NOTE: UPDATED JAN 2, 2018
Clients and long-lost friends have been calling incessantly and I’ve been overwhelmed by emails and facebook posts since the new tax legislation was passed. Most of the questions I’m getting are on the topic of an attempt at ‘parity’ between the new, permanently lower C-corp tax rates, and the tax rates paid by sole proprietors and flow-through entities.
So thank goodness that my favorite tax writer, Tony Nitti, has done it again. He’s managed to make the most asinine, overly-complex piece of tax law comprehensible. Well, mostly. Given that the congressmen that passed the law have clearly never read any of it, there’s only so far you can go.
Tony’s recent article in Forbes, Tax Geek Tuesday: Making Sense Of The New ‘20% Qualified Business Income Deduction’, does its best to interpret, analyze, and instruct on the topic of the new mysterious 20% income deduction for flow-through entities. Tony states:
On its surface, Section 199A will allow owners of sole proprietorships, S corporations and partnerships — and yes, even stand-alone rental properties reported on Schedule E — to take a deduction of 20% against their income from the business. The result of such a provision is to reduce the effective top rate on these types of business income from 40.8% under current law to 29.6% under the new law (a new 37% top rate * a 20% deduction= 29.6%).
Courtesy of this new deduction, sole proprietors and owners of flow-through businesses retain their competitive rate advantage over C corporations: it is 10% under current law, and will be 10% under the new law (39.8% versus 29.6%).
He reviews the following areas, being careful to note what we don’t know (given the rushed passing of this law and the lack of precedent or regulations, there’s a lot of that):
- Overview of the QBI Deduction
- Qualified Business Income
- W-2 Limitations
- Exception to W-2 Wage Limitations
- Phase-In of W-2 Limitations
- Treatment of “Specified Service Trades or Businesses”
- Phase-Out of Deduction for Specified Service Businesses
- Ancillary Issues
He somehow manages to do this all with illustrations using various scenarios and examples, and above all — humor. Again, he stresses that “Section 199A, however, is in its infancy. We don’t have regulations.” There are “definitional debates” all over the internet already… and without any precedent from court cases on some of the related topics, we’re likely to see a lot of loopholes until this section makes its way through the justice system.
At 10,000 words, it’s a long one, but it’s worth the read. This is the shortest, clearest, and most entertaining description I’ve seen so far of this particularly messy section of the new tax code. As Tony says, “with no regulations, no form instructions, and most unfortunate of all, no one who helped craft the bill or vote on the thing who actually understands what it says, it may be a while before clarity is forthcoming.”
UPDATE: January 2, 2018 — some clarity and additional explanation of complex areas came out in another Nitti article, a follow-up to the one noted above, in which he interviews a former IRS attorney about this new section of the law. It fills in some gaps in the last article, and the two of them discuss additional potential issues, as well as a timeline for technical corrections. My biggest take-away is that this thorny section of the code will be causing us all massive headaches well into 2019.