Recently wealthy clients who own businesses qualified for the new 20 percent deduction for qualified business income. Before they jump to take the deduction, however, clients should know that the IRS has issued more clarifications about the deduction.
The 21 new questions—making the total 47—released by the IRS attempt to flesh out the agency’s views on 199A, the tax code section covering QBI. The additional questions cover such topics as patrons and cooperatives, taxable income under thresholds, rental real estate deductions, fiscal-year pass-through entities, health insurance premiums by S corporations, and income and losses, among other topics.
Many CPAs agree with the need for clarification. “This was a messy area of the Tax Cuts and Jobs Act. The legislation was passed in December of 2017 and QBI was never defined, so the IRS was left in limbo for much of 2018 and 2019 until this ruling,” said Evan Guido, president and senior wealth advisor at Aksala Wealth Advisors in Lakewood Ranch, Fla.
But some advisors say more clarification is needed.
“Although this FAQ was helpful, it’s like putting a Band-Aid on a wound that requires 10 stitches,” said John Vento, a CPA/CFP and president at Comprehensive Wealth Management in New York. “There are many technical issues under this code section that still need to be addressed and, in many cases, corrected.”
While they await guidance, tax experts generally said that high-net-worth business-owning clients benefited from tax reform and 199A. “We found that many with ownership in qualified flow-through entities that are profitable and have a large payroll did and should continue to benefit from this opportunity,” said Nathan DeFilippi, a senior tax associate with H2R CPA in Pittsburgh.
As part of Trump's tax reform, the corporate tax rate (C corporations, typically publicly traded) dropped from 35 percent to a flat 21 percent. “This was, in my opinion, the driving force that has caused the stock market to rally over the last year and a half, since this increased the profitability of almost every profitable corporation in the U.S.,” Vento said.
“Even if you do not own your own small business, the benefits of [QBI] can result in a reduced federal income tax bill,” he added. “This deduction, which applies even if you don’t itemize personal deductions, may help investors reduce their tax if they have direct investments in real estate, own master limited partnerships, real estate investment trusts or specified cooperatives.”
Vento, author of "Financial Independence (Getting to Point X): A Comprehensive Tax-Smart Wealth Management Guide," said one chapter of his book outlines some of the major changes and “knowing these new rules early on put many small-business owners in the position to maximize the benefit.”
For example, certain owners benefited from either remaining a sole proprietorship or single-member LLC, as opposed to being a subchapter S corporation or partnership.