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Last year's sweeping tax overhaul, the Tax Cuts and Jobs Act of 2017 (TCJA), introduced a new tax break for owners of many businesses called the deduction for qualified business income. It’s also known as code Section 199A deduction. If you qualify for it, you will receive a 20% deduction on your qualified business income.

Last year's sweeping tax overhaul, the Tax Cuts and Jobs Act of 2017 (TCJA), introduced a new tax break for owners of many businesses called the deduction for qualified business income. It’s also known as code Section 199A deduction. If you qualify for it, you will receive a 20% deduction on your qualified business income.

Qualified Business Income - Qualified business income means the net income from a qualified trade or business. However, qualified business income does not include certain investment-related income, including:

1. Short and long-term capital gain and losses;
2. Dividend income, income equivalent to a dividend, or payment in lieu of a dividend;
3. Any interest income other than interest income properly allocable to a trade or business;
4. Net gain from foreign currency transactions and commodities transactions;
5. Income from notional principal contracts, other than items attributable to notional principal contracts entered into as hedging transactions;
6. Any amount received from an annuity that is not received in connection with the trade or business; and
7. Any deduction or loss properly allocable to any of these bulleted items described above.

Qualified Trade or Business – Qualified trade or business means any trade or business other than:

1. Employee
2. A Specified Service Trade or Business

Employee - As an employee you can never qualify for this deduction no matter what.

Specified Service Trade or Business – A specified service trade or business is defined as any trade or business involving the performance of services in the following fields:

1. Health.
2. Law.
3. Accounting.
4. Actuarial science.
5. Performing arts.
6. Consulting.
7. Athletics.
8. Financial services.
9. Brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities,
10. Any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Catch all rule.

Engineering & Architecture Services - Are specifically excluded from the definition of a specified service trade or business. Therefore, they qualify.

Some of the categories and fields listed above are fairly clear in their meaning. Others - such as "consulting" and "any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees" - are vague, and will be difficult to apply until the IRS provides guidance.

While doctors, accountants, and attorneys will clearly fall victim to the specified fields found in this definition, many businesses will not fit so neatly into one of the disqualified categories. For example, while an actor is in the field of performing arts, is a director? A makeup artist? A producer?

The catch all definition is a bit concerning that a disqualified business includes any trade or business of which the principal asset is the reputation or skill of one or more of its employees or owners. The most obvious problem posed by the catch-all is that it threatens any taxpayer who is not engaged in one of the businesses specifically listed as a disqualified field. Consider the case of a "personal trainer to the stars": Using the definition of "a specified service business" in the law the argument can be made that the trainer is not in the fields of health or athletics. Application of the catch-all, however, would likely yield a different result. What is the principal asset of a celebrity? personal trainer if not the reputation and expertise of that trainer?

To further illustrate the complications caused by the catch-all, compare two restaurants - the first a prominent chain, the second a stand-alone bistro with a world-renowned, five-star chef. Neither restaurant is in a listed disqualified service nor so the initial presumption is that both eateries generate qualified business income eligible for the deduction. Now, consider the application of the catch-all. The principal asset of the chain restaurant is clearly not the skill of its employees or owners; after all, if the chef at one of the locations leaves the restaurant, he or she will be replaced and life will go on. As a result, the chain restaurant should not fall victim to the catch-all. The bistro, however, may not be so fortunate. In this scenario, it is much more likely that the business's principal asset is the skill and reputation of the five-star chef who prepares its food. Put in simple terms, if that chef leaves the bistro, the business probably shutters its doors, adding further evidence that it is the expertise of the chef that drives the business. Thus, based on the current structure of the law it would not be unreasonable to conclude that the second restaurant is a specified service business. But why should the owners of the two restaurants be treated differently when they both provide the same mix of food and services to customers?

As one can see, until further guidance is issued that narrows the scope of the catch-all, it threatens to ensnare far more taxpayers than the specifically delineated disqualified fields.

Real Estate Activities – An emerging consensus among practitioners and expert commentators is that most rental real estate activities other than those involving triple net (NNN) rentals will qualify as trades or businesses, because such rental activities typically involve the regular provision of substantial services to tenants. Also, the fact that last-minute changes were made to the bill to make the deduction more readily available to rental property owners is seen an indication that Congress intended that rental income would be eligible for the deduction.

Limitations – There are three limitations that come into play at different income levels. They are:

1. Specified Service Trade or Business Limitation – if you are a specific service trade or business, married and your taxable income is $315,001 to $415,000 or single $157,501 to $207,500, your deduction will be limited. Above these thresholds it will be completely denied and you will not qualify for the deduction. The limitation is based on the amount that you are over the $100,000 allowed for married and $50,000 for single.
2. Wage Limitation – The W-2 wage limitation on the deduction for qualified business income is based on either W-2 wages paid by the trade or business, or W-2 wages paid plus tangible assets owned by the trade or business. It is the greater of:
3.  

1. 50% of the W-2 wages paid with respect to the qualified trade or business, or
2.  
3. The sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted tax basis, immediately after acquisition, of all qualified property.

1. Taxable Income Limitation – The qualified business income deduction can never be more than 20% of your taxable income.
2.  

Wages – Only W-2 wages paid and reported to the Social Security Administrator qualify. Thus wages paid by an S Corporation to its sole shareholder/employee qualify. However, guaranteed payments paid by a partnership (LLC, GP, LP or LLP) to its member(s) do not. Therefore, in some cases an S Corporation will qualify for the deduction while partnerships that have no employees will not.

Furthermore, IRS is very specific that a partnership cannot pay/issue a W-2 to its members. Only to its non-member employees.

Who Can Claim the Deduction – Shareholders of S Corporations, members/partners of Limited Liability Company (LLC), partners of a general partnership (GP), partners of a limited partnership (LP), members/partners of a limited liability partnership (LLP), independent contractors and sole proprietorships. Going forward the Code refers to these businesses as a “Pass-Through Business”. Trusts and estates qualify for the tax break as well.

Different Rules Apply at Different Levels of Taxable Income – Therefore, we have created three categories of income to address each rule that is applicable to that category. They are:

Category 1 – Married with taxable income of less than $315,000 or single less than $157,500.

Category 2 - Married with taxable income of $315,001 to $415,000 or single $157,501 to $207,500.

Category 3 - Married with taxable income over $415,001 or single over $207,501.

Category 1 – Married with taxable income of less than $315,000 or single less than $157,500

If you fall under this category, everyone who is a Pass-Through Business, regardless of what trade or business you are in, will qualify for the deduction. However, the taxable income limitation applies.

For simplicity in all examples below, we will assume either the taxpayer is married or single, has no dependents, mortgage interest or property taxes to deduct.

Example 1A:    Assume that the taxpayers are married. One spouse receives $50,000 of W-2 income and the other $250,000 from any trade or business. Their qualified business income deduction is $50,000 ($250,000 x 20%). Therefore, they will pay federal income tax on $250,000 ($300,000 - $50,000) not $300,000. Their federal income tax liability is approximately $42,900.

Example 1B:    Assume that the taxpayers are married. One spouse receives $50,000 of W-2 income and the other $250,000. They do not qualify for the qualified business income deduction because both are employees. Their federal income tax liability is approximately $55,300.

As employees the taxpayers will pay approximately $12,400 more in federal tax.

Example 1C:    Assume that the taxpayers are married. One spouse does not work. The other spouse has $300,000 of income from any trade or business. Their qualified business income deduction should be $60,000 ($300,000 x 20%). However, their taxable income is $276,000 ($300,000 minus the standard deduction of $24,000). Based on the taxable income limitation their qualified business income deduction is the lesser of:

1. 20% of the qualified business income, $60,000 ($300,000 x 20%) or
2. 50% of wages paid – Not applicable since they are below the threshold of $315,000 or
3. 20% of their taxable income, $55,200 ($276,000 x 20%).
4.  

Their qualified business income deduction is $55,200. Their federal income tax liability is approximately $41,600.

Example 1D:    Taxpayer is single and an employee, but not an owner, of a qualified business. Taxpayer receives a salary of $100,000 in 2018. Taxpayer does not qualify for the deduction because he or she is only the employee of the qualified business and not an owner.

If you are an employee, it may be tax advantageous for you to consider becoming a Pass-Through Business such as an S Corporation.

Category 2 - Married with taxable income of $315,001 to $415,000 or single $157,501 to $207,500

If you fall under this category you can still claim the qualified business income deduction but you are subject to the specified service trade or business, wage and taxable income limitations. Therefore, your deduction can either be limited or denied.

Example 2A:    Single taxpayer has taxable income of $187,500, of which $150,000 is from a specified service trade or business. Assume that the specified service trade or business has paid sufficient W-2 wages to its employees. He or she is over the threshold allowed by $30,000 ($187,500 - $157,500). The maximum amount allowed that a single taxpayer can be over is $50,000. Therefore, he or she is 60% ($30,000 / $50,000) over the maximum amount allowed. Thus, he or she is only allowed 40% (100% - 60%) of the maximum amount of the qualified business income. The qualified business income is $150,000 x 20% = $30,000. However, he or she only claim 40% of it. Therefore, the deduction for the qualified business income is $12,000 ($30,000 x 40%).

Example 2B:    Single taxpayer has taxable income of $187,500, of which $150,000 is from a specified service trade or business. Assume that the specified service trade or business has paid $40,000 in W-2 wages to its employees. He or she is over the threshold allowed by $30,000 ($187,500 - $157,500). The maximum amount allowed that a single taxpayer can be over is $50,000. Therefore, he or she is 60% ($30,000 / $50,000) over the maximum amount allowed. Thus, he or she is only allowed 40% (100% - 60%) of the maximum amount of the qualified business income. But, he or she has only paid $40,000 in wages. Thus, the maximum qualified business income that the taxpayer qualifies for is the lesser of:

1. 20% of the qualified business income, $30,000 ($150,000 x 20%) or
2. 50% of wages paid, $20,000 ($40,000 x 50%).
3.  

However, the taxpayer can only claim 40% of the lesser amount since he or she was over the threshold. Therefore, the deduction for the qualified business income is $8,000 ($20,000 x 40%).

Example 2C:    Single taxpayer has taxable income of $217,500, of which $150,000 is from a specified service trade or business. Since its taxable income is more than the maximum threshold allowed, $207,500, the taxpayer does not qualify for the qualified business deduction.

Example 2D:    Single taxpayer has taxable income of $187,500, of which all of it is from a qualified trade or business and it paid $60,000 in W-2 wages to its employees. The qualified business income deduction is the lesser of:

1. 20% of the qualified business income, $37,500 ($187,500 x 20%) or
2. 50% of wages paid, $30,000 ($60,000 x 50%).

Therefore, the deduction for the qualified business income is $30,000, the lesser of the two figures above.

Category 3 - Married with taxable income over $415,001 or single over $207,501

If you fall under this category the only way that you will qualify for the deduction is if you have a qualified trade or business. You will not qualify for the deduction if your only source of income is from a specified service trade or business. The wage and taxable income limitations apply.

Example 3A:    Robert is single and the sole shareholder/employee of ABC, Inc., an S corporation that is a qualified trade or business. ABC has net income in 2018 of $250,000 after deducting Robert's salary of $150,000. Assume that the $150,000 salary paid to Robert is the only W-2 wages paid. Robert’s tentative qualified business income deduction is $50,000 ($250,000 x 20%). However, he has to calculate the wage limitation to determine if its less. The wage limitation is $75,000 ($150,000 x 50%). Therefore, Robert can deduct the $50,000 because the wage limitation is bigger.

Example 3B:    Taxpayers owns residential or commercial rental properties through an LLC. His or her share of the rental income earned by the LLC is $800,000. The LLC pays no W-2 wages, but taxpayer’s share of the unadjusted basis of the building is $5 million. Taxpayer’s tentative qualified business income deduction is $160,000 ($800,000 x 20%). However, taxpayer has to calculate the wage limitation to see if its less. Taxpayer has the option of choosing the greater of the following for the wage limitation calculation:

1. 50% of W-2 wages= $0; or
2. 25% of W-2 wages, $0, plus 2.5% of qualified property = $125,000 ($5M x 2.5%).

Therefore the taxpayer’s qualified business income deduction is $125,000.

Example 3C:    Taxpayer is a sole proprietor. During 2018, the business generates $400,000 of qualified business income, pays $120,000 of W-2 wages, and has $1.5M of qualified property. Taxpayer flies jointly with his or her spouse and their combined taxable income for the year, including the qualified business income, is $600,000. Taxpayers’ tentative deduction is $80,000 ($400,000 x 20%). However, taxpayers’ have to calculate the wage limitation to determine if its less. Taxpayers have the option of choosing the greater of the following for the wage limitation calculation:

1. 50% of W-2 wages = $60,000 ($120,000 x 50%)
2. 25% of W-2 wages, $30,000 ($120,000 x 25%) plus 2.5% of unadjusted basis of qualified property $37,500 ($1.5M x 2.5%) = $67,500 ($30,000 + $37,500).

Therefore, taxpayers’ qualified business income deduction is $67,500.

Reasonable Compensation - S corporations have long had an incentive to classify payments made to shareholder-employees as dividends rather than wages, because wages are subject to employment taxes such as social security and Medicare dividends are not. The IRS, however, can re-characterize "dividends" that are paid lieu of reasonable compensation for services performed for the S corporation to wages. So, "reasonable compensation" of an S corporation shareholder refers to any amounts paid by the S corporation to the shareholder, up to the amount that would constitute reasonable compensation.

Example 4A:    Assume taxpayers A & B own identical businesses. Neither business has any employees or quailed property. Each business generates $500,000 of qualified business income before any wages are paid. A operates his business as a sole proprietor; B an S corporation.

Because A's business has no employees and because, as a sole proprietor, A cannot pay himself a wage, A has a W-2 wage limitation and its zero. Thus, A does not get a deduction.

B as the shareholder of his S Corporation, must comply with the reasonable-compensation requirement. As a result, assume B pays himself $80,000 in 2018.

B's is the lesser of:

1. 20% of the qualified business income, $84,000 (20% x $420,000) or
2. 50% of wages $40,000 ($80,000 x 50%).

B’s qualified business income deduction is $40,000 because B paid him or herself $80,000 of W-2 wages and was able to qualify for the deduction. If B was a member/partner of a LLC and received an $80,000 in guaranteed payments, he or she would not have qualified for the deduction because guaranteed payments do not count as wages.

Example 4B:    Assume the same facts as in the previous example, except the income earned in each business is $150,000, not $500,000. Assume further that both A and B have taxable income below the $315,000/$157,500 thresholds. A, the sole proprietor, is entitled to a deduction of $30,000 (20% of

$150,000). B, the sole shareholder of the S corporation, remains required to pay himself reasonable compensation. Assume he is paid W-2 wages of $70,000.

This reduces the qualified business income B receives from the S corporation to $80,000 ($150,000 - $70,000) and in turn reduces B's deduction to $16,000 ($80,000 x 20%). Thus, when income is below the threshold, the reasonable-compensation requirement works against the shareholder in the S corporation, reducing both his qualified business income and deduction. A, the sole proprietor, has no such requirement and thus preserves the full amount of his qualified business income, giving him a deduction of $30,000, when his S corporation shareholder counterpart receives a deduction of only $16,000.

Netting of Qualified Business Income and Loss – The deduction must be determined separately for each qualified trade or business. After calculating the qualified business income deduction for each trade or business, the taxpayer totals the amounts. If there is an overall loss, no deduction is allowed for that year and the loss is carried over to next year.

Example 5A:    In 2018 taxpayer is allocated qualified business income of $20,000 from qualified business 1 and a qualified business loss of $50,000 from qualified business 2. Taxpayer is not permitted a deduction in 2018 and has a carryover qualified business loss of $30,000 to 2019.

Unadjusted Tax Basis - Only the unadjusted basis of qualified property is counted toward the limitation. Qualified property is tangible property subject to depreciation. As a result, the basis of raw land and inventory, for example, would not be taken into account.

The basis of property used to determine the limitation is unadjusted basis determined before the close of the tax year. The depreciable period begins on the date the property is placed in service and ends on the later of:

• 10 years after the date placed in service; or
• The last day of the last full year in the applicable recovery period that would apply to the property under Sec. 168

Example 6A:    On April12, 2010, Partnership AB, a calendar-year partnership, places in service a

piece of machinery purchased for $50,000 that has a five-year life. The partners may take into account their allocable share of the $50,000 unadjusted basis of the property in 2018, despite the fact that the asset was fully depreciated before the year began. This is because the depreciable period runs for the longer of:

• 10 full years from April12, 2010 (to April12, 2020); or
• The last day of the last full year in the recovery period, which for a five-year asset placed in service during 2010 would have been 2014.

The partners will also take into account the $50,000 unadjusted basis of the property in 2019. The basis will not be taken into account in 2020, however, because the depreciable period ends on April12, 2020, before the end of the 2020 tax year. Alternatively, assume the machinery

was placed in service on June 1, 2008. The partners of Partnership AB would not take the $50,000 unadjusted basis into account in 2018 because the depreciable period ended on June 1, 2018, before the close of the 2018 tax year.

How to Avoid Specified Service Trade or Business Status – We are constantly being asked by clients that are a specified service trade or business, what they can do to qualify for the deduction?

Option 1 - One strategy that has been discussed is to infuse a qualified business into a disqualified business - for example, a law firm might acquire commercial real estate that it rents to tenants, or a famous actor might launch a clothing line – in the hopes that it "muddies the waters" enough to convert the entire enterprise into a qualified business. This strategy faces two significant hurdles. First, because the law requires that the deduction be determined on a business-by-business basis, the IRS may force a taxpayer to distinguish among multiple lines of business within the same entity, denying a deduction attributable to any disqualified business line. But even if the businesses could be commingled, the law treats as a disqualified specified service business any business involving the performance of services in the fields of health, law, etc. Thus, the language suggests that even a small amount of services provided in a disqualified field could taint an entire business. Thus, in the examples above involving the law firm/real estate company or actor/clothing line scenarios, because each business would continue to provide some element of personal services in a disqualified field, those services could taint the entire business, potentially preventing the rental income or the income from the clothing line from being treated as qualified business income.

Option 2 - Perhaps a more prudent alternative to maximizing the deduction involves the opposite approach: Having a disqualified business "spin off" the activities of a potentially qualifying business into a separate entity.

Example 7A:    Assume Doctor A currently owns a medical/dental S Corporation, S Corporation 1. He or she is the sole shareholder/owner. It has a net income of $500,000 after it pays Doctor A wages of $200,000 and $300,000 to other employees. Doctor A is married. If Doctor A does nothing, he/she will not qualify for the deduction because being a doctor or dentist a specified service trade or business and his or her taxable income is over $415,000.

                            Doctor A’s federal tax liability will be approximately $189,500.

Example 7B:    Same facts as Example 7A. Doctor A creates two new S Corporations. S Corporation 2 which will do the billing for S Corporation 1. S Corporation 2 which will provide professional services such as administration, purchasing, billing paying and hiring non-licensed professionals for S Corporation 1. These types of organizations are know by many names such as Professional Service Organizations (PSO), Professional Employer Organizations (PEO), Management or Medical Service Organizations (MSO), Dental Service Organization (DSO) and etc.

To make the math simple, assume the only expenses S Corporations 2 and 3 have are the employees that used work for S Corporation 1 to the billing, $50,000, and the non-licensed employees, $100,000. Thus, S Corporation’s 1 salaries and wages expense will decrease by $150,000 ($50,000 + $100,000) because going forward they will be paid by S Corporations 2 and 3.

S Corporation 1 pays fair market fees to S Corporation 2 of $100,000 and $200,000 to S Corporation 3 for the services that they provide it. S Corporation 1 now has a net income of $350,000 ($500,000 - $100,000 - $200,000 + $150,000). Assume S Corporation 2 pays $50,000 in wages so its net income is $50,000 ($100,000 - $50,000) and S Corporation 3 pays $100,000 in wages so its net income is $100,000 ($200,000 - $100,000).

Doctor A’s federal tax liability will be approximately $178,400.

By “spinning-off” the activities of his or her medical/dental practice into three separate entities that two qualify as a qualified trade or business, Doctor A was able to reduce his or her federal tax liability by approximately $11,100.

The above structure is not limited to medical or health professionals. Law firms can do the same. Real estate management companies can “spin off” the janitorial and repair divisions into separate entities. Financial planners can hire their spouses to provide them with administrative services and etc.

The “spin off” division would take the position that because its new business not in the field of health, it is not a specified service trade or business. The IRS could craft regulations which provide that administrative and support services provided to a specified service trade or business are treated as the provision of services in that same specified service trade or business. If this were the case, rendering administrative and support services to a doctor group would be treated as services provided in the field of health, converting that business from a qualified to a disqualified or specified service trade or business.

Furthermore, you need to take into account the cost, management & etc. associated with opening new entities.

Option 3 - Perhaps a safer alternative is for a specified service trade or business - for example, a doctor - forms a new LLC that purchases the building it currently leasing, which then rents the building to the medical practice at the highest justifiable rate. It is unlikely future regulations would deny such a structure, provided the rent were fairly valued, because, in this example, it is property, rather than services, that is being provided to a specified service trade or business.

Example 7C:    Same facts as Example 7B. However, Doctor A purchases the building he or she practices out of for $5M. Assume the rent that was paid to the old landlord, $60,000 per year, is now paid to Doctor A’s LLC. Assume the LLC has no other income, expenses or employees.

                            The LLC qualifies for the deduction it even though it has no employees. The tentative deduction is 20% of the qualified business income, $12,000 ($60,000 x 20%). Or the lesser of:

1. 50% of the W-2 wages paid, which is zero or,
2. The sum of 25% of the W-2 wages, zero, plus 2.5% of the unadjusted tax basis which is $125,000 ($5M x 2.5%).

Thus the deduction is $12,000.

Advantages & Disadvantages S Corporation versus Sole Proprietorships – The following are the advantages of conducting your business through an S Corporation versus a sole proprietorship:

1. Payroll Tax Savings – S Corporations pay payroll taxes on the wages paid to its shareholder/employee(s). Sole proprietorships pay payroll taxes on the net income of the business. Payroll tax is made up of:

1. Social Security or FICA – 12.4% on the first $128,400 of wages and
2. Medicare – 2.9% and there is no limit.
3. Hospital Insurance (HI) - 0.9% of wages over $250,000 for married and $200,000 for single.

Example 8A:    Taxpayer is single and the sole shareholder/employee of his or her S Corporation. Its net income is $330,000 before wages. The S Corporation pays the taxpayer wages of $80,000. Taxpayer will pay the following payroll taxes:

                            $9,920 in Social Security or FICA – 12.4% x 80,000

                            $2,320 in Medicare – 2.9% x $80,000

                            $0 in Hospital Insurance

                            Total payroll tax paid by the taxpayer is $12,240.

Example 8B:    Same facts as above except that the taxpayer is a sole proprietorship. Thus, its net income is $330,000. Taxpayer will pay the following payroll taxes:

                            $15,923 in Social Security or FICA – 12.4% x $128,400

                            $9,571 in Medicare – 2.9% x $330,000

                            $943 in Hospital Insurance - .9% x ($330,000 – $200,000 - $15,922 - $9,570)

Total payroll tax paid by the taxpayer is $26,437. By being an S Corporation and receiving a reasonable compensation the taxpayer saved $14,197 ($26,437 - $12,240) in payroll taxes.

In Example 4B, A the sole proprietorship received a bigger deduction than B the sole shareholder/employee of the S Corporation. However, you have to take into account the additional payroll tax cost to accurately calculate if there is a tax savings as a sole proprietorship.

1. Liability Protection – Generally S Corporations provide liability protection to their shareholders. A sole proprietor is liable for his or her business. This is a legal issue and it should be discussed with an attorney.
2.  
3. Audit Protection – S Corporations have the least chance of being audited by IRS. Sole proprietors have a higher chance.
4.  

The following are the disadvantages of conducting your business through an S Corporation versus a sole proprietorship:

1. Incorporation Fee – There is a one-time fee to incorporate with the Secretary of State.
2.  
3. Annual Minimum Franchise Tax – State a California charges the greater of $800 or 1.5% of the S Corporation’s net income as a franchise tax. Thus, at minimum you will pay $800 a year in franchise tax.
4.  
5. Quarterly & Annual Federal and State Payroll Tax Returns – You have to file quarterly and annual federal and state payroll tax returns.
6.  
7. Annual S Corporation Income Tax Returns – You have to file annual federal and California S Corporation income tax returns. Furthermore, you need to keep separate books and records for the corporation. Therefore, you should have some kind of a bookkeeping system implemented.

We are able to provide you with any and all of the services listed above. We can incorporate your business, provide bookkeeping services, prepare the required quarterly and annual payroll tax returns and prepare your annual S Corporation income tax returns.

Gain on the Sale of Depreciable Asset Used in a Trade or Business, Section 1231 Gain – The law is silent on the treatment of the gain when you sell an asset that you have used in your trade or business for more than one year. This is called a Section 1231 gain.

Is the gain qualified business income? Since Section 1231 asset is specifically excluded from the definition of a capital asset it seems like until guidance from the IRS provides otherwise, it is reasonable to include the gains and losses in qualified business income.

Like-Kind Exchanges - Regulations will provide rules for determining the unadjusted basis immediately after acquisition of qualified property acquired in like-kind exchanges or involuntary conversions.

Tiered Entities - Future regulations will provide guidance on how to determine the deduction in the case of tiered entities.

Commonly Controlled Entities - At present, the law does not allow for an allocation of the W-2 wages paid by the management company to each of the operating companies. As a result,

assuming the shareholders of the operating companies have taxable income exceeding the threshold amounts, they would be precluded from claiming a deduction, courtesy of the W-2 limitations. Similar problems arise in the case of employees leased through a professional

employer organization (PEO) or employee leasing firm.

Increased Exposure to Underpayment Penalty - Generally, for taxpayers other than C corporations, the understatement is substantial if its amount for the tax year exceeds the greater of:

• 10% of the tax required to be shown on the return for the tax year; or
• $5,000

Under the new law, substantial understatement penalty is applied when:

• 5% of the tax required to be shown on the return for the tax year; or
• $5,000

This lower threshold is particularly harsh, given the lack of guidance surrounding key aspects of this new law and the resulting challenges taxpayers and their advisers face in implementing the

provision. Importantly, the changes do not require the substantial understatement to be attributable to the qualified business income deduction. Thus, any taxpayer who claims the deduction will be subject to the lower threshold, even if the understatement on the return is unrelated to the qualified business income deduction.

Conclusion - While the purpose of the deduction is clear, its statutory construction and legislative text is anything but clear. The provision is rife with limitations, exceptions to limitations, phase-ins and phase-out’s, and critical but poorly defined terms of art. As a result, the new law has created ample controversy since its enactment, with many tax advisers anticipating that until further guidance is issued, the uncertainty surrounding the provision will lead to countless disputes between taxpayers and the IRS. Adding concern is that, despite the ambiguity inherent in the law, Congress saw fit to lower the threshold at which any taxpayer claiming the deduction can be subject to a substantial understatement penalty.

Right now is a great time for tax planning and creating an analysis specific to your business to determine if you qualify for the deduction. If you do not qualify for the deduction we can advise you on other options that may be available to you. Please do not hesitate to call us.

The information within this email is an accumulation from many sources; especially, Parker Tax Pro Library and The Tax Adviser April 2018 issue.

President Trump signed into law the first two phases of the House’s coronavirus economic response package. Meanwhile, the Senate has been developing and negotiating "much bolder" phase three legislation.

President Trump signed into law the first two phases of the House’s coronavirus economic response package. Meanwhile, the Senate has been developing and negotiating "much bolder" phase three legislation.

Families First Coronavirus Response Act
The House had sent its Families First Coronavirus Response bill (HR 6201) and accompanying technical corrections resolution to the Senate on the evening of March 16. "I have decided we are going to vote…on the bill that came over from the House, and send it to the president for his signature," Senate Majority Leader Mitch McConnell, R-Ky., told reporters during a March 17 press briefing. "A number of my members think there are a number of shortcomings in the bill, and I counsel them to gag and vote for it anyway… and address those shortcomings in the next measure."

Senate Democrats were largely pleased with leadership’s decision to pass the House bill without amending it, while moving forward on additional legislation. "We will have other opportunities to legislate," Senate Minority Leader Chuck Schumer, R-N.Y., said from the Senate floor on the morning of March 17.

President Trump signed the Families First Coronavirus Response Act ( P.L. 116-127) into law on the evening of March 18.

Paid Leave Credits
The Families First Coronavirus Response Act increases funding for COVID-19 testing, and extends paid sick leave to employees all over the country affected by the pandemic. Under the new law, employers with fewer than 500 employees and government employers must provide paid sick leave to employees who are forced to stay home due to illness, quarantining, or caring for a family member because of COVID-19, or to care for a son or daughter if the school or place of care is closed due to COVID-19.

The new law compensates non-governmental employers for the required paid leave with refundable credits against the employer’s portion of the Old-Age, Survivors, and Disability Insurance (OASDI) payroll tax or the Railroad Retirement Tax Act (RRTA) Tier 1 payroll tax, as appropriate. It also provides similar credits for paid leave "equivalent amounts" to self-employed individuals affected by COVID-19.

Paid sick leave credit. For an employee who is unable to work because of a COVID-19 quarantine or self-quarantine, or who has COVID-19 symptoms and is seeking a medical diagnosis, eligible employers may receive a refundable sick leave credit for sick leave at the employee's regular rate of pay, up to $511 per day and $5,110 in total, for a total of 10 days. For an employee who is caring for someone with COVID-19, or is caring for a child because the child's school or child care facility is closed, or the child care provider is unavailable, due to the COVID-19, eligible employers may claim a credit for two-thirds of the employee's regular rate of pay, up to $200 per day and $2,000 in total, for up to 10 days.

Paid family care (child care) leave credit. For an employee who is unable to work because of a need to care for a child whose school or child care facility is closed, or whose child care provider is unavailable, due to the COVID-19, eligible employers may receive a refundable family care (child care) leave credit. This credit is equal to two-thirds of the employee's regular pay, up to $200 per day and $10,000 in total. Up to 10 weeks of qualifying leave can be counted towards the child care leave credit.

Phase Three
"That legislation [the Families First Coronavirus Response Act] was hardly perfect. It imposes new costs and uncertainty on small businesses at precisely the most challenging moment for small businesses in living memory," Senate Majority Leader McConnell said from the Senate floor on March 19. "So the Senate is even more determined that our legislation cannot leave small business behind."

The phase three measure under consideration includes several key components, such as:

• new federally-guaranteed loans for small businesses;
• direct financial help/emergency tax relief;
• targeted lending to industries of national importance; and
• health resources for those working on the front lines of combating COVID-19.

"The small business relief will help. And so will a number of additional tax relief measures, which will be designed to help employers maintain cash flow and keep making payroll," McConnell said. He also highlighted Republicans’ focus of putting "cash in the hands of the American people…from the middle class on down."

To that end, Treasury Secretary Steven Mnuchin reportedly said on March 19 that the forthcoming economic stimulus package would deliver $1,000 to every U.S. adult and $500 for every child. Further a second round of checks in the same amount would go out to individuals six weeks later, Mnuchin added.

"Americans need cash now and the president wants to get cash now. And I mean now, in the next two weeks," Mnuchin said at the White House.

Meanwhile, Senate Minority Leader Schumer has continued discussions with Senate Republicans and the Trump administration. As this Issue went to press, it still remained unclear how quickly Democrats and Republicans will reach consensus on the phase three measure.

"We don’t want bailouts unless they are used for workers, unless the industries keep all their employees, unless they don’t cut salaries of their employees, and unless they are not allowed to buy back their own stocks or raise corporate salaries," Schumer said in a March 19 tweet.

"At President Trump’s direction, we are moving Tax Day from April 15 to July 15," Treasury Secretary Steven Mnuchin said in a March 20 tweet. "All taxpayers and businesses will have this additional time to file and make payments without interest or penalties."

"At President Trump’s direction, we are moving Tax Day from April 15 to July 15," Treasury Secretary Steven Mnuchin said in a March 20 tweet. "All taxpayers and businesses will have this additional time to file and make payments without interest or penalties."

The Treasury and IRS officially announced the extension on March 21 (IR-2020-58; more details can be found in Notice 2020-18).

The move to extend this year’s tax filing deadline to July 15 follows the IRS’s formal announcement that certain 2019 tax year payments could be deferred without interest or penalties (see "Due Date for Federal Income Tax Payments Extended to July 15" in this Issue).

File as Usual if a Refund is Expected
"Working with our members, state societies, and tax professionals everywhere, AICPA scored a victory in the extension of the tax filing deadline to July 15, 2020," the American Institute of CPAs (AICPA) said in a March 20 tweet. However, the AICPA noted that it still encourages taxpayers to file their returns as soon as possible so that refunds can stimulate the economy.

"The AICPA understands the need for economic stimulus and, if possible, those who can file and get refunds should do so now," AICPA president and CEO Barry Melancon said in a statement.

Similarly, Mnuchin also encouraged taxpayers to file their returns, if possible. "While I still encourage taxpayers who expect to get a refund to file their taxes, this deadline extension will give everyone maximum flexibility to do what is best for them."

See Tax Filing and Tax Payment Relief for Coronavirus/COVID-19 Pandemic for a summary of filing and payment delays allowed by the federal and state governments.

The Treasury Department and IRS have extended the due date for the payment of federal income taxes otherwise due on April 15, 2020, until July 15, 2020, as a result of the ongoing coronavirus (COVID-19) emergency. The extension is available to all taxpayers, and is automatic. Taxpayers do not need to file any additional forms or contact the IRS to qualify for the extension. The relief only applies to the payment of federal income taxes. Penalties and interest on any remaining unpaid balance will begin to accrue on July 16, 2020.

The Treasury Department and IRS have extended the due date for the payment of federal income taxes otherwise due on April 15, 2020, until July 15, 2020, as a result of the ongoing coronavirus (COVID-19) emergency. The extension is available to all taxpayers, and is automatic. Taxpayers do not need to file any additional forms or contact the IRS to qualify for the extension. The relief only applies to the payment of federal income taxes. Penalties and interest on any remaining unpaid balance will begin to accrue on July 16, 2020.

Dollar Limits
The due date for making federal income tax payments otherwise due on April 15, 2020, for any taxpayer is automatically extended until July 15, 2020. The extension is limited to a maximum amount:

• up to $1 million for individuals, regardless of filing status, and other unincorporated entities such as trust and estates; and
• up to $10 million for each C corporation that does not join in filing a consolidated return or for each consolidated group.

Federal Income Tax Payments Only
The relief is available for federal income tax payments, including payments of tax on self-employment income, otherwise due on April 15, 2020. Thus, it applies to the payment of federal income taxes for the 2019 tax year, as well estimated income tax payments for the 2020 tax year that are due on April 15, 2020. The extension is not available for the payment or deposit of any other type of federal tax.

Taxpayers are urged to check with their state tax agencies for details on any delays in filing and payment state taxes.

Penalties and Interest
Any interest, penalty, or addition to tax for failure to pay federal income taxes postponed will not begin to accrue until July 16, 2020. The period from April 15, 2020, to July 15, 2020, will be disregarded but only for interest, penalties, or additions to tax up to maximum dollar amounts ($1 million or $10 million as applicable).

Interest, penalties, and additions to tax will continue to accrue from April 15, 2020, on the amount of any federal income tax in excess of the maximum dollar amounts. Taxpayers subject to penalties or additions to tax that are not suspended may seek reasonable cause under Code Sec. 6651 for failure to pay tax.

Individuals and certain trusts and estates may also seek a waiver to a penalty under Code Sec. 6654 for failure to pay estimated income taxes. Similar relief is not available for estimated tax payments by corporations or tax-exempt organizations for the penalty under Code Sec. 6655.

The IRS has provided emergency relief for health savings accounts (HSAs) and COVID-19 health plans costs. Under this relief, health plans that otherwise qualify as high-deductible health plans (HDHPs) will not lose that status merely because they cover the cost of testing for or treatment of COVID-19 before plan deductibles have been met. In addition, any vaccination costs will count as preventive care and can be paid for by an HDHP.

The IRS has provided emergency relief for health savings accounts (HSAs) and COVID-19 health plans costs. Under this relief, health plans that otherwise qualify as high-deductible health plans (HDHPs) will not lose that status merely because they cover the cost of testing for or treatment of COVID-19 before plan deductibles have been met. In addition, any vaccination costs will count as preventive care and can be paid for by an HDHP.

HSAs and HDHPs
Eligible individuals can deduct contributions to HSAs. One requirement to qualify as an individual is to be covered under an HDHP and have no disqualifying health coverage. An HDHP is a health plan that satisfies certain requirements, including requirements with respect to minimum deductibles and maximum out-of-pocket expenses.

COVID-19 Relief
A health plan that otherwise satisfies the HDHP requirements will not fail to be an HDHP merely because it provides medical care services and items purchased related to testing for and treatment of COVID-19 prior to satisfaction of the applicable minimum deductible. As a result, the individuals covered by such a plan will not fail to be eligible individuals merely because of the provision of health benefits for testing and treatment of COVID-19.

This relief provides flexibility to HDHPs to provide health benefits for COVID-19 testing and treatment without application of a deductible or cost sharing. Individuals participating in HDHPs or any other type of health plan should consult their particular health plan regarding health benefits for COVID-19 testing and treatment provided by the plan, including the potential application of any deductible or cost sharing.

Caution. The IRS states that this relief applies only to HSA-eligible HDHPs. Employees and other taxpayers in any other type of health plan should contact their plan with specific questions about what their plan covers.

The American Institute of CPAs (AICPA) has requested additional guidance on tax reform’s Code Sec. 199A qualified business income (QBI) deduction.

The American Institute of CPAs (AICPA) has requested additional guidance on tax reform’s Code Sec. 199A qualified business income (QBI) deduction.

199A Deduction Guidance
The IRS issued final and proposed regulations in February 2019 on the Code Sec. 199A QBI deduction enacted in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). Additionally, the IRS later issued Frequently Asked Questions (FAQs) on the computation of QBI and instructions to Form 8995, Qualified Business Income Deduction Simplified Computation, and Form 8995-A, Qualified Business Income Deduction.

However, taxpayers and practitioners need additional related guidance, according to the AICPA. "We urge that you provide additional certainty regarding which deductions are not reductions for QBI," the AICPA wrote in a March 4 letter addressed to David Kautter, Treasury’s assistant secretary for tax policy, and Michael J. Desmond, IRS chief counsel. The letter was released by AICPA on March 6.

In brief, the AICPA recommends that Treasury and the IRS confirm that the deductible portion of self-employment tax under Code Sec. 164(f), the deduction for self-employed health insurance under Code Sec. 162(l), and the deduction for contributions to qualified retirement plans under Code Sec. 404 are not automatically reductions of QBI. Additionally, it recommends that the IRS update form instructions to reflect the same treatment for a charitable deduction under Code Sec. 170.

199A Rules Under Review
Meanwhile, the White House’s Office of Information and Regulatory Affairs (OIRA) is currently reviewing Code Sec. 199A rules as related to guidance on computations for shareholders of real estate investment trusts (REIT). OIRA received the rules from Treasury on March 5, according to its website.

The IRS has issued guidance that:

• exempts certain U.S. citizens and residents from Code Sec. 6048 information reporting requirements for their transactions with, and ownership of, certain tax-favored foreign retirement trusts and foreign nonretirement savings trusts; and
• establishes procedures for these individuals to request abatement or refund of penalties assessed or paid under Code Sec. 6677 for failing to comply with the information reporting requirements.

The IRS has issued guidance that:

• exempts certain U.S. citizens and residents from Code Sec. 6048 information reporting requirements for their transactions with, and ownership of, certain tax-favored foreign retirement trusts and foreign nonretirement savings trusts; and
• establishes procedures for these individuals to request abatement or refund of penalties assessed or paid under Code Sec. 6677 for failing to comply with the information reporting requirements.

The guidance is effective as of the date the revenue procedure is published in the Internal Revenue Bulletin, and applies to all prior open tax years, subject to the limitations under Code Sec. 6511.

Reporting on Foreign Trusts
Code Sec. 6048 generally requires annual information reporting of a U.S. person’s transfers of money or other property to, ownership of, and distributions from, foreign trusts. Reporting is not required, however, for transactions with foreign compensatory trusts described in Code Secs. 402(b), 404(a)(4), or 404A. Further, the IRS is authorized to suspend or modify any Code Sec. 6048 reporting requirement if the United States has no significant tax interest in obtaining the required information.

Reporting Relief
The Treasury and IRS have determined that U.S. individuals should be exempt from the Code Sec. 6048 reporting requirement for certain tax-favored foreign trusts because:

• the trusts are generally subject to written restrictions (e.g., contribution limitations, conditions for withdrawal, and information reporting) by the laws of the country where the trust is established; and
• U.S. individuals with an interest in these trusts may be required by Code Sec. 6038D to separately report information about their interests in accounts held by or through the trusts.

A foreign trust covered by this guidance is a trust established under a foreign jurisdiction’s law to operate exclusively or almost exclusively to provide, or earn income for the provision of, either pension or retirement benefits and ancillary or incidental benefits, or medical, disability, or educational benefits. To be eligible for coverage, the foreign trust must meet other requirements listed in the guidance that have been established by the laws of the trust’s jurisdiction.

An eligible individual:

• must be compliant with all requirements for filing a U.S. federal income tax return for the period he or she was a U.S. citizen or resident; and
• to the extent required by U.S. tax law, must have reported as income any contributions to, earnings of, or distributions from, an applicable tax-favored foreign trust on the return or an amended return.

Penalty Relief
Eligible individuals who have been assessed a penalty for failing to comply with Code Sec. 6048 for an applicable tax-favored foreign trust and want relief must complete Form 843, Claim for Refund and Request for Abatement. The individual must write "Relief pursuant to Revenue Procedure 2020-17" on Line 7 of the form, and explain how the individual and the foreign trust meet the requirements in the guidance. The form should be mailed to Internal Revenue Service, Ogden, UT 84201-0027.

Scope
This guidance does not affect:

• any reporting obligations under Code Sec. 6038D or any other provision of U.S. law, including the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR);
• the exception from reporting for distributions from certain foreign compensatory trusts (Section V of Notice 97-34, 1997-1 C.B. 422); or
• the exception from information reporting requirements for certain Canadian retirement plans ( Rev. Proc. 2014-55, I.R.B. 2014-44, 753).

Proposed Regs
The Treasury and IRS intend to issue proposed regulations that would modify the information reporting requirements to exclude eligible individuals’ transactions with, or ownership of, applicable tax-favored foreign trusts. The Treasury and IRS request comments about these and other similar types of foreign trusts that should be considered for an exemption from Code Sec. 6048 reporting.

The Treasury and IRS have adopted as final the 2016 proposed regulations on covered assets acquisitions (CAAs) under Code Sec. 901(m) and Code Sec. 704. Proposed regulations issued under Code Sec. 901(m) are adopted with revisions, and the Code Sec. 704 proposed regulations are adopted without revisions. The Code Sec. 901(m) rules were also issued as temporary regulations. The CAA rules impact taxpayers claiming either direct or deemed-paid foreign tax credits.

The Treasury and IRS have adopted as final the 2016 proposed regulations on covered assets acquisitions (CAAs) under Code Sec. 901(m) and Code Sec. 704. Proposed regulations issued under Code Sec. 901(m) are adopted with revisions, and the Code Sec. 704 proposed regulations are adopted without revisions. The Code Sec. 901(m) rules were also issued as temporary regulations. The CAA rules impact taxpayers claiming either direct or deemed-paid foreign tax credits.

Covered Asset Acquisitions
The CAA rules are designed to address transactions that result in a basis difference for U.S. and foreign income tax purposes. In a CAA, the disqualified portion of any foreign income tax determined with respect to income or gain attributable to relevant foreign assets (RFAs) is not taken into account in determining direct or indirect foreign tax credits. Foreign taxes that are disqualified for foreign tax credit purposes remain eligible to be deducted.

Under Code Sec. 901(m), a CAA includes the following categories of transactions:

• a qualified stock purchase (defined in Code Sec. 338(d)(3) to which Code Sec. 338(a) applies (Code Sec. 338 CAA);
• a transaction treated as the acquisition of assets for U.S. income tax purposes and as an acquisition of stock for foreign income tax purposes;
• any acquisition of an interest in a partnership that has an election in effect under Code Sec. 754 ( Code Sec. 743(b) CAA); and
• any similar transaction determined by the Secretary of the Treasury.

An RFA is any asset, if income, deduction, gain or loss, attributable to the asset is taken into account in determining the foreign income tax.

The disqualified portion of the foreign income tax for the tax year is the ratio of:

• the aggregate base differences (i.e., excess of U.S. basis of RFA after CAA over U.S. basis before CAA) allocable to the tax year with respect to all RFAS, and
• the income on which the foreign income tax is determined.

Exemptions, Other Changes
The proposed regulations added the following three CAA transaction categories which are retained in the final regulations:

• transactions treated as an acquisition of assets for U.S. tax purposes, and as an interest in a fiscally transparent entity for purposes of foreign income tax purposes;
• transactions treated as a partnership distribution of one or more assets, the U.S. basis of which is determined under Code Sec. 732(b), Code Sec. 732(d), or which causes the U.S. basis of the partnership’s remaining assets to be adjusted under Code Sec. 734(b), provided the transaction results in an increase in the U.S. basis of one or more of the assets distributed by the partnership or retained by the partnership without a corresponding increase in the foreign basis of such assets; and
• transactions treated as an acquisition of assets for purposes of both U.S. income tax and a foreign income tax, provided the transaction results in an increase in the U.S. basis without a corresponding increase in the foreign basis of one or more assets.

The final regulations provide an exemption for CAAs if a domestic Code Sec. 901 payor or members of its consolidated group recognized the gains or losses or took into account its distributive share of the gains and losses recognized by a partnership for U.S. tax purposes as part of the original CAA. The term "aggregate base difference" is modified to take into account adjustments based on gain or loss recognized with respect to an RFA as a result of a CAA.

Under the foreign basis election in the proposed regulations, a taxpayer can elect to determine base difference as the U.S. basis in the RFA immediately after the CAA less the foreign basis in the RFA immediately after the CAA. Taxpayers may apply the election retroactively to CAAs that occurred on or after January 1, 2011, provided the remaining rules in the proposed regulations were applied retroactively. The final regulations modify the consistency requirement so that it applies only for tax years that remain open. Under a new requirement, deficiencies must be taken into account that would have resulted from the consistent application of the final regulations for a closed tax year.

The final regulations also extend the scope of the de minimis rule, under which a basis difference is not taken into account if:

• the sum of the basis differences for all RFAs is less than the greater of $10 million or 10 percent of the total U.S. basis or all RFAs after the CAA; or
• the RFA is part of a class of RFAs for which the sum of the basis differences of all RFAs in the class is less than the greater of $2 million or 10 percent of the total U.S. basis of all RFAs in the class immediately after the CAA.

An additional exclusion is added for an individual RFA with a base difference of less than $20,000.

The final regulations add a priority rule to address transactions to which both Code Sec. 901(m) and Code Sec. 909 apply. Under the rule, Code Sec. 901(m) calculations are taken into account before applying Code Sec. 909.

Tax Cut and Jobs Act changes, including the repeal of Code Sec. 902, are also reflected.

Applicability Date
The final regulations apply to CAAs occurring on or after the date the final regulations are published in the Federal Register. A taxpayer may choose to apply the regulations before they would otherwise apply, provided consistency requirements are met, for tax years open for assessment. Returns for tax years ending before the date the final regulations are published must be filed no later than one year after the publication date. For tax years not open for assessment, appropriate adjustments must be made to account for deficiencies that would have resulted from a consistent application of the rules.