Question

Because the definition of a specified service business is not clear, you have been asked to write a memo describing the tax effects of treating this business as a service business or as a non-service business.

Facts:

1. Because the definition of a specified service business is not clear, you have been asked to write a memo describing the tax effects of treating this business as a service business or as a non-service business.

2. The deduction may be limited where the taxpayer’s taxable income exceeds a threshold amount. If the business is a specified service business there is a separate limit, in which the parameters used to compute the deduction (QBI. W-2 wages, unadjusted basis of property) are first reduced by the “applicable percentage.”

3. Your client (make up a name) is a fairly well-known author of self-help books. He is married and files a joint tax return. In addition to writing, he is booked for programs in which he presents a 2-hour summary of the many lessons in his books. The sessions are called “The Nine Key Methods of Changing Your Life.” In 2018 (assume the year has ended), his only activity is presenting these sessions.

The following facts are available:

Taxable Income from all sources                                                                               $375,000

Net capital gain income (included in taxable income)                       $ 45,000

Qualified Business Income (included in taxable income)                  $220,000

W-2 wages Paid to Administrative Assistant                                         $ 40,000

Unadjusted basis of property used in the business                            $ 15,000

Answer 1

Qualified Trade or Business

Taxpayer’s qualified business income (“QBI”) is determined by each qualified trade or business (“QTB”) in which Taxpayer is an owner.[6] A QTB includes any trade or business conducted by a PTE other than a specified service trade or business.[7]

A “specified service trade or business” means any trade or business involving the performance of services in the fields of health, law, accounting, consulting, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, or which involves the performance of services that consist of investing and investment management, or trading or dealing in securities.[8] However, a trade or business that involves the performance of engineering or architectural services is not a “specified service.”

Qualified Business Income

Taxpayer’s QBI from a QTB for a taxable year means Taxpayer’s share of the net amount of qualified items of income, gain, deduction, and loss that are taken into account in determining the taxable income of the QTB for that year.[9]

Items of income, gain, deduction, and loss are “qualified items” only to the extent they are effectively connected with the PTE’s conduct of a QTB within the U.S.[10]

“Qualified items” do not include specified investment-related income, gain, deductions, or loss; for example, items of gain taken into account in determining net long-term capital gain, dividends, and interest income (other than that which is properly allocable to a trade or business) are not included[11]; nor are items of deduction or loss allocable to such income.

Taxpayer’s QBI also does not include any amount paid to Taxpayer by an S corporation that is treated as reasonable compensation for services rendered by Taxpayer. Similarly, Taxpayer’s QBI does not include any “guaranteed payment” made by a partnership to Taxpayer for services rendered by Taxpayer.[12]

The Deduction

In general, Taxpayer is allowed a deduction for any taxable year of an amount equal to the lesser of:

(a) Taxpayer’s “combined QBI amount” for the taxable year, or

(b) an amount equal to 20% of the excess (if any) of

(i) Taxpayer’s taxable income for the taxable year, over

(ii) any net capital gain for the taxable year.

The combined QBI amount for the taxable year is equal to the sum of the “deductible amounts” determined for each QTB “carried on” by Taxpayer through a PTE.[13]

Taxpayer’s deductible amount for each QTB is the lesser of:

(a) 20% of the Taxpayer’s share of QBI with respect to the QTB, or

(b) the greater of:

(i) 50% of the “W-2 wages” with respect to the QTB, or

(ii) the sum of:

(A) 25% of the W-2 wages with respect to the QTB, plus

(B) 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property”.[14]

In general, the W-2 wages with respect to a QTB for a taxable year are the total wages subject to wage withholding, plus any elective deferrals, plus any deferred compensation paid by the QTB with respect to the employment of its employees during the calendar year ending during the taxable year of Taxpayer.[15]

“Qualified property” means, with respect to any QTB for a taxable year, tangible property of a character subject to depreciation that is held by, and available for use in, the QTB at the close of the taxable year, which is used at any point during the taxable year in the production of QBI, and for which the depreciable period[16] has not ended before the close of the taxable year.

This “wage limit” is phased in for a taxpayer with taxable income in excess of the threshold amount. The limit is fully applicable for a taxpayer with taxable income equal to the threshold amount plus $50,000 ($100,000 in the case of a joint return).

STEP:1

Here , 1) Qualified business income of $220000 not included in total income (or),

         2) 20% of taxable income i.e 375000 =$75000

Taxpayer’s combined QBI amount for 2018 is equal to “deductible amount” with respect to Company. The deductible amount is the lesser of:

(a) 20% of Taxpayer’s QBI (220000*20%)                 =     44000 (or)

(b)50% of wage w-2 i.e 40000*50%                          = 20000