The new 20% QBI deduction
By Mark W Mirsky, CPA MST CGMA
Mark (“Coach”) W Mirsky, CPA, MST, CGMA, co-founded ROI Business Services, LLC in 2004 located in Bartlett, Illinois, where he leads the Taxation and Management Advisory Services. Teaching CPAs Nationally since 2008, in 2018 he founded ROI CPE, LLC to provide quality education to the CPA industry. With a focus on partnerships, S-corporations, C-corporations, and multi-state taxation, Mark also provides assistance for business startups, the acquisition and transition of businesses, international taxation, and real estate.
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (“TCJA”), Public Law No. 115-97. The effective date for many TCJA provisions relating to businesses is tax years beginning after December 31, 2017 and was made permanent. However, as of the date this article was written, the §199A Qualified Business Income (“QBI”) deduction only applies for tax years beginning after December 31, 2017 and does not apply to tax years beginning after December 31, 2025. (The Protecting Family and Small Business Tax Act which has passed the House as part of Tax Cuts 2.0 would extend the QBI deduction permanently)
In order to understand how to properly compute the QBI deduction, tax preparers must gain an understanding of all of the relevant terms and nuances related to this computation. In addition, we need to understand which taxpayers are eligible for the deduction and which taxpayers are excluded or ineligible for the deduction. This article is intended to provide insight into the computations of how to compute the QBI for your client.
The deduction appears to be a easy formula (at least that is what our clients believe – simple 20% deduction, right?). The new §199A deduction equals the sum of:
However, the limitation on CQBI related to the greater of W-2 wages or combination of W-2 wages and UBIA only applies if the taxpayer’s taxable income before §199A deduction is above the threshold ($157,500 for all taxpayers other than married filing joint - $315,000). Therefore, if your client’s taxable income before §199A is less than the threshold, your client does not need to take into account either the W-2 wages limit or W-2 plus UBIA limit in computing their deduction. In addition, the level of participation does not impact the ability to obtain the QBI deduction.
Overall limit
As an example, in 2018 if your client, Joseph, who is a single individual, has $155,000 of taxable income before §199A deduction and $5,000 of net capital gains, has S corporation qualified trade or business income that is not an SSTB (this has already been determined and indicated on the K-1) in box 1 of $200,000 and listed separately are flow through W-2 wages of $50,000 and UBIA of $150,000, how would you compute the QBI deduction?
Since the taxpayer’s taxable income before §199A is less than the threshold for single taxpayers of $157,500, the W-2 wages and UBIA are irrelevant for the computation.
The overall limitation (TI-NCG) x 20% is $155,000-$5,000 or $150,000 x 20% = $30,000. While the tentative QBI deduction 20% of QBI is ($200,000 x 20%) = $40,000. Therefore, the QBI deduction is the lesser of these two amounts $30,000.
Phase-in
What if taxable income for Joseph in 2018 were $187,500 which included $5,000 of net capital gains, the same $200,000 of box 1 income, flow through W-2 wages of $50,000, and UBIA of $150,000? How do you compute the deduction?
First determine the overall limitation (TI-NCG) x 20%. ($187,500-$5,000) x 20% = $36,500. Next compute tentative deduction or 20% of QBI ($200,000 x 20%) = $40,000. Since Joseph is in the phase-in range, we must determine what the amount by which 20% of QBI exceeds the potential limitation amount (greater of 50% of W-2 wages or 25% of W-2 wages and 2.5% of UBIA). This is known as the Excess Amount. The limitation is the greater of 50% x $50,000 = $25,000 or 25% x $50,000 + 2.5% x $150,000 = $16,250. So, the Excess Amount is $40,000 (20% x $200,000) - $25,000 (greater of $25,000 or $16,250) or $15,000.
Finally, we need to apply a percentage to the Excess Amount. The percentage is (TI-Threshold) / $50,000 ($100,000 for MFJ). For Joseph the percentage would be ($187,500-$157,500) / $50,000 = 60%. 60% x $15,000 = $9,000 is the amount by which we must reduce the 20% of QBI. $40,000 - $9,000 = $31,000. Since this is less than the overall limitation, Joseph would be allowed a QBI deduction of $31,000 for 2018.
If Joseph’s taxable income were $250,000 (beyond the phase-in range), then the entire wage limitation of $25,000 (vs the $16,000 phased-in amount) would be applied and would limit his deduction to the $25,000.
Specified Service
If Joseph’s K-1 income were generated from a specified service trade or business using the same facts as the phase-in example (TI = $187,500), there is an additional step we must perform prior to computing the QBI deduction. We need to determine the applicable percentage. This is computed by taking 100% less the percentage we computed above (TI-Threshold) / $50,000 ($100,000 for MFJ). In Joseph’s case, the applicable percentage is 1-60% = 40%. Then apply that percentage to the QBI, wages, and UBIA. $200,000 x 40% = $80,000 QBI. $50,000 x 40% = $20,000 W-2 wages, $150,000 x 40% = $60,000 UBIA. Now we can compute the QBI deduction using the reduced amounts.
The tentative deduction is now $80,000 x 20% = $16,000. The W-2 limit is $20,000 x 50% = $10,000. We know we are below the overall limit so Joseph’s deduction would only be $10,000.
If Joseph’s taxable income were $250,000 (beyond the phase-in range), then he would not be entitled to any deduction since this is a specified service.
One item to note, while under the passive activity rules of §469 we can group at the entity level and also at the individual level, for purposes of the §199A deduction we must report activity by activity at the entity level on K-1s properly reporting the distributive share of QBI, W-2 wages, UBIA, and whether each activity is an SSTB. Failure to report this information on an activity by activity basis (allocating all QBI/W-2/UBIA items to each separate trade or business within an entity) would mean the deemed QBI is zero for that entity.
The computation of the QBI deduction may actually be made easy by our software programs. However, putting in the proper information into the system, the definitions of each item in computing the deduction, the determination of which trades or businesses qualify for the deduction, and planning to maximize the deduction will make the computation more complex than our clients may believe it should be.