199A and self employed- according to Congress

[kathyc2]

Shortly after the bill was passed I sent an e-mail to Rep asking if 1/2 SE tax deduction, SEHI and retirement funding are before or after the income used for QBI. The answer I received today was:

"After verifying with the Ways and Means Committee, the three issues you asked about with regard to the tax bill are considered “above the line” and therefore do not factor into QBI."

Make of that what you will.....

[ttbtaxes]

The amount of the retirement-plan deduction that reduces AGI can affect the amount of the 20% of QBI deduction because it affects taxable income.

I ran calculations on BNAs Income Tax Planner which has the new tax act changes included. Very simple projection....single taxpayer, $200,000 Schedule C income, non-SSB, standard deduction, no other income. I calculated the tax in Option A. Then I included the max SEP contribution of $37,868 in Option B.

The 20% deduction in Option A (no SEP) is $24,126 and the 20% deduction in Option B ($37,868 SEP) is $27,895. Therefore, the SEP served to reduce taxable income by $41,637, which is the amount of the SEP of $37,878 plus the increase of $3,769 in the 20% deduction.

[ATSMAN]

Are you guys comfortable using any tax planner so early in the season to do 2018 projections for your clients?

I have a feeling we may see some unexpected corrections etc. I am planning on doing projections early summer

[ttbtaxes]

I am comfortable. What material uncertainties concern you? If it's interpretation about issues related to the 20% deduction, such as whether a business qualifies as an SSB, that would be disclosed to the client ahead of time.

Hopefully the regulations to be released will clarify ambiguities because a technical corrections bill would need 60 votes in the Senate (per Steve Mnuchin). In this political climate that may not happen.

[John of PA]

Does a Sch C proprietorship with say an 80,000 profit stand a chance for this deduction? Given that "Wages" would be zero.

[ttbtaxes]

With a Schedule C, the wage limit only comes into play if the taxable income threshold amount is exceeded. So in your example, as long as the $157,500/$315,000 threshold is not breached, the owner will get a $16,000 deduction.

That is why a Schedule C (with no employees) that can project the taxable income WILL exceed the limit might want to consider converting to an S corporation. In that case, the only employee would be the sole shareholder and if you can set the wage level to be "reasonable" then the S corporation might make sense.

For example, let's take a sole proprietor with no employees whose business profit is $500,000. Since it above the taxable income limit, the 50% wage calculation comes into play and the deduction is the lesser of $100,000 ($500,000 x 20%) or $-0- ($zero wages x 50%) which means no deduction.

If he, or she, incorporates as a an S corp and pays himself, or herself, a W-2 of $125,000 then you have a deduction of $62,500 calculated as follows:

QBI of $375,000 x 20% = $75,000
Wages $125,000 x 50% = $62,500

You use the lesser of the two. So, in this case, converting the business to an S corporation yields a $62,500 deduction for that year.

[TaxGuyBill]

So in your example, as long as the $157,500/$315,000 threshold is not breached, the owner will get a $16,000 deduction.

The deduction would not necessarily be $16,000. If the Schedule C profit was $80,000 and the "taxable income" (Line 43 of Form 1040) is $60,000, the owner would only have a $12,000 deduction. If "taxable income" was $80,000 or more (up to the $157,500/$315,000 limit), then the owner would have a $16,000 deduction.

[TaxGuyBill]

For example, let's take a sole proprietor with no employees whose business profit is $500,000.

If he, or she, incorporates as a an S corp and pays himself, or herself, a W-2 of $125,000 then you have a deduction of $62,500 calculated as follows:

My personal opinion: With no employees and $500,000 of profit, $125,000 of salary is not "reasonable" unless there was a very large capital investment.

[New York Enrolled Agent]

If he, or she, incorporates as a an S corp and pays himself, or herself, a W-2 of $125,000 then you have a deduction of $62,500 calculated as follows:

QBI of $375,000 x 20% = $75,000
Wages $125,000 x 50% = $62,500

You use the lesser of the two. So, in this case, converting the business to an S corporation yields a $62,500 deduction for that year.

Am I wrong? I was under the impression that wages of an S-corp shareholder are not considered in the calculation. TGB notes all reasonable compensation would also be ignored.

One other comment - you wrote " whose business profit is $500,000. Since it above the taxable income limit,". The net income (profit) is only part of the determination of taxable income. You would deduct possible SEHI, pension contributions, possible ordinary losses, standard or itemized deduction and so on to reach taxable income.

[ttbtaxes]

Taxable income could be lower which would change the calculation. Retirement plan contributions, itemized or standards, and many others all play into the final analysis along. In my example, I also purposely chose to assume the S-corporation wage was reasonable for calculation purpose only.

There are any number of permutations which could be used and debated and all are good points. I chose not to add any of those to take away from demonstrating my main point.

[ttbtaxes]

Am I wrong? I was under the impression that wages of an S-corp shareholder are not considered in the calculation. TGB notes all reasonable compensation would also be ignored.

Section 199A(c)(4)(A):

Qualified business income shall not include -

(A) reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business,

How it is interpreted is up for debate. Tony Nitti has written about this very issue in Forbes and is of the belief that the shareholder's wages reported on his Form 1040 are subtracted by the S corporation when calculating QBI.

YMMV

[TaxGuyBill]

Am I wrong? I was under the impression that wages of an S-corp shareholder are not considered in the calculation. TGB notes all reasonable compensation would also be ignored.

One other comment - you wrote " whose business profit is $500,000. Since it above the taxable income limit,". The net income (profit) is only part of the determination of taxable income. You would deduct possible SEHI, pension contributions, possible ordinary losses, standard or itemized deduction and so on to reach taxable income.

The way I read it is that the W-2 wages are not part of the QBI (for the 20%), but the shareholder W-2 does still count as W-2 wages for purposes of the limitation.

In other words, the 20% is based on Box 1 of the K-1 (after W-2 wages are subtracted from profit), but the shareholder W-2 still allows the credit.

[John of PA]

Thank you for these helpful responses.

[Snaggletooth]

Self Employment Tax

One thing I've missed in the discussion. While we are singing the praises of the 20% reduction, does the reduction apply to self-employment income for purposes of calculating SE Tax?

[kathyc2]

One thing I've missed in the discussion. While we are singing the praises of the 20% reduction, does the reduction apply to self-employment income for purposes of calculating SE Tax?

I'm not singing the praises. I think it's going to be a cluster. Does not apply to SE tax or AGI, it's a 1040 page 2 deduction.