Seven Answers to Your Section 199A Questions
For most small businesses and the self-employed, the 20 percent tax deduction from new tax code Section 199A is the most valuable tax deduction to come out of the Tax Cuts and Jobs Act tax reform.
The Section 199A tax deduction is complicated, and many questions remain unanswered even after the IRS issued its proposed regulations on the provision.
And to further complicate matters, there’s also a lot of misinformation out there about Section 199A.
In this article, we answer seven questions that small businesses and the self-employed are asking.
Question 1: Real Estate Agents
Question. Are real estate agents and brokers an out-of-favor specified service trade or business for purposes of Section 199A?
The proposed regulations specifically exclude real estate agents and brokers from the “broker” category.
Question 2: Shareholder Wages
Question. Do my S corporation shareholder wages count as wages paid by the S corporation for purposes of the 50 percent Section 199A wage limitation?
All wages properly allocable to your qualified business income (QBI) count, including S corporation shareholder wages.
In addition, let’s clarify two common misconceptions about S corporation shareholder reasonable compensation.
- Your S corporation shareholder reasonable compensation is a tax deduction for the S corporation. It is not by itself QBI eligible for the 20 percent deduction. But when your taxable income is above the $157,500 (single) or $315,000 (married, filing jointly) threshold, the wages paid by the S corporation, including wages paid to the more than 2 percent shareholder, can improve and even create the Section 199A tax deduction.
For Section 199A purposes, the reasonable compensation requirements and considerations apply to S corporations only.
Question 3: Retirement Contributions
Question. Will my allowable SEP/SIMPLE/401(k) contribution as a Schedule C taxpayer be based only on Schedule C net earnings, or do I first subtract the Section 199A deduction?
Answer. You’ll continue to use Schedule C net earnings with no adjustment for Section 199A.
You base your retirement contribution amounts for your sole proprietorship on the net income from self-employment less the deduction for one-half of self-employment tax.
Nothing in Section 199A or its proposed regulations adjusts this rule for the Section 199A deduction.
Question 4: Bonus Depreciation and Section 179
Question. Is QBI reduced by either bonus depreciation or Section 179 expensing?
Answer. Yes, to both.
QBI is the net amount of qualified items of income, gain, deduction, and loss with respect to the trade or business.
Qualified items of income, gain, deduction, and loss are those that are
- effectively connected with the conduct of a trade or business within the United States, and
included or allowed in determining taxable income for the taxable year.
Both bonus depreciation and the Section 179 deduction are qualified items of deduction and reduce QBI.
Question 5: Shareholder Loan Interest
Question. I took out a loan to buy S corporation stock. The interest is deductible on my Schedule E. Does the interest reduce my QBI?
Answer. It is a full deduction from QBI in most circumstances.
If you use debt to acquire S corporations stock, then the interest tracing rules apply and you’ll allocate the interest among all of the S corporation’s assets using any reasonable method.
You deduct the interest amounts allocable to the S corporation’s trade or business directly on Schedule E against the S corporation’s net income. For example, if the S corporation uses all the assets in its trade or business, then the interest is 100 percent deductible.
Since it meets the definition of a qualified item od deduction that we discussed above, the interest reduces QBI.
The only exception would be interest not allocable to the S corporation’s trade or business, such as passive investments.
Question 6: No Section 199A Deduction
Question. The out-of-favor specified service trade or business does not qualify for the Section 199A deduction, correct?
Looking at your taxable income is the first step to see whether you qualify for the Section 199A deduction. If your taxable income on IRS Form 1040 is $157,500 or less (single) or $315,000 or less (married, filing jointly) and you have a pass-through business such as a proprietorship, partnership, or S corporation, you qualify for the Section 199A deduction.
With taxable income equal to or below the thresholds above, your type of pass-through business makes no difference. Retail store owners and medical doctors with income equal to or below the thresholds qualify in the same exact manner.
Question 7: Notaries Public
Question. Are notaries public an out-of-favor specified service trade or business?
Answer. We aren’t certain, but likely not.
You might consider the notary public to be performing services in the field of law, as that category includes non-attorney professionals such as paralegals and mediators.
However, the proposed Section 199A regulations are silent on notaries public.
Also, there’s no guidance on whether notaries public fell under the field of law in the qualified personal service corporation rules (which the IRS mostly followed when interpreting Section 199A).
With 4.4 million notaries public in the United States, you have to think that at some point the IRS will provide a crystal-clear answer. (But don’t hold your breath waiting for this to happen.)
Even if notaries public are out of favor, as long as your notary services meet the de minimis rule, the IRS won’t consider them out of favor for Section 199A purposes.
Under the de minimis rule found in the IRS proposed regulations, if your business has $25 million or less in gross receipts and less than 10 percent of its gross receipts are from out-of-favor services, then it is 100 percent not an out-of-favor business. If the business has $25 million or more in gross receipts, the percentage goes down to 5 percent.
To see if these tax deductions might apply to you or to start implementing a lifestyle plan, feel free to give us a call at 972-385-0007 or send us an email.