QBI Deduction? Not for the American Abroad! AND Next Year, IRS Will Be Checking Your Numbers!

Section 199A of the Internal Revenue Code was created by the Tax Cuts and Jobs Act (TCJA). If a taxpayer can utilize the new law, the taxpayer can save a bundle in taxes since the provision provides a 20% deduction for so-called “qualified business income” (“QBI”).  The American abroad will not be so lucky since in general, he or she will not be able to use the QBI deduction.  Readers of my blog will probably not be surprised by this; they likely realize by now that anything “foreign” is not looked upon kindly by the US tax man.

Brief Overview

Section 199A is a new provision allowing many owners of sole proprietorships, partnerships, trusts and S corporations to deduct 20 percent of their QBI. QBI generally means the bottom-line profit of the business as adjusted for other deductions directly connected to the business, including for example, self-employment taxes.  QBI also includes an investor’s real estate rental income provided that the real estate activity rises to the level of a “trade or business”.  This is a tricky concept and one must look to the court cases to see if the rental activity can meet the “trade or business” standard. It is not an easy standard  to meet.

What it’s not – Certain items are excluded from the definition of QBI.  QBI does not include wages paid to S corporation shareholder-employees, or guaranteed payments made to partners of a partnership, or other amounts paid to a partner for services rendered.  QBI does not include capital gains, interest, or dividend income.

The way the tax law defines QBI also means “tough luck” for the American abroad. Why?  The reason is simple: QBI does not include income from non-US sources. In other words, the income must be earned within the US in order to possibly qualify as QBI.  So, for the typical American abroad who is running his business overseas, or who is investing in a foreign partnership or a foreign rental property “trade or business” – absolutely no QBI deduction will be available.

Note – this does not mean the QBI deduction will necessarily be denied to a nonresident alien individual (NRA). There is nothing in the law limiting the QBI deduction to US persons, but the source of the income for which the deduction is claimed must be from the US. As an example, I can think of rental income earned by the NRA from a US property when that real estate activity rises to the level of a “trade or business”.  That NRA has the opportunity to use Section 199A for the QBI deduction.  So, we can see that the Section 199A deduction rules apparently treat a foreign person more favorably than one of the United States’ own citizens. Hmmmmmm, this certainly seems to be the case… but let me not digress.

The new deduction is effective for tax years beginning after Dec. 31, 2017. Eligible taxpayers can claim it for the first time on their 2018 federal income tax return.  That’s the return you or your return preparer is struggling with right now.

The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. It’s generally equal to the lesser of 20 percent of their qualified business income plus 20 percent of their qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income or 20 percent of taxable income minus net capital gains. Deductions for taxpayers above the $157,500/$315,000 taxable income thresholds may be limited.

Final Treasury Regulations under Code section 199A were issued in January, but there’s still a lot of uncertainty surrounding the QBI deduction.

A New Form

On February 13, 2019 the Internal Revenue Service (IRS) completed a draft version of a new form, Form 8995, Qualified Business Income Deduction Simplified Computation.  This form will be required with 2019 tax returns for taxpayers who claim a QBI deduction under new Code Section 199A.  The new form will require taxpayers to show how they computed their QBI deduction; but (sadly) it does not help the taxpayer in the computation.  Taxpayers who have QBI, REIT dividends, or qualified income from a PTP will use the Form 8995 to report the computation.

The draft form is quite short and sweet. It fits on one-page and it contains the same computation information that is currently found on the “2018 Qualified Business Income Deduction — Simplified Worksheet”. This Worksheet is on page 37 of the 2018 instructions to Form 1040U.S. Individual Income Tax Return.  For 2018 income tax returns, the taxpayer keeps the Worksheet in his own file and does not send it to the IRS.  For 2019 tax returns, however, Form 8995 must be attached to the taxpayer’s 2019 return and submitted to the IRS. Better check those computations carefully, and then, check again!

The form requires the typical information such as the taxpayer’s name, taxpayer identification number.  QBI or loss for up to five trades or businesses must first be listed separately. QBI from all of the taxpayer’s trades or businesses is then aggregated and combined with any carryover loss from the prior year. Separate line entries are provided for the net capital gain limitation calculation, qualified REIT dividends and PTP income or loss.

Posted: March 4, 2019

 

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