Page 6 - Tax Act First Look: The Complex New World Of The Qualified Business Deduction Rule

through to its shareholders on a daily proportionate basis based on stock own- ership, including shares of nonvoting stock. [Otherwise, an S corporation must only issue a single class of stock per IRC section 1361(b)(1)(D).] As with partners in a partnership, each S corporation’s shareholder reports taxable income or loss on his individual return based on the tax items reflected on Form K-1. Losses may be deducted to the extent of a share- holder’s stock basis, which is not adjust- ed for entity-level obligations as is required under IRC section 752 for part- nerships. Any excess losses may be car- ried forward [IRC section 366(d)]. The at-risk rules, passive activity loss rules, and investment interest limitations also apply to shareholders in an S corporation. A shareholder’s stock basis is increased for capital contributions and the pass- through of income items reflected on Form K-1. Stock basis is further adjusted for distributions and losses.
es conducted by a partnership, S corpo- ration, or sole proprietor, than the House version. As mentioned above, Congress adopted the Senate version but lowered the deduction percentage to 20% of QBI subject to special limitations and appli- cable rules.
Where a business is operated as a sole proprietorship, including a single mem- ber LLC, the items of income, loss, deduction or credit are reported by the owner on a Schedule C to Form 1040. Such income or loss may alternatively be shown on Schedule E (rental real estate and royalties) or Schedule F (farm- ing income or loss). A single-member LLC is disregarded for federal income tax purposes unless its owner files an election on Form 8832 to be treated as a C corporation [Treasury Regulations section §301.7701-3(b)(1)(ii)]. The sale of the owner’s interest in the business is treated as the sale of each individual asset based on a fair market value allocation [see Williams v. McGowan, 152 F.2d 570 (2d Cir. 1945)].
The Senate version, which was enacted into law, allows a noncorporate taxpayer a deduction for QBI for taxable years beginning after December 31, 2017, and sunsets after 10 taxable years.
New IRC section 199A. The Senate version, which was enacted into law, allows a noncorporate taxpayer a deduc- tion for QBI for taxable years beginning after December 31, 2017, and sunsets after 10 taxable years. Under the new IRC section 199A, a taxpayer other than a corporation is entitled to deduct 1) the lesser of A) the combined QBI of the taxpayer or B) an amount equal to 20% of the excess, if any, of the taxable income of the taxpayer for the taxable
S corporations that have converted from C corporation status are subject to a corporate level tax on their recognized built-in gains under IRC section 1374, subject to applicable rules and limita- tions, for the five succeeding years after the effective date of the conversion and an annual corporate level tax on excess passive investment income under section 1375, which requires that the S corpora- tion have undistributed C year accumu- lated earnings and profits as well as “excess passive investment income” [IRC section 375(b)(1)].
Provisions for Owners of Pass-through Entities
year, in excess of the sum of any net cap- ital gain, plus the aggregate amount of qualified cooperative dividends; plus 2) the lesser of A) 20% of the aggregate amount of qualified cooperative divi- dends or B) taxable income reduced by net capital gains, as defined by the law. The amount determined may not exceed taxable income as reduced by net capital gain and is subject to other applicable rules and limitations.
A shareholder selling shares of S cor- poration stock to a third party generally will report any resulting gain or loss as capital gain or loss, based on the amount realized less the shareholder’s basis as adjusted through the date of closing. There is no “look-through” recharacter- ization rule under Subchapter S as there is in IRC section 751 for partnerships [Treasury Regulations section 1.1366- 1(b)(1)].
Both the House and Senate bills pre- scribed lower tax rates for partnership income, but adopted different models— wholesale tax rate cuts (House) versus a more limited deduction in computing tax- able income (Senate). The House bill provided a maximum 25% rate for qual- ifying pass-through business income. The Senate bill adopted a rule permitting a deduction for 23% percent of qualifying business income to arrive at a lower, variable individual rate (new IRC section 199A). It was easily seen that the tax deduction approach in the Senate version would generate far less tax savings for “passive” investors in qualified business-
Combined QBI is defined in IRC sec- tion 199A(b) as an amount equal to the sum of the QBI amounts for each QBI plus 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer
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