Tax reform: Clearing up 2 key areas, 2 years in
December 5, 2019
By Josh Miller, CPA
We're coming up on the second anniversary of the signing of the Tax Cuts and Jobs Act. With one filing season under our belts, some questions have been answered while many remain.
When it comes to the impact of the TCJA on businesses, we're happy to provide greater clarity in the Qualified Business Income deduction and the treatment of fixed assets.
The never-ending story - the QBI deduction
You might think you've read everything out there on QBI but, as is the norm with new legislation, there's always something to clear up. Let's get beyond the basics of QBI and clear up four key points:
Wages: The QBI deduction often is limited to 50% of W-2 wages. Even if you're a fiscal year filer, you're limited to the wages reported on your calendar year W-3. As such, wage expense might differ significantly from the wages paid for QBI purposes, but the guidance does make the calculation easily verifiable. Remember, in partnerships or sole proprietorships, W-2 wages for owners are impermissible, thus favoring the S Corporation choice of entity.
Rentals: The safe harbor by which rental activities are automatically QBI eligible is determined at the owner level and requires 250 hours of activity within the rentals of that person/entity by the owner or owner's agent. Rentals might be eligible for the deduction without this safe harbor election based on various facts and circumstances. Note that landlords have typically not issued 1099s to subcontractors. However, if you determine your rental activity constitutes a trade or business (thus eligible for this QBI deduction), you are required to issue 1099s.
Previously disallowed losses: If losses from activities were disallowed and carried over from tax years ending in 2017 or before because of either passive activity, at-risk limitations or basis in your ownership interest, guidance provided states those were to be taken on a first-in first-out (FIFO) basis from the earliest carryover to the most recent. In other words, if losses were incurred in tax years ending prior to 2018, they do not reduce QBI from that activity. Conceivably, you might have zero taxable income from an activity (due to loss carryovers) and qualify for a QBI deduction.
Aggregation: The election to aggregate activities is used to share wages or assets to qualify for the full 20% deduction on business income earned in separate activities. Common ownership is the main requirement, meaning at least 50% of ownership of each activity must be within the same family. The activities also must satisfy at least two of the following:
- Provide similar products and services.
- Share facilities or management.
- Operate in coordination with, or reliance upon, one another (for example, supply chain interdependencies).
The land of opportunity - fixed assets
To understand the opportunities in the treatment of fixed assets, let's take a closer look at four main areas:
Section 179: The maximum deduction for Section 179 increased this year to $1.02 million with the phase-out increased to $2.55 million of purchased assets. Important to note is the relationship between your state's treatment of the deduction. For example, Wisconsin and Illinois typically allow the full federal deduction while Iowa limits the deduction to $100,000 for 2019 (will match federal in 2020).
Bonus depreciation: Bonus depreciation remains at 100% of cost of assets with no maximum. Bonus depreciation now only requires the asset be original use to the taxpayer not original use, overall. Again, don't neglect state ramifications. Iowa and Wisconsin do not allow bonus depreciation, but Illinois allows the complete deduction.
Qualified Improvement Property (QIP): QIP relates to improvements to real property after that property has been place in service. The authors of the TJCA clearly intended QIP to be 15-year property and eligible for bonus depreciation, however, in the haste to draft and pass the regulations, the 15-year life never was specified, and QIP thus defaults to a 39-year life and is ineligible for bonus depreciation. Taxpayers can elect to expense QIP under Section 179, but this deduction can only reduce income from an activity to zero whereas bonus depreciation can reduce income from an activity below zero.
Like kind exchanges: A like kind exchange allows a taxpayer to defer gain on the sale of an asset by investing the proceeds in a similar asset. Real property remains eligible for like kind exchange treatment; however, personal property is no longer eligible. Personal property includes vehicles, equipment and virtual currencies.
While we're able to see tax reform through a clearer lens after one filing season, there's more to come. We look forward to further guidance and rulings and are reminding clients that proactive tax planning remains key to navigating the ever-changing landscape.
This article was previously published in the Tri-State bizTimes.