In today's post, Aimee McWhorter of Smith Leonard, a leading full service accounting firm, is walking us through the Qualified Business Income deduction. As you will see, the rules are complicated, ambiguous, and continuously forthcoming so please consult with a tax advisor familiar with your particular situation. We hope today's topic helps get your wheels turning as we approach Tax Day!
The QBI, Qualified Business Income, deduction was created under the 2017 Tax Cuts and Jobs Creation Act.
The deduction for QBI was intended to level the playing field as related to income tax rates for C corporations and flow through tax entities, meaning entities where the tax burden flows through to owners or partners rather than landing at the corporate level. You’ve likely heard that “big business” (usually meaning large C corporations) received a tax cut with The Tax Cuts and Jobs Creation Act. The corporate tax rate did, in fact, go from a tiered rate system with rates as high as 35% to a flat 21% rate. Immediately questions arose about “flow through entities” potentially benefitting by converting to C Corps. Generally, the answer was “no” since many flow throughs, partnerships and S-corporations, enjoy distributions of cash to owners and partners while C corporations wishing to distribute cash do so by way of dividends which are not deductible to the corporation and are taxable to the owner.
The QBI deduction, also known as the 20% deduction, was an attempt to reduce overall tax rates for flow throughs engaged in “trades or businesses”. The 20% deduction is not at all straight forward but rather involves hoops, hurdles, thresholds and phaseouts. The complexity grows when you introduce rental real estate. Is rental real estate an investment or a trade or business? The answer may differ depending on who is asking the question. Again, the rules are complicated, ambiguous, and continuously forthcoming so please consult with a tax advisor familiar with your particular situation.
Generally, for real estate to qualify for the QBI deduction the activity must be a “trade or business” as defined under Section 162 of the Code. Factors to consider in making this determination include:
- Types of properties rented
- Level of involvement by owner or owner’s agent
- Types and significance of ancillary services provided
- Terms of the lease
- Treating it like a business (ex. filing appropriate forms such as 1099s)
Triple net leases generally don’t qualify. There are also special rules for rentals to related parties and further, recent guidance has provided proposed safe harbor rules as related to the Section 199A QBI deduction. Another complication related to QBI is the possibility that the income potentially available for the QBI deduction could, in related party situations, be classified as SSTB (Specified Services Trade or Business) income which further limits a taxpayer’s ability to take the deduction based on income thresholds. SSTB income is generally derived from fields such as law, health, securities dealing, accounting, and consulting. Renting to a related party that generates SSTB creates rental income that is also SSTB.
Since many rental activities generate tax losses due to tax favorable depreciation rules, it is important to note that losses from rentals create negative QBI. Therefore, losses on a particular rental activity will offset the income available for the QBI deduction from other activities with positive QBI income.
Is the QBI deduction available to you? Good question! Consult with a tax advisor about your particular situation to find out. And good luck as we all navigate these uncharted waters and wait for Treasury to issue additional guidance.