Sec 199A(c)(4) - sole proprietor - "reasonable compensation"

Technical topics regarding tax preparation.
#81
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I don't see anything in the law that would carve out compensation for either a sole proprietorship or a partnership. Neither can pay wages to their owners though partnerships CAN pay guaranteed payments. The term "reasonable compensation" is used only in the context of what is included in qualified business income. This is very clear for an S corporation.

Ironically for taxpayers over the threshold, S corps need W2 wages (assuming the 2.5% of depreciable property is of little benefit) to get the deduction. It actually makes sense to increase the S corp wages to the shareholder/employee in some cases as the deduction will save more tax than the wages create in payroll taxes once the payroll taxes include only medicare. for an S corp with income of $700,000 I worked out a spreadsheet and figured somewhere around 28% of income paid as wages is the crossover.
 

#82
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Texas Al wrote:I don't see anything in the law that would carve out compensation for either a sole proprietorship or a partnership. Neither can pay wages to their owners though partnerships CAN pay guaranteed payments. The term "reasonable compensation" is used only in the context of what is included in qualified business income. This is very clear for an S corporation.

Ironically for taxpayers over the threshold, S corps need W2 wages (assuming the 2.5% of depreciable property is of little benefit) to get the deduction. It actually makes sense to increase the S corp wages to the shareholder/employee in some cases as the deduction will save more tax than the wages create in payroll taxes once the payroll taxes include only medicare. for an S corp with income of $700,000 I worked out a spreadsheet and figured somewhere around 28% of income paid as wages is the crossover.



Shhhhhhhhh. We cannot confirm or deny that there are any unintended consequences anywhere here.
 

#83
Wiles  
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Texas Al wrote:The term "reasonable compensation" is used only in the context of what is included in qualified business income. This is very clear for an S corporation.

Clearly 199A(c)(4)(A) is meant to be read this way:
reasonable compensation described in section 1366(e) paid to the shareholder taxpayer by any qualified trade or business of the shareholder taxpayer for services rendered with respect to the trade or business

They were just being silly when they wrote it the vague way they did. The wanted all of us to speculate whether this use of the term reasonable compensation could apply outside of an S-corporation.

It does make me wonder why they didn't use the same vague technique on 199A(c)(4)(B). They could have written it this way and continued the silly game of making us wonder if guaranteed payments could apply to non-partnership entities.
any guaranteed payment described in section 707(c) paid to a partner taxpayer for services rendered with respect to the trade or business
Last edited by Wiles on 10-Jan-2018 3:53pm, edited 3 times in total.
 

#84
JR1  
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Right, so we're left with reading their minds. Well, no, IRS gets to. What are the odds that it'll go in the taxpayers' favor?
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#85
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Wiles wrote:
Texas Al wrote:It does make me wonder why they didn't use the same vague technique on 199A(c)(4)(B). They could have written it this way and continued the silly game of making us wonder if guaranteed payments could apply to non-partnership entities.
any guaranteed payment described in section 707(c) paid to a partner taxpayer for services rendered with respect to the trade or business


Because they left the vagueness for 199A(c)(4)(C), an issue referenced a few times up-thread:

QBI shall not include...
(C) to the extent provided in regulations, any payment described in section 707(a) to a partner for services rendered with respect to a trade or business.


Which regulations? The regulations to 199A that don't exist yet? Existing regulations around 707?

Let's say it means the 199A regulations. There are no 199A regulations. Therefore, no extent to those regulations so no adjustment necessary. Just stop it with those guaranteed payments.

Speaking of drafting code at 3:44AM on your fifth Venti - isn't it stupid that Qualified Business Income is defined as 20% of Qualified Business Income? There's (a)(1)(A) saying deduct combined QBI and (b) rambles on to make its "amount" equal 20% of QBI. In CS we used to call that recursion.
QBI = 20% X QBI
= 20% X (20% X QBI)
= 20% X (20% X (20% X QBI))
= 20% X (20% X (20% X (20% X QBI)))
...
= 0 - well now that does make it easier I guess
 

#86
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MEMCPA wrote:Just to further stir the pot: https://www.forbes.com/sites/anthonynit ... c2028c2076


This article makes sense to me. Keeps the entity classification out of the equation, and makes the deduction equal for all three choices (Sole Proprietor, Partnership, or SubS).

I have two high income (>$315K of taxable income), both engineers, that I was going to suggest moving into a SubS for 2018. Now however, depending on how this law is interpreted, I'm not sure the SubS will save them tax dollars. So frustrating.
 

#87
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I came across this white paper. Curious as to what you guys think about it, as I was looking for something to start to build my own set of guidance for discussions with my clients this year.

https://www.watsoncpagroup.com/Section199A.pdf
Site admin and software developer for TaxProTalk.com and https://TheSiteFactory.com
 

#88
JR1  
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Is this the same Watson that we have the famous compensation case on? lol
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#89
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Different firm. Google kindly pointed me to https://www.watsoncpagroup.com/kb/tax-c ... y_334.html
 

#90
JR1  
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And that white paper was written early...so I don't think it has much value at this point, even tho' we're only a few weeks later.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#91
chris  
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updated dec 31. but maybe that is still considered 'early' for this topic...
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#92
Coddington  
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Jeff-Ohio wrote:
And, under the House Bill, those items would clearly have been added back. One can argue that is what is intended in the final bill. In other words, QBI means the net amount of items of income, deduction, etc. W-2 wages are a deduction. QBI does not include reasonable compensation. Thus, the deduction for reasonable compensation is not included in calculating QBI.


Not sure why the House Bill is relevant, since it says something completely different than what was ultimately passed.



Agreed. In this situation, I do not see its relevance. Treasury generally does not act unconstrained by legislative history, especially when dealing with new laws. When providing guidance, they will look at the committee report and see that the provision was based on the Senate report. They'll look at the Senate report and see that reasonable comp is limited to S corps. They'll look at the text of similar laws and see that reasonable comp is only used in the corporate context. They will then issue guidance that limits the reasonable comp rule to S corps.
-Brian

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SourceAdvisors.com

Opinions my own.
 

#93
makbo  
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Coddington wrote:When providing guidance, they will look at the committee report and see that the provision was based on the Senate report. They'll look at the Senate report and see that reasonable comp is limited to S corps. They'll look at the text of similar laws and see that reasonable comp is only used in the corporate context. They will then issue guidance that limits the reasonable comp rule to S corps.


Are there still people at the IRS who are able to do all of the above? :twisted:
 

#94
Wiles  
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Just attended my annual Spidell update. Spidell is going so far as to replace the term "reasonable compensation" with "W-2". That would have certainly cleared all this speculation up. Just like they said "guaranteed payment paid to partner", they should say "W-2 paid to shareholder".
 

#95
Coddington  
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makbo wrote:
Coddington wrote:When providing guidance, they will look at the committee report and see that the provision was based on the Senate report. They'll look at the Senate report and see that reasonable comp is limited to S corps. They'll look at the text of similar laws and see that reasonable comp is only used in the corporate context. They will then issue guidance that limits the reasonable comp rule to S corps.


Are there still people at the IRS who are able to do all of the above? :twisted:


Of course there are. My sister-in-law's husband is an area counsel in TEGE and he said the attorneys in Chief Counsel are excited about being able to write regs again. Based on my observations, Chief Counsel hasn't lost any more talent than it normally does.
-Brian

Director of Tax Accounting Methods & Credits
SourceAdvisors.com

Opinions my own.
 

#96
MEMCPA  
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Treasury Mulls Applying Reasonable-Compensation Rules to Partners - https://www.bna.com/treasury-mulls-appl ... 982088602/
 

#97
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Treasury is not going to expand reasonable comp beyond s corps said the deputy assistant of tax policy at an ABA tax meeting last week in San Diego. If they were going to write a reg that did then he would know and he said they are not and have no intention of doing so. This is good for planning.
 

#98
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WilsonCA wrote:Won't the IRS argue that Sched C self-employed individuals will need to reduce QBI by an amount equal to "reasonable compensation" for the services they provide to the business?


We have an answer! In the proposed regs:

The Treasury Department and the IRS have received requests for guidance on whether the phrase “reasonable compensation” within the meaning of section 199A extends beyond the context of S corporations for purposes of section 199A. The Treasury Department and the IRS believe “reasonable compensation” is best read as limited to the context from which it derives: compensation of S corporation shareholders-employees.
 

#99
Wiles  
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Yes! They fixed Congress' unintentional subtlety.

Also note, reasonable compensation is not necessarily what shows up on the W-2. https://www.irs.gov/pub/irs-drop/reg-107892-18.pdf, Page 40:
The rule for reasonable compensation is merely a clarification that, even if an S corporation fails to pay a reasonable wage to its shareholder-employees, the shareholder-employees are nonetheless prevented from including an amount equal to reasonable compensation in QBI.
 

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