#QualifiedBusinessIncome #IRS Importance of Calculating Qualified Business Income

The 2017 tax overhaul presented a new set of challenges and questions for taxpayers to deal with in preparing their returns and making financial plans.  Tara Siegel and Ron Lieber of The New York Times wrote a great article on some of the more difficult questions facing taxpayers as a result of that legislation. You can read the article here.

I want to add my input to some of the points they raise in a series of blog entries, in no order.

The first issue I want to address is that of Qualified Business Income (QBI). It applies to so many taxpayers and in my opinion is the most confusing section of the new tax law. Reviewing the IRS website addressing QBI, you can tell that this area provides fertile ground for future #IRSAudits and adjustments.

The key provision from my viewpoint is what is not QBI:

A qualified trade or business is any section 162 trade or business, with three exceptions (Specified Service Trades or Businesses or SSTB):

1.      A trade or business conducted by a C corporation.

2.     For taxpayers with taxable income that exceeds the threshold amount, specified service trades or businesses (SSTBs). An SSTB is a trade or business involving the performance of services in the fields of:

Health;

Law;

Accounting;

Actuarial science;

Performing arts;

Consulting;

Athletics;

Financial services;

Investing and investment management;

Trading; or

Dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. The principal asset of a trade or business is the reputation or skill of its employees or owners if the trade or business consists of the receipt of income from endorsing products or services, the use of an individual's image, likeness, voice, or other symbols associated with the individual's identity, or appearances at events or on radio, television, or other media formats.

The SSTB exception does not apply for taxpayers with taxable income below the threshold amount and is phased in for taxpayers with taxable income above the threshold amount. For 2018, the threshold amount is $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers. The threshold amounts will be adjusted for inflation in subsequent years.

3.     The trade or business of performing services as an employee.

The common thread in the exceptions are that they are all service based. Characterization becomes important for those taxpayers above the threshold and phased in range. Wow, can this be any more confusing? I often tell taxpayers that the tax law will occasionally present a range of positions that one can take in reporting their income and expenses. Careful analysis of case law, Revenue Rulings and practical experience provide a foundation for taking a reporting position. The more dramatic the impact on a return, the more conservative position I want to be in taking that position. With a potential $20,000 deduction at hand, QBI will impact most taxpayers in a very significant manner, making a reporting decision all that more serious.

One important side note here. Owning your own business can make obtaining credit -mortgage loans, credit cards, or car loans - more difficult than for wage earners who receive a w-2. Underwriters will rely on tax returns to verify income. From my past experience as a mortgage banker, I can tell you that underwriters at the local level and the secondary level will have a hard time comprehending a 20% non-cash deduction on a tax return and why it should be added back to taxable income when calculating gross income for use in debt service coverage ratios. Do yourself a favor and fully document the calculation of QBI. Keep it for use in future years. Not only will it assist you with any credit applications your client may have in the future, it will serve as an insurance policy in dealing will a potential #IRSAudit or #IRSNotice.