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Business Tax

IRS releases draft forms to compute qualified business income deduction

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

Draft 2019 Form 8995 (Qualified Business Income Deduction Simplified Computation)

Draft 2019 Form 8995-A (Qualified Business Income Deduction)

IRS has released two draft forms which are to be used to compute the qualified business income deduction under Code Sec. 199A. The draft forms are Form 8995 (Qualified Business Income Deduction Simplified Computation) and Form 8995-A (Qualified Business Income Deduction).

Background. in general, for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, Code Sec. 199A, as added by the Tax Cuts and Jobs Act (TCJA), allows a deduction to a non-corporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship. The deduction is the lesser of: (a) the “combined qualified business income amount” of the taxpayer, or (b) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the net capital gains. (Code Sec. 199A(a))

The “combined qualified business income amount” means, for any tax year, an amount equal to: (i) the deductible amount for each qualified trade or business of the taxpayer (defined as the lesser of (a) 20% of the taxpayer’s QBI or (b) the greater of two W-2 wage limits, one of which also looks to the unadjusted basis of certain tangible, depreciable “qualified property”); plus (ii) 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year. (Code Sec. 199A(b))

QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer. (Code Sec. 199A(c)(1)) For this purpose, qualified items of income, gain, deduction, and loss are items of income, gain, deduction, and loss to the extent these items are effectively connected with the conduct of a trade or business within the U.S. under Code Sec. 864(c) and included or allowed in determining taxable income for the year. If the net amount of qualified income, gain, deduction, and loss relating to qualified trade or businesses of the taxpayer for any tax year is less than zero, the amount is treated as a loss from a qualified trade or business in the succeeding tax year. (Code Sec. 199A(c)(2))

QBI does not include: certain investment items; reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered with respect to the trade or business; any guaranteed payment to a partner for services to the business under Code Sec. 707(c); or a payment under Code Sec. 707(a) to a partner for services rendered with respect to the trade or business.

Certain limitations apply to the deduction. Except as provided below, the deduction cannot exceed the greater of:

…50% of the W-2 wages with respect to the qualified trade or business (W-2 wage limit), or

…the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition (UBIA), of all “qualified property.” Qualified property is defined in Code Sec. 199A(b)(6) as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

The above limit and the disallowance of the deduction for certain specified service trades or businesses of the taxpayer does not apply for taxpayers with taxable income below the “threshold amount” ($315,000 for married individuals filing jointly, $157,500 for other individuals, indexed for inflation after 2018). The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly ($50,000 for other individuals). (Code Sec. 199A(b)(3)) Thus, for 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and other individuals with taxable income over $207,500.

Special deduction rules apply to agricultural and horticultural cooperatives and their patrons.

For 2018, IRS did not issue a tax form for taxpayers to compute their Code Sec. 199A qualified business income deduction; some taxpayers were able to use the worksheet (2018 Qualified Business Income Deduction-Simplified Worksheet) in the Instructions to the 2018 Form 1040.

Draft Form 8995. The Draft Form 8995 is comprised of one section (17 lines) with a fairly straightforward computation of the qualified business income (taking into account any real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income (or loss)). Draft Form 8995 is similar to the 2018 Qualified Business Income Deduction-Simplified Worksheet in the Instructions to the 2018 Form 1040.

Taxpayers are instructed to file Form 8995, rather than Form 8995-A, If their taxable income isn’t more than $160,700 for single and head of household returns; $160,725 if married filing separately; and $321,400 if married filing jointly, and the taxpayer isn’t a patron of an agricultural or horticultural cooperative.

Draft Form 8995-A. The Draft Form 8995-A contains four sections and four schedules covering the computation of the qualified business income deduction.

The sections are:

Part I. Trade, Business, or Aggregation Information. Taxpayers are instructed to complete Schedules A, B, C, and/or D, as applicable, before starting Part I, and to attach additional worksheets where needed. In Part I, the taxpayer is provided with three lines (A, B, and C) to: (a) list the trade, business, or aggregation name for up to three businesses, etc.; (b) check a box if the business is a specified service; (c) check a box if aggregation applies; (d) provide the business’s taxpayer identification number; and (e) check another box if the business is an agricultural and horticultural cooperative patron.

Part II. Determine Your Adjusted Qualified Business Income. This Part provides a computation of the qualified business income taking into account the general 20% limitation, the two (50% and 2.5%) W-2 wage limits, and the allocable share of UBIA of qualified property. The form allows taxpayers to skip the limitation computations If their taxable income for 2019 is $160,700 or less for single and head of household returns; $160,725 if married filing separately; and $321,400 if married filing jointly. This section also take into account the phase-in reduction, as figured in Part III, if the taxpayer’s taxable income is above these thresholds.

Part III. Phased-in Reduction. Taxpayers complete Part III only if their taxable income for 2019 is more than $160,700 but less than $210,700 for single and head of households; is more than $160,725 but less than $210,725 if married filing separately; and is more than $321,400 but less than $421,400 if married filing jointly.

The amount of the phase-in reduction is the amount that bears the same ratio to the excess amount as the amount by which the taxpayer’s taxable income for the year exceeds the threshold amount, bears to $50,000 ($100,000 for a joint return). The excess amount is the excess of 20% of the taxpayer’s QBI from a qualified trade or business (determined without regard to this rule), over the greater of 50% of W-2 wages, or 25% of W-2 wages plus 2.5% of the UBIA of qualified property (determined without regard to this rule).

Part IV. Determine Your Qualified Business Income Deduction. To determine the Code Sec. 199A deduction, taxpayers start with the total qualified business income component from all qualified trades, businesses, or aggregations from Part II, line 16. In many ways, this part resembles the Draft Form 8995’s computation of the qualified business income (taking into account REIT dividends and PTP income (or loss); capital gains; the qualified business income deduction limitation.

The Draft Form 8995-A contains four schedules:

Schedule A. Specified Service Trades or Businesses. Taxpayers are advised to complete Schedule D before beginning Schedule A. Taxpayers complete Schedule A only if their trade or business is a specified service trade or business and their taxable income is more than $160,700 but less than $210,700 for single and head of households; $160,725 but less than $210,725 if married filing separately; and $321,400 but less than $421,400 if married filing jointly. Taxpayers don’t file Form 8995-A If their taxable income isn’t more than $160,700 for single and head of households; $160,725 if married filing separately; and $321,400 if married filing jointly, and the taxpayer isn’t a patron of an agricultural or horticultural cooperative, don’t file this form; instead, they file Form 8995. Taxpayers with a specified service trade or a business with taxable income that is more than $210,700 for single and head of household returns; $210,725 if married filing separately; and $421,400 if married filing jointly) do not qualify for the QBI deduction. Schedule A includes two parts: Part I, Non-Publicly Traded Partnership, and Part II, Publicly Traded Partnership.

Schedule B. Aggregation of Business Operations.  This Schedule requires the taxpayer to provide a description of the aggregated trade or business and an explanation of the factors that allowed the aggregation in accordance with Reg. §1.199A-4. A taxpayer that holds a direct or indirect interest in a relevant pass-through entity (RPE; i.e., a partnership (other than a PTP) or an S corporation that is owned, directly or indirectly, by at least one individual, estate, or trust) that aggregates multiple trades or businesses must attach a copy of the RPE’s aggregations.

The Schedule also asks if the trade or business aggregation has changed from the prior year, including changes in the aggregation due to a trade or business being formed, acquired, disposed of, or ceasing operations. If so, the taxpayer must provide an explanation.

Schedule C. Loss Netting and Carryforward. If an individual’s QBI from at least one trade or business (including an aggregated trade or business) is less than zero, the individual must offset the QBI attributable to each trade or business (or aggregated trade or business) that produced net positive QBI with the QBI from each trade or business (or aggregated trade or business) that produced net negative QBI in proportion to the relative amounts of net QBI in the trades or businesses (or aggregated trades or businesses) with positive QBI.

If an individual’s QBI from all trades or businesses combined is less than zero, the QBI component is zero for the tax year. This negative amount is treated as negative QBI from a separate trade or business in the individual’s succeeding tax years. This carryover rule doesn’t affect the deductibility of the loss for purposes of other Code provisions.

Schedule D. Special Rules for Patrons of Agricultural or Horticultural Cooperatives (Coop). Specified agricultural or horticultural cooperatives are allowed a deduction for income attributable to domestic production activities that is similar to the domestic production activities deduction under former Section 199. Specified agricultural or horticultural cooperatives are cooperatives, to which Part I of subchapter T applies, that are engaged in the manufacturing, production, growth or extraction in whole or significant part of any agricultural or horticultural product, or in the marketing of agricultural or horticultural products.

References: For the Code Sec. 199A deduction, see FTC 2d/FIN ¶L-4305 et seq; United States Tax Reporter ¶199A4.

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