Question

John, a single taxpayer, has taxable income of $305,000. He owns a qualified sole proprietorship that generated $100,000 of qualified business income (QBI) and paid no wages. The sole proprietorship has a qualified property with an unadjusted basis of $50,000. Under Sec. 199A, what is the deductible amount John can claim for the sole proprietorship?

$10,000

$61,000

$50,000

$1,250

Answer 1

When Congress passed the Tax Cuts and Jobs Act (TCJA), it reduced the C corporation tax rate from 35% to 21%. Congress did not want to disadvantage owners of pass-through entities (sole proprietors, S corporations, and partnerships) by leaving them with a substantially higher tax liability than C corporations. Congress reduced this tax burden by creating Section 199A, also known as the Qualified Business Income Deduction (QBID).

The QBID is the last deduction before determining a taxpayer’s taxable income. It is based on qualified business income (QBI). The QBID is a below-the-line deduction. Thus, the QBID can be paired with either the standard deduction or itemized deductions.

QBI must come from a flow-through entity. This includes business income from a sole proprietorship (reported on Schedule C of Form 1040), a partnership (reported on Form 1065), or an S Corporation (reported on Form 1120S).

• A taxpayer’s share of an S Corporation or partnership’s qualified business income and wages and property (discussed below) will be reported to them on Schedule K-1.

QBI must be income effectively connected with (1) conducting a trade or business within the United States or Puerto Rico and (2) included in determining taxable income for the tax year. However, amounts paid to taxpayers for reasonable compensation (e.g., wages and guaranteed payments) do not count as QBI. For Sec. 199A, Congress divided pass-through entities into two categories:

• Specified service trades or businesses
• Qualified trades or businesses

Specified service trades or businesses

In general, a specified service trade or business (SSTB) is any trade or business in which the principal asset is the reputation or skill of one or more of its employees. Specifically, SSTBs include the following types of trades and businesses:

• Health (e.g., physicians, nurses, dentists, and other similar healthcare professionals)
  • Health does not include services not directly related to a medical field, such as medical device sales, coding, billing, and payment processing.
• Law
• Accounting
• Actuarial science
• Performing arts
• Consulting
• Athletics
• Financial services (e.g. financial advisors, wealth planners, retirement advisors, investment bankers, brokerage services, and other professionals performing similar services)
  • This includes any professional service consisting of investing, investment management, trading or dealing in securities, partnership interests, or commodities.

Additionally, an SSTB is any trade or business wherein a principal earns income (e.g., fees, licenses, or compensation) for any of the following activities:

• Endorsing products or services
• Use of the principal’s likeness, image, name, etc.
• Appearance fees for an event or media performance (e.g., radio, TV, etc.)

Trades and businesses specifically not considered SSTBs include:

• Architects
• Engineers
• Real estate agents and brokers
• Insurance agents and brokers

Qualified trades or businesses

In general, a qualified trade or business is any pass-through entity not considered an SSTB. Specifically, a pass-through entity can be identified as a qualified trade or business if it has QBI.

Other Section 199A rules

Taking the Sec. 199A deduction does not affect the taxpayer’s basis (outside adjusted basis or shareholder’s accumulated adjustment’s account) in the pass-through entity.

In addition to SSTBs and qualified trades or businesses, taxpayers can deduct qualified REIT dividends and qualified publicly-traded partnership income. The IRS defines qualified REIT dividend income neither as a capital gain dividend nor a qualified dividend income. Due to these extensive limitations, many tax professionals are waiting for further guidance from the IRS to determine how a REIT dividend could practically be considered a qualified REIT dividend.

How to calculate the qualified business income deduction

Before introducing the 4 steps needed to calculate the QBID, it’s helpful to think of the deduction being limited as follows:

• A taxpayer is never going to be able to take a deduction greater than 20% of QBI.
• This deduction will be less than 20% of QBI if the taxpayer is single and makes more than $160,700 or is married filed jointly and makes more than $321,400.
• Taxpayers may need to further reduce their deduction by an overall limitation.

If you understand these 3 limits, it’s harder to get lost in the weeds as we go into more detail on how to calculate the QBID.

Each of the following steps are discussed in greater detail in the next section.

Step 1 – Determine the QBI for every pass-through entity

This information will be reported on a Schedule K-1 (or a Schedule C if the entity is a sole proprietorship). Thus, this step is completed or determined by the pass-through entity and provided to the taxpayer. This step should be “easy” for the individual since the information is provided by the relevant entity or entities. In practice, many tax professionals will be completing both the pass-through entity’s tax forms and the individual’s tax forms.

See the details of Step 1 below.

Step 2 – Reduce QBID for each pass-through entity based on limits

The most a taxpayer will be able to deduct is 20% of QBI.

The allowed QBID for each pass-through entity can be reduced to less than 20% if the taxpayer’s income is in the phase-in range (of W-2 wage limit) or beyond the upper threshold.

• Single taxpayers reach the phase-in range once taxable income exceeds $160,700 and enter the upper threshold at $210,700.
• Married Filing Jointly taxpayers reach the phase-in threshold when taxable income exceeds $321,400 and enter the upper threshold at $421,400.

See the details of Step 2 below.

Step 3 – Combine all of the QBIDs

If a taxpayer has more than one pass-through entity with QBI, these amounts must be combined.

A taxpayer determines the combined QBID by adding together the allowed QBID amount for each respective entity. If there is only one pass-through entity, then the QBID for the one entity is the combined QBID.

See the details of Step 3 below.

Step 4 – Apply overall limitation

The final step is to apply the overall limitation to the combined QBID to determine the correct amount to deduct. This amount is then reported on line 10 of Form 1040

So as Per Above Discussion we can Caim 20% of Taxable income so ans $ 61000/- Only