in addition to authenticating the taxpayer, tax professionals must also verify that the individual has a covered relationship with the business.
- Tax professionals entering the tool for the first time must accept the terms of service. This is a one-time entry.
- The tool will ask a series of questions that a user must answer to correctly route the forms to the proper Centralized Authorization File (CAF) unit.
- The client’s taxpayer identification number must be entered before the tax professional selects the authorization file for upload.
- Once the uploaded file is visible, the tax professional selects "submit" to send the file to the CAF.
- Tax professionals can use various file formats, including PDF or image files such as JPG or PNG. Only one file may be uploaded at a time.
- The word "success" will appear if the submission goes through. The tool then gives tax professionals the option to upload another file without the need to go through secure access again.
- Tax professionals can also view an "Uploading Forms 2848 and 8821 with Electronic Signatures" webinar, at https://www.irsvideos.gov/Webinars/UploadingForms2848And8821WithElectronicSignatures.
The tool is intended to be a bridge until an all-digital option launches in the summer of 2021. The IRS has plans to launch the Tax Pro Account in 2021 which will allow tax professionals to digitally sign third-party authorizations and send them to the client's IRS online account for digital signature.
The IRS has urged taxpayers to e-file their returns and use direct deposit to ensure filing accurate tax returns and expedite their tax refunds to avoid a variety of pandemic-related issues. The filing season opened on February 12, 2021, and taxpayers have until April 15 to file their 2020 tax return and pay any tax owed.
The IRS has urged taxpayers to e-file their returns and use direct deposit to ensure filing accurate tax returns and expedite their tax refunds to avoid a variety of pandemic-related issues. The filing season opened on February 12, 2021, and taxpayers have until April 15 to file their 2020 tax return and pay any tax owed.
"The pandemic has created a variety of tax law changes and has created some unique circumstances for this filing season," said IRS Commissioner Chuck Rettig. "To avoid issues, the IRS urges taxpayers to take some simple steps to help ensure they get their refund as quickly as possible, starting with filing electronically and using direct deposit," he added.
One planning thought if your do not get the full impact of your Charitable donations is to setup a Donor-Advised Fund. A donor-advised fund is like a charitable investment account, for the sole purpose of supporting charitable organizations you care about.
On December 22, the President signed into law the Tax Cuts and Jobs Act of 2017 (TCJA). Personal Exemptions have been eliminated and replaced with higher standard deductions for individuals and married couples. State and Local Taxes (SALT) for state income tax, property taxes have been limited to $10,000 for 2018. The Standard Deduction will increase from $6,350 per person in 2017 to $12,000 per person in 2018. All persons over age 65 will also be permitted an additional $1,300 increase in their Standard Deduction.
In 2018, married couple without a mortgage and regular medical expenses, that makes less than $14,000 in charitable contributions will not get any tax benefit for their donations, ($24,000 standard deduction, less $10,000 for state and local income taxes equal $14,000 maximum charitable contributions without tax benefit).
One planning thought if your do not get the full impact of your Charitable donations is to setup a Donor-Advised Fund. A donor-advised fund is like a charitable investment account, for the sole purpose of supporting charitable organizations you care about. When you contribute cash, securities or other assets to a donor-advised fund, you are generally eligible to take an immediate tax deduction. Then those funds can be invested for tax-free growth and you can recommend grants to virtually any IRS-qualified public charity.
Various brokerage firms sponsor donor-advised funds, such as Fidelity Investments, Charles Schwab and Merrill Lynch. Each firm have different requirements for minimum contributions, fees and minimum grants amounts to charities.
Let’s say you typically donate $5,000 per year. You could fund the next four years by donating $20,000 of appreciated stock to the fund. You are best to donate the stock with the largest gain. You pay no tax on the gain but get full deduction of the $20,000 fair market value in the year of donation. The fund will sell your stock but provide you an opportunity to invest that amount within the fund to grow tax deferred. You can than direct the fund to send money to charities of your choice with no minimum grant requirement. You can designate an heir to continue to send donations from your fund should you not complete all your donations. Once contributed to the fund, you can never get the funds returned.
Donation of appreciated securities usually makes the most sense. Let’s say you donate $20,000 stock with a cost of $10,000. If you sold those stock to make the donation you could owe $3,380 (Federal Capital Gain rate of 23.8% and California of 10%) in taxes leaving a net of $16,620 to charities. If you donated appreciated securities, you could grant the full $20,000 to charities. Keep in mind that in both cases, you would get a tax deduction up to 47% of the donation, (Federal maximum tax rate of 37% and California of 10%).
One further advantage of a donor-advised fund is that the record keeping requirement for individual donations is eliminated, since the fund will keep track of the donations.
If this is too complicated, many charities will also accept the direct donation of securities providing the same tax benefits.
Congress passed the most significant tax reform bill in thirty years, “The Tax Cuts and Jobs Act”. One of the more complex areas is the new deduction for “qualified business income” – often referred to as QBI. You may hear this talked about as the “New 20% Pass-Through Tax Deduction” or the “Section 199A Deduction”.
In December 2017, Congress passed the most significant tax reform bill in thirty years, “The Tax Cuts and Jobs Act”. One of the more complex areas is the new deduction for “qualified business income” – often referred to as QBI. You may hear this talked about as the “New 20% Pass-Through Tax Deduction” or the “Section 199A Deduction”. Regular “C” corporations do not qualify for this deduction; however, starting in 2018 they do qualify for a low 21% corporate tax rate.
The pass-through deduction is a deduction you may take on your Form 1040 even if you do not itemize. There will be a line to list it on the second page of our Form 1040. It is not an “above the line” deduction on the first page of Form 1040 that reduces your adjusted gross income (AGI). Moreover, the deduction only reduces income taxes, not Social Security or Medicare taxes
This new provision should provide a substantial tax benefit to individuals with qualified business income from a partnership, S corporation, LLC, or sole proprietorship. For tax purposes, what distinguishes these types of businesses is that the business pays no income taxes themselves. Instead, the profits (or losses) from such businesses are passed through the business to the owners whom pay tax on the money on their individual tax returns at their individual tax rates.
QBI is the net income (profit) your pass-through business earns during the year. You determine this by subtracting all your regular business deductions from your total business income. QBI includes rental income so long as your rental activity qualifies as a business. It also includes income from publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives. QBI does not include:
- short-term or long-term capital gain or loss—for example, a landlord would not include capital gain earned from selling a rental property
- dividend income
- interest income
- wages paid to S corporation shareholders
- guaranteed payments to partners in partnerships or LLC members, or
- business income earned outside the United States.
QBI is determined separately for each separate business you own. If one or more of your businesses lose money, you deduct (net) the loss from the QBI from your profitable businesses. If you have a qualified business loss—that is, your net QBI is zero or less--you get no pass-through deduction for the year. Any loss is carried forward to the next year and is deducted against your QBI for that year. This serves as a penalty for having a money-losing business.
To determine your pass-through deduction, you must first figure your total taxable income for the year (not counting the pass-through deduction). This is your total taxable income from all sources (business, investment, and job income) minus deductions, including the standard deduction ($12,000 for singles and $24,000 for marrieds filing jointly in 2018). You must have positive taxable income to take the pass-through deduction.
Moreover, the deduction can never exceed 20% of your taxable income.
Rules are in place to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction. These rules involve “thresholds.” This means that you might be ineligible for the deduction if you have a business that is classified as a specified service trade or business, SSTB. What is a specified service trade or business? These are trades or businesses involving the performance of services in the fields of health, law, consulting, athletics, financial or brokerage services. There is a final catchall category that includes any business where the principal asset is the reputation or skill of one or more of its owners or employees. This likely includes many individuals who provide services not listed above. However, all the details have yet to be worked out by the IRS. Architecture and engineering services are expressly not included in the list of personal services. So, spas and health clubs are in, medical services provided by high income physicians, nurses, dentists etc. are out. High income attorneys, accountants, actuaries, financial advisors, mortgage brokers, realtors, actors, musicians etc. are out, but promoters, broadcasters, engineers and architects are in.
Starting in 2018, taxpayers with qualified business income (including rental income), may be eligible to take a tax deduction up to 20% of their QBI. Determining whether you will be eligible to capture the full 20% deduction will be based on your total taxable income for year. The taxable income thresholds are as follows:
Single filers: $157,500 (SSBT with phase-outs at $207,500)
Married filing joint: $315,000 (SSBT with phase-outs at $415,000)
If your business is one of the Specified Service Trade or Services above these thresholds, you may not qualify for the deduction. The SSBT phased-out is 2% for every $1,000 your income exceeds the $157,500, or 1% for every $1,000 your income exceeds the $315,000 threshold.
If you exceed the income thresholds, your deduction is the lesser of:
- 20% of QBI
- The greater of:
50% of W-2 wages paid to employees
25% of W-2 wages paid to employees PLUS 2.5% of the unadjusted asset basis
The business property must be depreciable long-term property used in the production of income—for example, the real property or equipment used in the business (not inventory). The cost is its unadjusted basis—the original acquisition cost, minus cost of land, if any. The 2.5% deduction can be taken during the entire deprecation period for the property. For use in this property calculation, the period of use starts on the date the property is places in service and ends on the LATER 10 years or the last day of the asset regular depreciation period.
If you have neither employees nor depreciable property, you get no deduction if your income is over the thresholds. This is intended to encourage pass-through owners to hire employees and/or buy property for their business.
Fancy footwork may seem the way to go when dealing with the new tax rules, but the old reliable methods of reducing income have a better chance having stood the test of time. Lowering your income if you are already below the phaseout has less benefit than in the past as business deductions are technically only worth 80 cents on the dollar. (You get a 20% deduction anyway if you don’t invest in the expense.) The phase out is where things really get interesting. If you’re reasonably close to the phase out threshold, a modest amount of planning could make the difference between the full QBI deduction and no deduction at all.
Some Simple Examples:
Mark is married and files jointly. He earned $345,000 in taxable income this year. His sole proprietorship consulting business earned $345,000 and paid $100,000 to employees. Consulting is one of service provider categories SSTB, so his pass-through deduction is subject to the phase-out. His $345,000 taxable income is $30,000, or 30% ($30,000/$1,000,000), over the $315,000 threshold. Before the phase-out, his deduction is limited to 50% of the W2 wages he paid, which was $50,000 (50% x $100,000 W2 wages = $50,000). Since, his phase-out percentage is 30%, he gets 70% of the full deduction, or $35,000 (70% x $50,000 = $35,000). If his taxable income was over $415,000, there would be no QBI deduction.
Jim and Sue are married and file jointly. Their taxable income this year is $500,000, including $400,000 in QBI they earned from their bar business they own through an LLC. They employed four bartenders during the year to whom they paid $150,000 in W2 wages. They own their bar building. They bought it four years ago for $600,000 and the land is worth $100,000, so its unadjusted acquisition basis is $500,000. Their maximum possible pass-through deduction is 20% of their $400,000 QBI, which equals $80,000. However, since their taxable income was over $415,000, their pass-through deduction is limited to the greater of (1) 50% of the W2 wages they paid their employees, or (2) 25% of W2 wages plus 2.5% of their bar building’s $500,000 basis. (1) is $75,000 (50% x $150,000 = $75,000; (2) is $50,000 (2.5% x $500,000) + (25% x $150,000) = $50,000. (1) is greater so their pass-through deduction is $75,000.
Alice, a single taxpayer, owns a 5-unit apartment building. She earned $250,000 in QBI income and total taxable income during 2018, well over the $207,500 threshold for singles. She has no employees in her rental business. Thus, her pass-through deduction is limited to 2.5% of the unadjusted basis of the long-term property she uses in her rental business. This consists of her building, which she purchased five years ago. Her unadjusted basis in the building (purchase price minus value of the land) is $500,000. Her pass-through deduction is 2.5% x $500,000 = $12,500.