PPB August 2018

Specified service businesses operate in some capacity as service-based, and may be operating as attorneys, accountants, tech consultants, marketing consultants, real estate agents and other service- based professionals. Those who fall in the specified service category qualify for the 20 percent QBI deduction if their taxable income is $315,000 or less if filing as married jointly, and $157,500 or less if filing as single. The anti-abuse rule triggers at $157,500 and $315,000; the bubble range phase out kicks in between $157,500 to $207,500 for single taxpayers and $315,000 to $415,000 for married couples. Once the income reaches above $207,500 or $415,000, the 20 percent QBI deduction is phased out with no tax benefit. If the income is at or below the anti-abuse limits, the 20 percent deduction is available. However, the deduction is based on the lesser of a taxpayer’s taxable income less any capital gains plus the aggregate amount of qualified cooperative dividends, or 20 percent of QBI. A discussion on qualified cooperative dividends and its computation is beyond the scope of this article. Of course, there are tax planning opportunities to get a business owner’s taxable income below these phase- out limits and create an opportunity to benefit from the 20 percent QBI deduction if tax planning is done during the year. • Business qualifications. Businesses that fall in the non-specified service category qualify for the QBI deduction above the $157,500 and $315,000 anti-abuse limits. However, it becomes more complex because the deduction is based on several variables. Business owners will qualify for the QBI deduction based on the lesser of 20 percent QBI, or 20 percent taxable income. However, QBI is limited based on wages and capital so the attributable portion cannot exceed the greater of 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis of qualified property immediately after its acquisition. The deduction quickly becomes very complex for non-specified service businesses, including restaurants, construction companies, manufacturing companies or any business that sells or manufactures any kind of product. Many small businesses across the country will fall in the non-specified service category, which is good and bad. The good thing is they can benefit from the QBI deduction at income limits above $157,500 and $315,000, but it gets complex and tax planning from a qualified and knowledgeable tax professional will be required. Family-Owned Business Case Example There are many types of scenarios relating to these complex tax laws. For example, consider Joe and Mary, a husband and wife operating their family- owned manufacturing company taxed as an S corporation with a 50/50 ownership. In this example, we will use figures to illustrate the anti-abuse rules' trigger and how to navigate the deduction in the best interest of the business owners. Suppose in 2018, the company has gross income of $2.1 million less operating expenses of $1.6 million, arriving to a net income of $500,000. The QBI is $500,000, putting Joe and Mary above the $315,000 taxable income threshold triggering the anti- abuse rules. Without complicating things unnecessarily, we need to discuss the difference between QBI and taxable income since those two figures are never the same. QBI does not take into account any capital gains or losses, while taxable income accounts for capital gains and losses. QBI is simply the net income from business operations that will flow through Joe and Mary’s K-1 from the S corporation tax return. In this example, since Joe and Mary operate a manufacturing company categorized as a non- specified service business, and they have QBI income of $500,000 flowing through to their personal tax return that triggers the anti- abuse rules, we must compute the QBI deduction based on three variables. IRC §199A requires Joe and Mary to use the lower of 20 percent QBI, or 20 percent of taxable income. Since the business owners are above the anti-abuse income limit, we must use the wage and capital factor as the third variable to compute the QBI deduction. The wage and capital factor is the greater of 50 percent of the W-2 wages or 25 percent of W-2 wages and This new tax policy was draftedwith what I refer to as a “bubble effect” and “anti-abuse” rules. Thosewhowait until next year to showup at their tax professional’s office for tax preparation willmiss huge tax planning opportunities and may enduppaying more in taxes thannecessary. | AUGUST 2018 | 65 THINK