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

Technical topics regarding tax preparation.
#51
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JR1 wrote:Sch. C, it's the profit.


Just curious on your interpretation here, but would Sch C profit be reduced by any/all of the following:

1/2 SE tax deduction
SE health insurance
SE retirement contributions
 

#52
JR1  
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I've not seen or heard of any reductions for those.
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#53
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missingdonut, since the deduction is limited to 20% of net profit or taxable income, those items are considered.

Sch C Net Profit - 100,000.00
Front Pg SHI Deduction - 10,000.00
SE Tax Deduction - 7000.00
IRA Contribution - 5000.00
Standard Deduction - 12000.00

My understanding is it is 20% of 66,000 (100-10-7-5-12) and not 20% of 100k.
Last edited by sdodsoncpa on 4-Jan-2018 5:30pm, edited 1 time in total.
 

#54
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WilsonCA wrote:
sdodsoncpa wrote:In 2 CEUs I have taken since 12/22, both reference a calculation for Wages for the sole prop. Neither have a formula but believe a safe harbor will be released.

This would be for purposes of the 50% of W-2 wages limitation? Or for the sole prop paying "wages" to him/herself (to fulfill a supposed "reasonable compensation" requirement)? What's the "safe harbor" in reference to? Who was providing the CEUs? So many questions...


The reference was to it not being clear how/if the IRS would determine reasonable wages for a sole prop. They made mention of the safe harbor of 70/30 that was being considered but not in the final bill.

The CEU was from Surgent McCoy and Taxspeaker.

For me, its not clear. I mean, the Deduction is called "Deduction for Qualified Business Income of Pass-Thru Entities" but is applicable to a Sole Proprietor!? Because of the ambiguity involved it is hard for me to feel comfortable that the IRS won't issue a safe harbor on Sole Props. And, because of the way it is written: (4)(a) reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business" ... I am no so sure the IRS won't issue guidance on what the 'reasonable' comp of an S Corp should be.

Then, as I think about the deduction, it comes to mind that the deduction is (for S Corps and Partnerships) on income that is not subject to SE tax so that leaves me to wonder as well about Sole Props.
 

#55
Wiles  
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sdodsoncpa wrote:Then, as I think about the deduction, it comes to mind that the deduction is (for S Corps and Partnerships) on income that is not subject to SE tax so that leaves me to wonder as well about Sole Props.

The partnership QBI may or may not be subject to SE. QBI and SE are like Shinola and ...
 

#56
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MEMCPA wrote:Just to further stir the pot: https://www.forbes.com/sites/anthonynit ... c2028c2076

Woah, mind blown. His "alternative reading" makes perfect sense, and answers the question in my original post through a completely different tack. If only things had been written that way! But I guess we're stuck with the mess that was actually passed, so I'll be going with his "straightforward interpretation" until further notice.
 

#57
Jake  
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in the past few years my reasonable compensation has to be less than my net Sch C income. I surely hope that my AGI does not include more than 80% of my modest net Sch C profit. My personal issue is keeping my modified AGI from exceeding the $170,000 threshold where they impose Part B and D surcharges. I guess we will have to wait and see. I just need to see how much of my MRD from IRA;s need to be a direct charitable contribution to avoid that modified $170,000 threshold, My tax exempt binds have all now been called so that t-e interest is no longer an issue.
 

#58
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sdodsoncpa wrote:missingdonut, since the deduction is limited to 20% of net profit or taxable income, those items are considered.

Sch C Net Profit - 100,000.00
Front Pg SHI Deduction - 10,000.00
SE Tax Deduction - 7000.00
IRA Contribution - 5000.00
Standard Deduction - 12000.00

My understanding is it is 20% of 66,000 (100-10-7-5-12) and not 20% of 100k.


Oh, absolutely, that would be the case in that situation. The question I was more concerned with is: if we have the Schedule C with those figures, but the taxpayer also has other income (say, another $50k in W-2 wages), therefore the taxpayer has $116k in taxable income -- what is the 20% deduction in that case?
 

#59
Pitch78  
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WilsonCA wrote:
MEMCPA wrote:Just to further stir the pot: https://www.forbes.com/sites/anthonynit ... c2028c2076

Woah, mind blown. His "alternative reading" makes perfect sense, and answers the question in my original post through a completely different tack. If only things had been written that way! But I guess we're stuck with the mess that was actually passed, so I'll be going with his "straightforward interpretation" until further notice.



That is interesting. 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.

Make sense?

FYI, the house bill stated:

Net business income or loss also includes any amounts received by the individual taxpayer as wages, director’s fees, guaranteed payments and amounts received from a partnership other than in the individual’s capacity as a partner, that are properly attributable to a business activity. For example, if an individual shareholder of an S corporation engaged in a business activity is paid wages or director’s fees by the S corporation, the amount of wages or director’s fees is included in net business income or loss with respect to the business activity. This rule is intended to ensure that the amount eligible for the 25-percent tax rate is not erroneously reduced because of compensation for services or other specified amounts that are paid separately (or treated as separate) from the individual’s distributive share of passthrough income.
 

#60
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Under the House bill, not all of the income qualified for the 25% rate. Their bill required a 70/30 split (or that other asset-based formula) to determine how much income qualified. So, perhaps, the purpose of that bolded sentence was to make sure the calculation started with the correct number -- all of the income -- before we applied the formula.
 

#61
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I think congress intended for the disparate treatment across entities because if some entities don’t get the full deduction then some entities don’t get rate reduction. Look at the pass through deduction compared on the basis of straightforwardness to the Corp tax rate reduction. The Corp tax rate is much straightforward and that could be that they wanted the variety of limiting rules to apply to pass thrus so that they could meet their budget constraints.
 

#62
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missingdonut wrote:
Oh, absolutely, that would be the case in that situation. The question I was more concerned with is: if we have the Schedule C with those figures, but the taxpayer also has other income (say, another $50k in W-2 wages), therefore the taxpayer has $116k in taxable income -- what is the 20% deduction in that case?


In that case, the QBI is lower so the 20% is applied to the 100k and you get 20k as a deduction.
 

#63
Pitch78  
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Perhaps Wiles and Oraha are correct, but if you take it literally, i.e. QBI consists of deductions and reasonable comp is not included, then you can reach the premise in the article. Think about this. Reasonable comp is already deducted in determining QBI as the definition is written. So, why the clarification? Or is it to simply say you dont take the deduction in figuring QBI?

I am looking forward to the "Blue Book" explanation. Hopefully, it addresses it.
 

#64
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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.

As to the “one can argue” comment, it wouldn’t be a great argument, based on the what was passed. Take a look at “QUALIFIED ITEMS OF INCOME, GAIN, DEDUCTION, AND LOSS” in the statute.

You guys are trying real hard to massage things so that we end up with a completely level playing field between S-corp’s and sole-proprietorships. Good luck with that. At least Nitti had a clear enough head to realize that, as nice as that would be, it’s not what we get to under this new provision.
 

#65
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Terry Oraha wrote:I think congress intended for the disparate treatment across entities because if some entities don’t get the full deduction then some entities don’t get rate reduction. Look at the pass through deduction compared on the basis of straightforwardness to the Corp tax rate reduction. The Corp tax rate is much straightforward and that could be that they wanted the variety of limiting rules to apply to pass thrus so that they could meet their budget constraints.


Maybe I'm cynical, but I don't believe Congress actually thought about any of this at all, let alone "intended" any of this.

sdodsoncpa wrote:In that case, the QBI is lower so the 20% is applied to the 100k and you get 20k as a deduction.


Not that tax law has to make sense, but our taxpayer has $83k taxable income from the business (100 Sch C - 10 SEHI - 7 SE tax) and can take a 20% deduction against the $100k? The reason I ask is because of the way the law is written:

§199A(c)(1): "The term ‘qualified business income’ means, for any taxable year, the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer..."

§199A(c)(3)(A): "The term ‘qualified items of income, gain, deduction, and loss’ means items of income, gain, deduction, and loss to the extent such items are— (i) effectively connected with the conduct of a trade or business within the United States . . ., and ‘‘(ii) included or allowed in determining taxable income for the taxable year."

I am having trouble interpreting these deductions as not counting against QBI under §199A(c)(3).

Jeff-Ohio wrote:At least Nitti had a clear enough head to realize that, as nice as that would be, it’s not what we get to under this new provision.


+1
 

#66
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Jeff-Ohio wrote:

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

As to the “one can argue” comment, it wouldn’t be a great argument, based on the what was passed. Take a look at “QUALIFIED ITEMS OF INCOME, GAIN, DEDUCTION, AND LOSS” in the statute.

You guys are trying real hard to massage things so that we end up with a completely level playing field between S-corp’s and sole-proprietorships. Good luck with that. At least Nitti had a clear enough head to realize that, as nice as that would be, it’s not what we get to under this new provision.


All legislative history is relevant. This was a compromise between the House and Senate bills.

Anyway, I am not trying real hard to massage things. I am just saying I see the argument and I probably give it a bit more weight than Nitti. I have read the statute. What specifically are you referring to under “QUALIFIED ITEMS OF INCOME, GAIN, DEDUCTION, AND LOSS”?

Again, these talk in terms of items of income and deduction. Not net income or loss. Any net income would already have the reasonable comp deducted. So why do you have to mention it in a separate sub-section?
 

#67
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All legislative history is relevant.

Only if something is ambiguous, which it isn’t. And the fact that there were two separate bills might actually complicate things, in terms of ascertaining intent. But it doesn’t complicate anything here, since the statute is crystal clear.

What specifically are you referring to under “QUALIFIED ITEMS OF INCOME, GAIN, DEDUCTION, AND LOSS”?

See what Missingdonut wrote in Post #65 (i.e. “…or allowed in determining taxable income for the taxable year). Was the S-corp’s wage payment to the owner allowed as a deduction? If it was, then it factors in to the calculation as a deduction. And there is nothing, anywhere, that says to add it back at the entity level or for the shareholder to include it as QBI at the 1040 level. Hence Missingdonut’s conclusion.
 

#68
supdat  
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Interesting conversation here. My approach for schedule C’s (I don’t have many) will be to tell clients that it appears the deduction will be permitted with no carve out for reasonable comp. However, until the IRS writes regulations, we don’t know for sure.
 

#69
JR1  
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I agree, Sup. That seems to be the intent.
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#70
Pitch78  
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Jeff-Ohio wrote:
See what Missingdonut wrote in Post #65 (i.e. “…or allowed in determining taxable income for the taxable year). Was the S-corp’s wage payment to the owner allowed as a deduction? If it was, then it factors in to the calculation as a deduction. And there is nothing, anywhere, that says to add it back at the entity level or for the shareholder to include it as QBI at the 1040 level. Hence Missingdonut’s conclusion.



What is missing from his post is (c)(4) which states that QBI does not include reasonable comp. Thus, it is not an item of deduction under (c)(1).
 

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