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Draft Instructions for Calculating QBI Deduction Provide Additional Guidance

(Parker Tax Publishing September 2019)

The IRS released draft instructions for Form 8995, Qualified Business Income Deduction Simplified Method. The draft instructions include a 17-step flowchart to assist in determining whether an item constitutes qualified business income (QBI) for purposes of calculating the QBI deduction under Code Sec. 199A and discusses the tax treatment of various income and deduction items, some of which will require additional clarification. Draft Form 8995 Instructions.


Under Code Sec. 199A, owners of sole proprietorships, partnerships, S corporations and some trusts and estates, may be eligible for a deduction of income from a qualified trade or business. The deduction has two components. The first is the qualified business income (QBI) component. This component of the deduction equals 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. Depending on the taxpayer's taxable income, the QBI component is subject to multiple limitations including the type of trade or business, the amount of W-2 wages paid by the qualified trade or business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business. It may also be reduced by a patron reduction if the taxpayer is a patron of an agricultural or horticultural cooperative. The second component is the real estate investment trust (REIT)/publicly traded partnership (PTP) component. This component of the deduction equals 20 percent of the combined qualified REIT dividends (including REIT dividends earned through a regulated investment company) and qualified PTP income. This component is not limited by W-2 wages or the UBIA of qualified property.

QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. A qualified trade or business is any Code Sec. 162 trade or business except for (1) a trade or business conducted by a C corporation; (2) for taxpayers with taxable income that exceeds a threshold amount, specified service trades or businesses (SSTBs); and (3) the trade or business of being an employee.

With respect to the QBI component, the Code Sec. 199A deduction is limited to the lesser of the QBI component plus the REIT/PTP component or 20 percent of the taxpayer's taxable income minus the net capital gain. The deduction is available for tax years beginning after December 31, 2017, and ending before December 31, 2025. Most eligible taxpayers were able to claim the deduction for the first time on their 2018 tax return. The deduction is available regardless of whether an individual itemizes deductions on Schedule A or takes the standard deduction.

Draft Form 8995 Instructions Released

On August 29, the IRS issued draft instructions to accompany the 2019 Form 8995, Qualified Business Income Deduction Simplified Method. Previously, on July 25, the IRS issued drafts of Form 8995, Form 8995-A, Qualified Business Income Deduction, and various schedules to accompany Form 8995-A. At that time, the IRS had indicated that draft instructions for Form 8995 would be forthcoming. While the QBI deduction was first available for the 2018 tax year, there was no IRS form for reporting the deduction. Instead, the IRS issued worksheets in the Form 1040 instructions and in IRS Publication 535 to help taxpayers calculate the deduction. The IRS informed taxpayers that the worksheets should not be filed with their tax returns, but instead should be retained as back-up workpapers.

The Form 8995 draft instructions contain a 17-step flowchart to be used in determining whether an item of income, gain, deduction or loss is included in the QBI calculation. One new item that had not been previously addressed in the QBI calculation is the treatment of charitable deductions. According to the flowchart and the instructions, QBI is reduced by charitable deductions relating to a taxpayer's trade or business, even though such expenses are not considered Code Sec. 162 trade or business expenses.

Observation: Presumably, a check to a charity written on the taxpayer's personal checking account, as opposed to a business checking account, would not reduce QBI.

In addition, similar to the Code Sec. 199A frequently asked questions (FAQs) the IRS has posted on its website, the Form 8995 draft instructions indicate that QBI should be reduced by certain deduction items relating to a trade or business, such as the deduction for self-employed health insurance and the deductible portion of self-employment tax. However, as several practitioners have noted, the IRS needs to clarify in the instructions that the deductible portion of self-employment tax as well as the health insurance deduction should not reduce QBI to the extent those items relate to partnership guaranteed payments or S corporation compensation, both of which do not qualify for the QBI deduction.

Also new, the draft instructions provide that QBI must be reduced by interest expense incurred on the purchase of a partnership or S corporation interest. In the final Code Sec. 199A regulations, the IRS had declined to address whether such interest expense was attributable to a trade or business and said that the issue was beyond the scope of the final regulations.

For a discussion of the calculation of the Code Sec. 199A deduction, see Parker Tax ¶151,500.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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