On January 18, the Treasury Department and the Internal Revenue Service issued final regulations and three related pieces of guidance, implementing the new qualified business income (QBI) deduction, which is also known as Section 199A deduction. Click here to view IR-2019-04.
The new QBI deduction, created by the 2017 Tax Cuts and Jobs Act (TCJA) allows many owners of sole proprietorships, partnerships or S corporations to deduct up to 20 percent of their qualified business income. Eligible taxpayers can also deduct up to 20 percent of their qualified real estate investment trust (REIT) dividends and publicly traded partnership income.
The QBI deduction is available in tax years beginning after Dec. 31, 2017, meaning eligible taxpayers will be able to claim it for the first time on their 2018 Form 1040.
Please click here to read MCB’s previous article about IRC Section 199A and how it may impact you.
The QBI deduction is generally available to eligible taxpayers with 2018 taxable income at or below $315,000 for joint returns and $157,500 for other filers. Those with incomes above these levels, are still eligible for the deduction but are subject to limitations, based on the type of trade or business, the amount of W-2 wages paid in the trade or business and the unadjusted basis of depreciable property.
The QBI deduction is not available for wage income or for business income earned by a C corporation.
In summary, the new guidance focuses on the following:
- The treatment of previously suspended losses that constitute qualified business income.
- The determination of W-2 wages for 199A deduction purposes.
- Safe harbor rules for certain real estate enterprises that may be treated as a trade or business for purposes of the 199A deduction.
- The determination of the 199A deduction for taxpayers that hold interests in regulated investment companies, charitable remainder trusts, and split-interest trusts.
The first two changes are explained below. Safe harbor rules for real estate enterprises will be explained in Part 2 or this article series.
Suspended Losses
The final regulations provide that previously disallowed losses or deductions allowed in the current taxable year are generally taken into account for purposes of computing qualified business income (QBI) under IRC Section 199A except to the extent the losses or deductions were disallowed, suspended, limited, or carried over from taxable years ending before January 1, 2018.
A first-in-first-out ordering rule is also introduced to address situations when the taxpayer has grouped together entities for passive activity loss limitation purposes.
Determination of W-2 Wages
Revenue Procedure 2019-11 provides three methods for determining W-2 wages when calculating the 199A deduction for taxpayers whose taxable income exceeds the minimum threshold amount of $315,000 for joint filers ($157,500 for other filers). In all three calculation methods, only W-2 wages properly allocable to qualified business income (QBI) and properly reported on Forms W-2 should be considered.
Safe Harbor Method #1: Unmodified Box Method
Include the lesser of Form W-2, Box 1 (Wages, tips other compensation) or Form W-2, Box 5 (Medicare wages and tips).
Safe Harbor Method #2: Modified Box 1 Method
Begin with Form W-2, Box 1. Subtract any amounts included in Box 1 that are not wages for Federal income tax withholding purposes. Add the amounts reported on Form W-2, Box 12 as:
- Code D-Elective deferrals under a section 401(k) cash or deferred arrangement,
- Code E-Elective deferrals under a section 403(b) salary reduction agreement,
- Code F-Elective deferrals under a section 408(k)(6) salary reduction SEP,
- Code G-Elective deferrals and employer contributions (including nonelective deferrals) to any governmental or nongovernmental section 457(b) deferred compensation plan, and
- Code S-Employee salary reduction contributions under a section 408(p) SIMPLE plan.
Safe Harbor Method #3: Tracking Wages Method
Begin with the total amount of wages subject to federal income tax withholding. Add the total amounts that are reported on Form W-2, Box 12, Codes D, E, F, G and S just like in the Modified Box 1 Method.
The Unmodified Box Method allows for a simplified calculation while the Modified Box 1 Method and the Tracking Wages Method provide greater accuracy.
If you have questions about Section 199A Regulations, you may contact an MCB Tax Advisor at 703-218-3600 or click here. To review a summary of recent tax news articles, click here. To learn more about MCB’s tax practice and our tax experts, click here.