QBI calculation, S corp, sole shareholder

Technical topics regarding tax preparation.
#1
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I'm lost in the newly released Sec 199a regulations regarding the QBI calculation for a sole shareholder S corporation.
Single taxpayer
Sub S income after shareholder wages $35,000, there are no other wages.
Shareholder wages $50,000.00. Wages are considered reasonable.
No other income.

Is the QBI calculated as $35,000*20% = $7,000.00
or
$35,000 + $50,000 (shareholder wages) * 20% = $17,000.00

On page 115, example 3 indicates it would be a $7,000 deduction, but the example is for a high income taxpayer.

The regulations refer to shareholder wages are not part of the QBI calculation. If the wages are not added back to the Sub S income there is a disparity between entity choice.
 

#2
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Shareholder wages are not part of QBI. There are many disparities between entity choices.
 

#3
dave829  
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That same example says:
Because X is an S corporation, its QBI is determined at the S corporation level. X’s QBI is $100,000, the net amount of its qualified items of income, gain, deduction, and loss. The wages paid by X to C are considered to be a qualified item of deduction for purposes of determining X’s QBI.

So, you don’t add back shareholder wages to get QBI. QBI is the net income that flows to the K-1, computed after subtracting shareholder wages ($7,000 in your example).
 

#4
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So are we back to having to argue with clients on taking a salary? If the QBI is determined on the net income after wages they will want to take a smaller salary to have a higher net income and a higher QBI deduction.
 

#5
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davidlat, I am pretty sure there are anti-abuse rules to counteract that.
 

#6
dave829  
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SumwunLost, there is. Proposed reg 1.199A-3(b)(2)(ii)(H) says that although reasonable compensation received by a shareholder from an S corporation is not included in QBI, such reasonable compensation will reduce QBI from the S corporation. Page 40 of the proposed regulations explains this:
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.

The way I understand this is that in computing QBI from an S corporation, the S corporation must pay a reasonable wage to its shareholder-employees, and QBI is reduced by this wage whether or not the S corporation pays it.
 

#7
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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.


The other item to consider here is the IRS's position on recharacterization. If there are no cash distributions, the IRS has said they have no amount to recharacterize to wages. However, the 'reasonable compensation' item described in the QBID guidance doesn't reference the amount that is recharacterized to wages or even the amount that should be recharacterized to wages. It references the amount that represents RC. That means they could adjust QBID based solely on a judgment of RC without proposing that amount be classified as wages. This means they don't have to prevail on a wage reclassification to decrease a taxpayer's QBID.
~Captcook
 

#8
dave829  
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CaptCook wrote:This means they don't have to prevail on a wage reclassification to decrease a taxpayer's QBID.

Of course they do! The IRS can't merely disallow the deduction based on a wage reclassification without prevailing on the wage reclassification adjustment.
 

#9
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Another thought is what about corporations that use an employee leasing company.
The shareholder will not have a w/2 from his corporation. The w/2 will come from the employee leasing company.
Will the w/2 from the employee leasing company count as officer compensation for the QBI?
 

#10
sjrcpa  
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Yes. That is addressed in the new Regs.
 

#11
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dave829 wrote:
CaptCook wrote:This means they don't have to prevail on a wage reclassification to decrease a taxpayer's QBID.

Of course they do! The IRS can't merely disallow the deduction based on a wage reclassification without prevailing on the wage reclassification adjustment.


I disagree.
If there is no cash flow out of the business, there is nothing to reclassify. However, there is still an amount that represents reasonable compensation that should have been paid, which will impact QBID.
~Captcook
 

#12
dave829  
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CaptCook, you’re raising a different issue. You are saying that the IRS may not reclassify to wages all or a portion of an S corporation’s flow-through income where no distributions were made to the officer-shareholder. I’ve never seen a case where the IRS has proposed such a reclassification, and therefore, the likelihood that they will do that in the future is zero. See this excerpt from an IRS Fact Sheet regarding S corporation compensation:
The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. However, if cash or property or the right to receive cash and property did go the shareholder, a salary amount must be determined and the level of salary must be reasonable and appropriate.

https://www.irs.gov/pub/irs-news/fs-08-25.pdf
 

#13
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I'm not raising a different issue. They are related.
Based on the fact sheet you shared, there may be circumstances where the IRS may not be able to prevail on a wage reclass. However, I don't see that as an impediment to IRS adjusting QBID for RC when none has been paid.
~Captcook
 

#14
novacpa  
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OP says" "Wages are considered reasonable".

Nonsense - if its a "service business" with no-capital assets - Reasonable Compensation is 100%
 


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