By: Brian L. Johnson, CPA
The economy is in high gear, and the tax reforms of 2017 are undoubtedly part of the reason why. If you are a motorcoach operator, it is likely that your company will benefit from a new deduction introduced by the Tax Cuts and Jobs Act, known as the qualified business income (QBI) deduction (Section 199A). Your company can benefit from the deduction if you are doing business using a pass-through entity such as an S corporation or partnership, or if you are a sole proprietor. The following is a very general overview of how the QBI deduction is calculated. You should consult with your company’s tax provider for advice specific to your company.
The new law allows for a 20 percent deduction of QBI for individuals, estates, and trusts that own partnerships, S-corps, and sole proprietorships. The deduction is generally based on business income, but it is taken against taxable income of the individual (or trust).
The IRS defines “QBI” as the net amount of qualifying items of income, gain, deduction and loss from any qualified trade or business within the U.S. QBI does not include specified investment-related income, amounts paid by an S-corp to a shareholder that are treated as reasonable compensation of the taxpayer, guaranteed payments remitted for services, and amounts paid to a partner for services outside of being a partner.
If you own more than one business, the deduction is made for each business and totaled; there is no grouping election.
The IRS uses the following analysis to determine the amount of the deduction for each business: It is the lesser of a) 20 percent of QBI, or 20 percent of taxable income. A second set of limitations applies only if your taxable income is above $315,000 for married persons filing jointly or $157,000 for all other taxpayers. The wage and property limitation limits the deduction to the lesser of (a) above or b) the amount that is the greater of 1) 50 percent of the total wages paid by the business, or 2) 25 percent of the wages of the business plus 2.5 percent of the cost qualified business property.
For example: You are the sole owner of your business, an S-corp, which has profit (or QBI) of $500,000 and pays wages to employees totaling $400,000. You and your spouse file a joint return with taxable income totaling $600,000. To calculate your QBI deduction, you first take the lower of 20 percent of QBI or taxable income ($500,000 x 20 percent = $100,000).
Because your taxable income is over $315,000, you then apply the wage and property limitation ($400,000 x 50 percent = $200,000). Because the wage limitation is higher, you are allowed the full 20 percent QBI deduction of $100,000. (If total wages paid by the company had been $150,000 instead of $400,000, your QBI deduction would have been limited to $75,000 ($150,000 x 50 percent).
One of most well-known aspects of the new law is the lowering of the C corporation tax rates from 35 percent to 21 percent. Many people have asked if the lower corporate rates make a C-corp a better choice for their business than an S-corp or partnership. The answer largely depends on how much money the owner is going to distribute from the business each year. Remember: C-corp profits are subject to “double taxation,” meaning that the corporation pays tax (at the new 21 percent rate), and then the owner pays tax on dividends paid by the company. The dividend rates did not change with the new law and remain at 15 percent and 20 percent depending on your tax bracket.
It would take a separate article to discuss the decision on choosing whether a company should be a C- or S-corp, but, generally, because the new QBI deduction lowers the tax rate for pass-through entities, these entities remain very favorable, particularly if the majority of profits will be distributed to the owner each year.
Brian L. Johnson, CPA, is a partner specializing in taxation of closely held businesses and their owners in the accounting firm SuggsJohnson in Anderson, S.C. To contact Johnson, call (864) 965-9616 or email firstname.lastname@example.org.