A Summary of the New Tax Laws For Section 199A (Segment III)
Tax Implications and Planning Features with the Qualified Business Income Deductions
Tax Planning Features
When assisting taxpayers with business asset purchases, it is well advised to apply a Class V category on the Form 8594 to the greatest segment of asset transactions as realistic, because this class increases the capital base of the business property when computing application of a Section 199A threshold limit. Since depreciation rules permit accelerated expense rates, the tax benefit is optimized with Class V because the acquirer can still deduct the purchase in the year of acquisition, and obtain a greater 2.5% of property threshold advantage.
Correspondingly, individual losses in QBI for businesses, are aggregated with combined business activities. Secondly, if there is a loss for QBI in the current year, it is carried forward to future years to reduce QBI, and therefore the benefit the Section 199A deduction.
For example, say Bob owns two businesses, a convenience store with $35,000 of QBI earnings, and wholesale supplies business with a QBI loss of $40,000. Bob cannot apply a Section 199A deduction on his tax filing, and has a carryover of $5,000 to the subsequent year QBI calculation.
Tax planning factors are now most unique in that individual optimization of each business tax variables is required to minimize tax expenses, i.e. income and expenses and W-2 wages, and property in service, must be considered individually per business for multiple business activity taxpayers. Generally, a taxpayer in specified trade or business can claim a modified business deduction if their individual income is less than $415,000 MFJ or $207,500 for all other taxpayers.
In addition, 1231 gains have tax characteristics specific to Section 199A, because the 1231 gains are deducted from the activities QBI since they are capital gains for tax purposes, while the 1231 losses are deducted from QBI since they are ordinary, to reduce the Section 199A deduction. Bottom line 1231 gains and losses have a new tax planning variable that reduce the Section 199A benefit.
Service business classifications are now subject to tax optimization since the tax deduction for Section 199A is reduced to zero when the threshold level is exceeded. Architects and engineers are not considered service businesses presumably because they were eligible for Section 199 DPAD.
The skill and reputation definition and tax planning variable of service businesses will remain a grey area of Section 199A as it is not well-defined now, but likely following the guide lines of business activities that applied the Section 199A DPAD in prior years, will continue to be considered non-service businesses.
One item of note, is that service business must reduce QBI for reasonable compensation or guaranteed payments for services provided. So therefore, a consulting partnership will deduct guaranteed payments to partners from the QBI computation for the Section 199A deduction. S-Corporations will be subject to “reasonable compensation” thresholds. The tax planning characteristics relevant to this specific ruling will result in many service businesses not benefiting from the Section 199A because of the additional described threshold rules. From a practical standpoint, service businesses, e.g. consultants, attorneys, accountants, health care providers, etc. should not expect to avail benefits from Section 199A. Architects and engineers are the exceptions to this threshold rule.
Summary: The Section 199A Qualified Business Income Deductions are a new variable in tax planning beginning with the 2018 year. Entrepreneurs are hereby advised to apply appropriate tax planning for their businesses activities to optimize the tax benefits and nuances of these new tax laws beginning with the 2018 tax year.