Small businesses are the major contributors to the United States' Gross Domestic Product with their share standing at more than 50%. Inherently, the vitality of these enterprises to the US economy cannot be undermined, and any tax laws should be favorable to encourage their operations (Ackermann, 2012). It is thought that the new International Revenue Service (IRS) Qualified Business Income (QBI) Deduction is a welcome relief to these small enterprises that are set to save some money concerning taxes. The new tax laws under the Tax Cuts and Job Act aims at providing a considerable tax benefit to the people with pass-through incomes. Pass-through entities are subject to a 20% deduction for their business income beginning from the 2018 tax year and ends in the 2025 tax year. As such, it is paramount to discuss the defining features of the QBI deduction.
The QBI deduction affects pass-through entities whose operations are within the United States. These are business entities that pass through their income to the owners who then report the income that they have received from these entities on their returns. Doerring (2018) defines these pass-through businesses as those that do not belong to the corporation category. Those establishments that are subject to this deduction include sole proprietorships, S corporations, and partnerships (Doerring, 2018). When the business owners receive the income, they should deduct 20% of it if the taxable income that they report on their returns is within the bounds of specific margins. These margins are defined as $315,000 for individuals filing joint returns and $157,500 for those that register their returns as single taxpayers. Any taxable income that surpasses these boundaries is subject to exclusion from QBI as longs as these businesses are in the service-provision sector including law firms and accounting firms ("A Guide to the New Qualified Business Income Deduction", 2018). Further, those with incomes above these limits are subjected to a limitation on the amount of deduction based on the wages paid plus a capital element.
Hypothetically, a self-employed taxpayer who rakes in $310,000 in profit and files jointly should deduct 20% of this profit. The deduction amounts to $62,000, and this is applied to his benefit before any other deductions are made. It means that it is not the $310,000 that is subject to taxation but the $310,000 less $62,000 for a taxable income of $248,000. Using a marginal tax rate of 32%, the QBI for the taxpayer in this example is calculated as $62,000 0.32, and this equals $19,840, and this is the amount that the QBI relieves the taxpayer. It means that those taxpayers with larger QBI's will benefit from this new directive.
Notably, business income is exclusive of salaries and wages that are paid to taxpayers as guaranteed payments or W-2 wages. The former type of payment applied to partnerships while the latter is for S corporations. Also, the QBI excludes interest income, capital gains, and dividends ("A Guide to the New Qualified Business Income Deduction", 2018). Individuals with unlimited QBI income have a top effective tax rate of about 29.8%. Those that belong to this category include business owners and investors. It is a significant departure from the initial 39.6%. A reduction in the effective tax rate means that the total earned incomes in these groups after taxation will still be high and they are likely to gain from the new QBI depending on the level of their investment. Additionally, this pass-through business tax reform significantly diminishes federal income tax.
Apparently, the prescribed wage and capital limitations may encourage individuals to understate their salaries and compensation so that their income becomes eligible for a deduction. The IRS came up with some guidelines for the operation of the QBI so that such loopholes are sealed. For instance, an underestimation of one's yearly income attracts a severe penalty for underpayment of estimated taxes. However, one can fine-tune their estimated taxes so that they can account for a reduction in taxable income. Also, shareholders and partners may be tempted to underpay themselves so that they get a more suitable business income deduction. They can do this by making guaranteed payments for services or cutting off their wages. S corporations and partnerships should exercise caution even as they consider these options since the IRS is allowed to redefine colossal profit distributions as wages. Also, the IRS, upon suspicion of such activities, can apply stupendous penalties to the understated income. Also, the IRS can re-engineer policies concerning compensation to cater for any confusion that may arise on guaranteed payments ("Wagner Law Group Dissects Possible Tax Cuts and Jobs Act Loophole | PLANADVISER", 2018).
Finally, the QBI suffers some grey areas since it is a new venture. For instance, the fate of individuals whose income increases while the W-2 wages paid are low since the business is not capital intensive is unclear. Also, it is apparent that a Specified Service Trade or Business (SSTB) is not affected by the QBI in the same way that it affects a taxpayer's whose income is not an SSTB. The IRS, therefore, should come up with succinctly defined guidelines to cater for situations where one spouse has an SSTB income and the other does not yet their combined income is significant.
Ackermann, S. (Ed.). (2012). Are small firms important? Their role and impact.
Springer Science & Business Media.A Guide to the New Qualified Business Income Deduction. (2018). Beenegarter.com. Retrieved 12 April 2018, from https://beenegarter.com/articles/a-guide-to-the-new-qualified-business-income-deduction
Doerring, E. (2018). The New Section 199A 20% "Profit Deduction" for Pass-Through Businesses: The Undecided Issue of Owner Compensation - Welcome to McNair Attorneys | Columbia SC | Tax Lawyers. Retrieved 12 April 2018, from http://sctaxlawyers.net/new-section-199a-20-profit-deduction-pass-businesses-undecided-issue-owner-compensationWagner
Law Group Dissects Possible Tax Cuts and Jobs Act Loophole | PLANADVISER. (2018). PLANADVISER. Retrieved 12 April 2018, from https://www.planadviser.com/wagner-law-group-dissects-possible-tax-cuts-jobs-act-loophole/
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