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PILLA TALKS TAXES - Featured Article
_________________________________________ 

THE 20% DEDUCTION FOR SMALL BUSINESSES

Analysis of Section 199A of the Tax Cuts and Jobs Act

by Daniel J Pilla and Scott MacPherson 

 

We’ve written recently that the Tax Cuts and Jobs Act (“Jobs Act”) is NOT tax reform. It amounts to not much more than the same tweaking and tinkering that has marred tax legislation for the past five decades in general, and the past two decades in particular. In the case of the Jobs Act, all key provisions and benefits (with the exception of the corporate income tax rate cut) are temporary, set to expire after 2025.          

On the other hand, the Jobs Act is a tax cut. There’s no doubt about that. Despite what the Left says regarding “tax cuts for the rich,” about four out of five taxpayers will see their tax burden fall. Individual rates were reduced and the corporate rate is reduced considerably. That means more people will have more spendable income. The Tax Foundation estimates that spendable income will increase by about 2% to 3%. See the analysis of eight family scenarios in the March 2018 issue of PTT. 

For small businesses, the most significant aspect of the Jobs Act is the special 20% deduction under §199A. This deduction applies to sole proprietors, partnerships and S corporations. Contrary to some of the commentaries on this, one need not be an S corporation to take advantage of this deduction. However, there is a planning opportunity for S corporations, which we discuss later. The deduction is available for all businesses and is intended to provide a tax cut similar to C corporation rate reductions, which saw their income tax rates fall from 35% to 21%. 

The Starting Point for Figuring the Deduction 

Perhaps the most remarkable thing about the §199A deduction is that it doesn’t cost anything. By that we mean it’s not based on specific expenditures for certain business items. For example, to get a deduction for business tools and equipment, you must spend money on business tools and equipment. However, the §199A deduction is based on “qualified business income” (QBI), not any particular expense. 

The definition of QBI is found in §199A(a). It provides, generally, that QBI is net income from any “qualified trade or business,” plus 20% of qualified REIT dividends and qualified publicly traded partnership income. See: §199A(a) and §199A(b). 

The  precise statutory description is quite a mouthful. Shown below, it adequately proves the point that the Jobs Act is a far cry from tax simplification.

(a) IN GENERAL.—In the case of a taxpayer other than a corporation, there shall be allowed as a deduction for any taxable year an amount equal to the sum of—

(1) the lesser of—

(A) the combined qualified business income amount of the taxpayer, or

(B) an amount equal to 20 percent of the excess (if any) of—

(i) the taxable income of the taxpayer for the taxable year, over

(ii) the sum of any net capital gain (as defined in section 1(h)), plus the aggregate amount of the qualified cooperative dividends, of the taxpayer for the taxable year, plus 

(2) the lesser of—

(A) 20 percent of the aggregate amount of the qualified cooperative dividends of the taxpayer for the taxable year, or

(B) taxable income (reduced by the net capital gain (as so defined)) of the taxpayer for the taxable year. 

You must consider all elements in the calculus for figuring the deduction. 

The law provides that QBI is net income from any trade or business within the U.S. See: §199A(c)(3)(A). Thus, no offshore activities will qualify for this deduction. The income and expenses must be “effectively connected” with the conduct of a trade or business in the U.S. This can include income derived from assets used in the conduct of the business, or where the activities of the business were a material factor in generating income, per the language of §864(c)(2). 

Moreover, the general rule of §162 applies, in that the income and expenses must be allowable in computing taxable income. In that regard, the expenses must meet the “ordinary and necessary” test.

This is a portion of an article taken from the April- May  2018  issue of "Pilla Talks Taxes"  The rest of the article includes: 

      • Exceptions to QBI 
      • Disqualified Trade or Businesses            
      • Phase-out and Phase-in Amounts for Deduction Limits 
      • The Deduction Phases-out for Out-of-favor Businesses
      • Potential Planning Opportunity
      • Effective Dates

 

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ARTICLES FOUND IN THE LATEST 

PILLA TALKS TAXES ISSUE:

  

THE 20% DEDUCTION FOR SMALL BUSINESSES
Analysis of Section 199A of the Tax Cuts and Jobs Act
By Dan Pilla and Scott MacPherson

BANKRUPTCY AND UNFILED TAX RETURNS
Eight Circuit Reverses Prior Position on Late-filed Returns

 

FEDERAL EMPLOYEES:
DON’T WORRY ABOUT LOST MOVING EXPENSE DEDUCTIONS
It Must be Nice to Work for the Government

 

 

 

 

Missed a prior featured article?

Here are links to some of the favorites:

FIVE THINGS EVERY CITIZEN
NEEDS TO KNOW ABOUT IRS CONTACTS

 

LEVY OF SOCIAL SECURITY BENEFITS

 

HOW LONG DO I KEEP TAX RECORDS?

 

CHANGE IN POLICY ON
ENFORCEMENT OF STRUCTURING LAW

Laws Pertaining to Moving Your Money
from Account to Account

 

WHAT EVERY CITIZEN NEEDS TO KNOW 
ABOUT RETIREMENT FUND DISTRIBUTIONS

The Tax Consequences of Taking Your 401(k) or IRA  

 

"I'M FROM THE IRS... -And You're Going to Jail!"

 

PASSPORTS AND THE IRS
  They Have More in Common Than You Might Think

 

END OF THE YEAR TAX PLANNING
  9 Simple Steps That Can Cut Taxes and Pain

 

AVOIDING PENALTIES UNDER OBAMACARE

 



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