Question

THOMAS DRAKE'S 2018 TAX SCENARIO

Thomas Drake is a small business owner, operating a manufacturing plant in Chicago, Illinois (as an S-Corp.) He has heard about a new tax break called Section 199A (deduction for qualified business income) wherein he may be entitled to a deduction of up to 20% of his qualified business income. If he can qualify for this deduction, it would result in significant tax savings for his business. Consequently, he contacts your accounting firm to find out exactly what this deduction entails, and how, or if, he can qualify.

Thomas provides the CPA firm with the following information regarding his 2018 estimated income from his business, Rebecca, his spouse's income, and asset and payroll information related to his company. (Thomas and Rebecca file "married filing jointly.")

Item Amount Net Income from Operations (S Corp) $175,000 Spouse's (Rebecca) Income (from unrelated business) $50,000 Corporate Payroll $150,000 Corporate Total Assets $1,500,000 Taxable Income from Form 1040 $160,000 (Total Tax for Drake's after allowable deductions unrelated to the business)

Your team will prepare a tax research memorandum detailing the statutory framework of this deduction, a thorough explanation of Section 199A and all the key definitions, a determination of whether Thomas qualifies for the deduction, a determination of the amount of this deduction, and what Thomas could do to maximize this deduction in the future. The memorandum must be supported by tax research using IRC code, tax cases if any, and other scholarly journals and references. Since some of this data is estimated, he is asking for a general analysis of his tax situation relative to this deduction.

issues which must be addressed are the following:

What are some planning strategies for help Thomas maximize this deduction in future years?

The memorandum should be 1 page with references to the IRC code and other tax support. This memorandum will serve as the basis for the team PowerPoint presentation due in Week 8.

Answer 1

The deduction under section 166A is available for years 2018-2025.

It allows to deduct up to 20% of domestic qualified business income (QBI) earned by the business on the owner’s tax return, subject to other significant limitations.

Unlike a simple reduction in a tax rate, which is easy to calculate, this deduction is complex. It requires multiple assessments and calculations, new information to be gathered and shared by each pass-through with its owners, and is subject to numerous significant limitations.

Income that qualifies generally includes qualified items of income or loss. So long as they aren’t disallowed or suspended under other rules and are effectively connected.

Hence he should focus more on qualified business.

Qualified business income is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. Only items included in taxable income are counted. Qualified business income does not include income from performing services as an employee. Capital gains and losses, shareholders wages, certain dividends, and interest income are excluded as well.

Hence Drake can claim deduction on:

S corp- $175000

Spouse $50000

Corporate payroll 150000

Taxable income 160000