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20% Qualified Business Income Deduction Alert

Posted by Admin Posted on Feb 06 2019

BACKGROUND

 

The 2018 tax preparation season is upon us and Labenz & Associates will need more information than ever before from our clients to file certain tax returns.  

 

One of the new tax benefits for 2018 tax returns is the 20% Qualified Business Income (QBI) tax deduction.  This is a great tax benefit for those clients who qualify.  But as discussed below, the new deduction will require us to obtain additional information from our clients to assess qualification and to determine the amount of the deduction.  

 

In certain instances, these will be difficult assessments.  The better the information clients can provide to us, the better we will be able to determine the eligibility to claim the new tax benefits.

 

For noncorporate taxpayers – individuals, estates and trusts who own a business activity – the key question for their 2018 tax returns is:  Will you qualify for the 20% QBI deduction?  The analysis will apply to individuals, estates and trusts with:

 

  • One or more rental properties,
  • Farmland,
  • Ownership interest in an LLC, partnership or S corporation, and
  • Businesses operated as a sole proprietorship.

 

A simple example:  Mary and Bob own a hardware store through an S corporation.  The business earned a $100,000 profit in 2018.  Will Mary and Bob qualify for a $20,000 deduction on their 2018 tax return?

 

The purpose of this Alert is to provide an overview of the 20% QBI deduction, including some recently issued IRS guidance, so our clients can help us assess their ability to claim the deduction.  If a client does qualify, we may need more information to quantify the deduction when we prepare the 2018 tax return.  

 

The 20% QBI deduction is determined differently for taxpayers above or below certain taxable income threshold amounts.  Taxpayers below the threshold amount must satisfy one requirement whereas taxpayers above the threshold must satisfy three requirements.

 

TAXABLE INCOME UNDER $157,500 SINGLE AND $315,000 JOINT

 

Single individuals, estates and trusts with 2018 taxable income at or under $157,500 and married filing jointly with taxable income at or under $315,000 (the threshold amount) can qualify for the 20% QBI deduction by satisfying one requirement – their business activity must be classified as a “trade or business activity”.

 

A trade or business activity is not a defined term, but prior Court cases and the recently released IRS guidance shed some light on activities that will be considered a trade or business.  Examples:

 

  • Taxpayer, employees of the business activity or their agents must be involved in the activity with continuity and regularity.
  • A hobby or amusement type activity does not qualify.
  • Operating five days a week as a plumbing business, hardware store, dental practice or law practice are clear examples of a trade or business.
  • Farmland and rental properties are the most difficult business activities to determine whether they rise to the IRS requirement of a trade or business activity.  Examples are below:

 

  • An individual owns farmland which is cash rented or crop shared with a tenant.  The farm owner pays certain bills and is involved in certain decisions.
  • An individual owns two or three duplexes and collects rents, pays bills and arranges maintenance.
  • Do either of these business activities rise to being defined as a “trade or business activity”? 

 

To address rental situations, the IRS offered a safe harbor.  The rental activity (or multiple activities, if the taxpayer chooses to treat them as a combined enterprise) can be classified as a trade or business activity if all the requirements below are met.

 

  • Separate books and records are maintained for each rental activity (or the combined enterprise, if grouped together).
  • There are at least 250 hours or more of rental services performed per year for the activity.
  • Starting January 1, 2019, taxpayer maintains contemporaneous records, including time reports or similar documents, which support the 250 hours of rental service activities.
  • The taxpayer includes a statement on their tax return, under penalties of perjury, verifying the rental enterprise meets the above requirements.
  • Note:  Commercial and residential rental properties cannot be combined for the above requirements.

 

Triple net leases and vacation homes do not qualify as a trade or business activity under the safe harbor even if the 250 hours requirement can be documented.  Self-rentals do qualify even if the 250 hours requirement is not met if the self-rental is combined with a trade or business activity that is commonly owned by the taxpayer that is not a C corporation.

 

TAXABLE INCOME OVER $157,500 SINGLE AND $315,000 JOINT

 

Taxpayers with taxable income over the threshold amounts who have business activities that satisfy the trade or business requirement outlined above either by itself or on a combined enterprise basis must satisfy two additional requirements to claim the 20% QBI deduction:

 

Requirement #1 – THE TRADE OR BUSINESS CANNOT BE A SPECIFIED SERVICE TRADE OR BUSINESS.

 

For whatever reason, when Congress created the new 20% QBI deduction, certain trades or businesses were specifically excluded from claiming the deduction if the taxpayer’s income is above the threshold amount.  These trades or businesses are defined as Specified Service Trade or Businesses (SSTB) and include the following:

 

  • Trade or business of performing services as an employee, or
  • Trade or business of performing services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.

 

IRS guidance tried to address questions about who is and who is not an SSTB.  For example, with the right facts, surgery centers could fall outside the health field, as well as research, testing and the sale of pharmaceuticals and medical devices.

 

If your taxable income is above the threshold amount and your business activity includes an SSTB, a decision will need to be made if your business activity qualifies when we prepare your 2018 tax return.

 

The IRS provided a de minimis exception to address situations where a business activity with multiple trades or businesses, of which one or more is an SSTB, could still qualify for the 20% QBI deduction.  

 

For business entities with gross receipts less than $25 million for a taxable year:

 

  • The business qualifies for the deduction if less than 10% (lowered to 5% if gross receipts greater than $25 million) of gross receipts are from SSTB activities.
  • If the 10% de minimis exception is not met, but taxpayer has separate books and records, it may be possible to split the business between SSTB and non-SSTB activities.  If the qualifications are met, some portion of the business activity may still qualify for the 20% QBI deduction.

 

Requirement #2 – THE TRADE OR BUSINESS MUST HAVE WAGES OR INVESTMENT IN DEPRECIABLE ASSETS.

 

For taxpayers above the threshold amount, the 20% QBI deduction for non-SSTB business activities are limited to the greater of the following:

 

  • 50% of wages paid to employees during the taxable year and reported on Form W-2, or
  • 25% of the wages paid to employees during the taxable year plus 2.5% of the original cost of depreciable tangible property owned at the end of the taxable year.
  • Note:  Wages paid to owners only qualify if paid by an S corporation.

 

How this limitation impacts taxpayers above the threshold will vary greatly by taxpayer and by type of business activity.  For example:

 

We have found most banks have sufficient wages, whereas real estate investors will generally rely on the 25% of wages and 2.5% of depreciable tangible property to cover their 20% QBI deduction.  

 

Taxpayers who own farmland that is either crop share or custom farmed and have no wages and limited tangible property will have a significantly reduced 20% QBI deduction due to these limitations.

 

ALL IS NOT LOST

 

Remember even if your business activity does not qualify for the 20% QBI deduction, all is not lost.

 

Early planning in 2019 may enable the business activity to qualify in 2019.  For example:

 

  • Triple net leases could be converted to a more active type lease;
  • Partnerships or LLC’s could be converted to S corporations and wages paid to owners;
  • Business structures or ownerships can be adjusted; or
  • Taxpayers close to the threshold amounts can utilize planning techniques to insure their 2019 taxable income is below the threshold, making qualification simpler.

 

Please discuss your qualification for the 20% QBI Deduction with your Labenz & Associates tax advisor.  We are here to help. 

Partnership Audit Rules Alert

Posted by Admin Posted on Dec 10 2018

The Internal Revenue Service (IRS) has issued regulations regarding partnership audit rules effective for partnership tax years beginning on or after January 1, 2018 and may require an amendment to the partnership’s operating agreement.

Partnerships must designate a partnership representative (PR) with a substantial U.S. presence.

  • Substantial presence requires availability to meet with the IRS in the U.S., a U.S. taxpayer identification number (TIN), a street address in the U.S. and a telephone with a U.S. area code.
  • The PR receives all audit and other IRS correspondence and has the authority to bind the partnership.
  • Designation of the PR is made on the partnership’s Form 1065 tax return for the tax year to which the designation applies and is effective on the date the partnership return is filed.
  • The PR is not required to be a partner in the partnership.
  • If no PR is appointed, the IRS will designate one.
  • In general, it makes sense for a new partnership to designate its PR when formed.

 

Partnership audits will be conducted at the partnership level. 

  • IRS adjustments will be determined, and any tax will be assessed and collected, from the partnership, generally at the highest individual or corporate tax rate in effect for the year the audit adjustments become final. 
  • The adjustments and tax will NOT be assessed and collected from the partners for the year under audit at each partner's tax rate.
  • Partners are not able to opt out of the partnership procedures.

 

Eligible small partnerships with 100 or fewer partners can elect out of the partnership audit rules for any tax year.  The election must be made every year on the timely filed Form 1065.

  • If the election out is made, all adjustments and tax will be assessed and collected on amended returns from the partners for the year under audit at each partner’s tax rate.
  • The election out is only available if each of the partners are eligible:  Individuals, C corporations, estates of deceased partners, certain foreign entities and S corporations are eligible partners.
  • A partnership that has an S corporation partner must furnish the names and TINs of each S corporation shareholder.  Also, each of the S corporation shareholders must be counted as a partner for determining the 100-partner threshold.
  • Partners that prevent the entire small partnership from being able to elect out are partnerships, trusts, disregarded entities, estates of individuals that are not deceased partners and certain foreign entities.

 

If not eligible for the small partnership election out, the partnership can make a valid “push-out” election within 45 days after receipt of the final IRS audit adjustments.

  • The partnership must provide statements to the IRS and to each of the partners from the audited year showing each partner’s share of the adjustments.
  • The partners pay tax on the adjustments in the year the statement is furnished, plus interest.

 

All partnerships for which we prepare tax returns will receive a form from our office to complete and return as soon as possible, regarding specific information about partners and the partnership representative to be designated.

Importance of Year-End Tax Planning for 2018

Posted by Admin Posted on Nov 21 2018

As the end of 2018 rapidly approaches, we are sharing this alert as a reminder that 2018 is not business as usual from a Federal and state income tax year-end planning perspective.

 

The 2018 tax year is the first year the changes made by the 2017 Tax Cuts and Jobs Act go into effect for most businesses and individuals.

 

MAJOR BUSINESS CHANGES

 

  • Corporate tax rate.  The C corporation tax rate was reduced to a flat 21 percent rate.  For some corporations this will be a tax rate increase.

 

  • Section 199A pass-through deduction.  A new 20 percent tax deduction was created for businesses, including farming and rental real estate, operating as a sole proprietorship, S corporation, limited liability company or partnership.  The new tax deduction comes with a great deal of complexity and requires review prior to year-end for optimization.

 

  • Depreciation.  More liberal depreciation rules were put into effect starting September 17, 2017.  The new rules carry over into 2018 and future tax years.  Both new and used equipment purchases qualify for some of these new liberalized rules, including business acquisitions.  Coordinating with the new Section 199A tax deduction is required.

 

  • Like-kind exchanges.  Like-kind exchange of personal property was repealed.  Now all car and equipment trade-ins are taxable.

 

  • Cash method of accounting.  Expansion of the ability to utilize the cash method of accounting may provide an opportunity for additional flexibility for year-end planning.

 

  • Interest expense deduction.  A limitation on the use of interest expense as a tax deduction was enacted for larger corporations.

 

MAJOR INDIVIDUAL CHANGES

 

  • Section 199A deduction.  The Section 199A deduction from pass-through entities is discussed above.  Managing your taxable income is important to maximizing your Section 199A deduction.

 

  • Standard deduction increase.  For many individuals, the increased standard deduction may limit the ability to itemize tax deductions each year.  Bunching deductions in alternative years will become an important planning tool for many individual taxpayers.  

 

  • Limit on state and location tax deduction.  The itemized deduction for state income tax, real estate tax and personal property taxes is limited to a combined $10,000 annually.

 

  • Charitable giving alternatives.  Direct charitable gifts from IRA accounts for individuals over 70 ½ and the use of donor advised funds will become important planning tools for those with charitable giving objectives.

 

  • Reduced Federal withholding.  The 2018 Federal income tax withholding tables could cause individual taxpayers to owe money when they file their 2018 tax return.  Check your withholding before year-end so you can plan for this possibility. 

Meals and Entertainment Charts

Posted by Admin Posted on Nov 19 2018

Meals and Entertainment

 

Activity

2018 Expenses
(New Law)

2017 Expenses
(Old Rules)

 

Office holiday parties,
  summer picnics

100% deductible
 

100% deductible
 

 

Entertaining clients













 

Meals 50% deductible

50% deductible

Meals with prospects
  and referral sources –
  50% deductible

50% deductible

 

Events such as theatre
  tickets, sporting tickets,
  golf outings – not
  deductible, meals 50%
  deductible, if separated
  on invoice or receipt

50% deductible




 

Charitable event tickets –
  charitable portion
  deductible, meals 50%
  deductible if separated
  on invoice or receipt

Tickets to qualified charitable
  events – 100% deductible


 

 

Business meetings of employees,
  stockholders, agents or directors

50% deductible
 

50% deductible
 

 

Expenses for attendance at a
  501(c)(6) business meeting or
  convention of a business league

Meals – 50% deductible

 

50% deductible

 

 

Employee travel meals

50% deductible

50% deductible

 

Meals provided for the
  convenience of the employer
 

50% deductible
  (not deductible after 2025)
 

100% deductible if a
  de minimis fringe benefit;
  otherwise 50% deductible

 

Examples

 

Example Activity

2018 Expenses
(New Law)

2017 Expenses
(Old Rules)

 

 

 

Meal with a client in town (not
  away from home)

50% deductible
 

50% deductible
 

 

 

 

Meal with a client while traveling
  away from home

50% deductible
 

50% deductible
 

 

 

 

All employee meeting with food
  and beverages served after

100% deductible
 

100% deductible
 

 

 

 

Open house for customers and
  employees

 

Employee portion –
  100% deductible
Customer portion –
  50% deductible

Employee portion –
  100% deductible
Customer portion –
  50% deductible

 

 

 

Company sponsors a table at a
  charitable event attended by
  employees and customers

 

Value of meals – 50% if
  separated on invoice
  or receipt
(Remainder is charitable contribution)

Meals – 50% deductible
(Remainder is a charitable contribution)

 

 

 

 

Golf sponsorship and outings
  $1,000 of which $300 is
  charitable contribution



 

Meals – 50% deductible if
  separated on invoice
  or receipt
Cost of golf – Not
  deductible

(Remainder is charitable contribution)

Meals and golf –
  50% deductible
(Remainder is a charitable contribution)


 

  • Note the cost of the meal must not be lavish or extravagant under the circumstances.
  • Assumes appropriate documentation exists in all instances.
  • Additional guidance and clarification from the IRS is still forthcoming.

Wayfair Decision State Tax Alert

Posted by Admin Posted on Oct 12 2018

On June 21, 2018, the U.S. Supreme Court (the Court) issued a decision in South Dakota v. Wayfair, overturning the physical presence standard requirement for states to impose sales and use tax filing obligations on companies doing business in a state.  As a result, companies are in the process of understanding how the Wayfair decision impacts their sales and use tax filing requirements.

 

We are alerting our clients that the Wayfair decision could also have other state tax filing implications, including income and franchise taxes as examples.

 

The Court observed in their Wayfair ruling that targeted advertising and electronic sales may allow a business to have “substantial virtual connections” to a state without traditional physical presence.  The Court noted that other functions of e-commerce, such as websites leaving cookies on customer hard drives and applications that can be downloaded on customer phones, may be considered to create something akin to a physical presence in a taxing state.

 

Given the Court's conclusion that “physical presence is not necessary to create substantial nexus”, the Wayfair decision could impact other state taxes, such as state income or franchise taxes, for companies conducting business activities in a state without necessarily having a physical presence.

 

For example, even prior to Wayfair, many state and Federal courts have taken the position that the physical presence standard does not apply for purposes of state income taxes.  Many states have been emboldened to enact “factor presence” laws tied to sales, property or payroll in their state.  Wayfair decision type states have attempted to subject companies to their state tax regime if they are doing business in their state even without physical presence.

 

The Court has declined to hear challenges to economic nexus laws for state income tax filing purposes.  With the test announced in Wayfair, more states may enact aggressive legislation.  Effects are likely to be especially pronounced in the handful of states that have taken the position that physical presence is not necessary for the state to assert income tax nexus against a company doing business in their state.  Physical presence is not required to establish nexus with Nebraska. [Neb. Rev. Stat.  §77-2734.04(5)]. 

 

We believe the Wayfair decision may empower states to not only enact legislation, but also pursue audit and collection activities against companies doing business in their state that currently are not subject to their state taxing regime.

 

Therefore, we believe it is necessary for companies that have customers or clients in multiple states to actively review their state filing positions in light of the recent Wayfair decision.

 

Please contact us if you need assistance with such a review or have questions about the Wayfair alert. 

2017 Tax Planning

Posted by Admin Posted on Dec 06 2017

Congress is currently working on a massive tax reform proposal that could change many aspects of income tax law. It is uncertain what the final version of the bill will look like or if anything will get passed at all, but there are still income tax planning opportunities available under the current law. We highlight below a few strategies you may want to consider before the end of the year to reduce your 2017 taxes.

  • Postpone income until 2018 and accelerate deductions into 2017 including:
    • Maximize your charitable contributions including prepayment of athletic event seating donations.
    • Prepay real estate taxes, state income taxes and miscellaneous itemized deductions (e.g., investment fees) unless you  are in an alternative minimum tax situation.
    • Defer any year-end bonuses.
    • If you have a health savings account (HSA), maximize your contributions for 2017 in December.
  • For individuals age 70 ½ or older, consider making charitable gifts up to $100,000 per person directly from your  individual retirement account (IRA).
  • Maximize your retirement plan contributions.
  • Reduce potential capital gains by selling securities in a loss position.

 

We also want to alert you to some new rules that will affect our partnership and LLC clients.

  • Beginning with partnership tax years starting on or after January 1, 2018, the partnership will be liable for any assessments levied on prior years’ tax returns.
  • This will eliminate the need to proceed against individual partners.
  • Current partners will be held responsible for tax liabilities of prior partners.
  • The “tax matters partner” will be replaced with a “partnership representative.”
    • This person will have complete authority to act on behalf of the partnership and the partners when dealing with the IRS.
    • This person also has the authority to make various elections.

 

In light of these changes, we recommend you review your partnership or LLC agreement with your attorney as soon as possible to ensure it addresses the significant changes required.

If you would like our assistance with any of your year-end planning questions, please let us know.