With the recent changes to the U.S. tax code, we’ve had several small business owners ask us how this will affect them when they complete their 2018 taxes. They know that the Tax Cuts and Jobs Act (TCJA) has shaken things up, and they want to make sure they’re maximizing their deductions.
In July, we covered the Top 8 Provisions of the Tax Cuts and Jobs Act, the latest revision to United States tax law. The question we’ve received most frequently since then is about Section 199A, which allows small business owners a new deduction. And in October 2018, the IRS made clarifications and updates to the TCJA, changing some of the details from the blog earlier this year. As such, we’ve put together an overview of the basics of Section 199A as well as the IRS’ clarifications regarding work meals and holiday parties.
How Small Business Owners Can Use Section 199A to Save Money
The TCJA contains a new deduction for business owners of entities taxed on a “pass-through” basis. It is called the Qualified Business Income Deduction (QBID), the deduction is included Section 199A of the TCJA. This deduction allows certain business owners to deduct up to 20% of their qualified business income (QBI) on their personal tax income tax return.
So, for example, if you own a furniture store that qualifies for the deduction with QBI of $10,000 during the year, you will be able to claim up to a 20% of QBI, or $2,000 as a deduction on your personal income tax return, provided you meet all of the other criteria to claim the deduction. However, this is a simple example and many factors can make the calculation more complex.
Some believe that Section 199A will help businesses taxed on a pass-through basis keep pace with the corporate income tax rate reductions written into the TCJA. However, it can be challenging to know who can utilize (or qualify for) Section 199A deductions, and how much income they can deduct.
Who qualifies for the 20% QBID deduction?
Under Section 199A, owners of businesses who are taxed as pass through entities such as S-corporations, partnerships, trusts, and sole proprietors who operate a qualified trade or business with qualifying business income are able to claim the QBID. Qualified business income includes business income related operations in the United States of America, however it does not include the business’s investment income, such as interest income, dividend income, capital gain/loss or other investment-related income.
Also, owners of certain “specified service trade or businesses” may qualify for the deduction, depending on their taxable income. Specified service trade or businesses include professionals in the fields of health, law, accounting, performing arts, athletics, financial, brokerage, etc.
To qualify for the simplest calculation of QBID, the taxpayer’s taxable income must be less than $157,500 or $315,000 if filing jointly. If your taxable income is above $157,500, or $315,000 if filing jointly, there are complicating factors that may be included in your QBID calculation, including a phase out range, wages paid by your business, and qualified business property in service. If you are the owner of a specified service trade or business, as mentioned in the previous paragraph (lawyer, accountant, etc.), and your taxable income is more than $207,500 or $415,000, if filing jointly, you will not qualify for the QBID.
Keep in mind that there are some complicating limitations within Section 199A. Other considerations in the calculation of QBID include being the owner of more than one business and how to account for business losses. Another issue is whether rental activities qualify for the deduction. The IRS has issued some guidance regarding rentals, however, the guidance is limited to certain rental situations. Most experts agree that additional IRS guidance is needed to clarify some provisions of Section 199A, so we recommend you consult an accountant if you’re planning to take advantage of Section 199A.
October 2018 changes: meal and entertainment deductions for businesses
As mentioned earlier, the IRS also recently provided more explanation as to what percent of work meals, client meals, and holiday parties are tax deductible. Entertainment expenses, such as a football game, Broadway show, or a membership to a social club are not deductible. However, business meals with clients are 50% deductible with the proper documentation. Business meals while out of town, business meals for the convenience of the employer and company parties are also deductible at 50%. If you have an event that involves entertainment and business meals, the entertainment portion of the event is not deductible, however the meal portion of the event is 50% deductible if billed separately. The IRS continues to provide explanations of current tax law throughout the year, so expect more updates, alterations and clarifications to the TCJA in 2019. Remember, especially because the TCJA has left many taxpayers confused, seeking a personal tax advisor will help you make sure you’re preparing and filing your taxes correctly. Working with a tax advisor will also empower you to maximize the deductions available to you.
Looking for an accountant or CPA to complete your small business’ 2018 taxes in the new year? Contact us today to see how we can help!