Tax Cuts and Job Act 199A Calculating the 20% deduction

The hurdles in obtaining  the deduction under the Tax Cut and Job Act.

If you pass all of the limits below you still have an umbrella limit of 20% of (taxable income- capital gains).

In addition to the umbrella limit there are three bucket tests.

I.   Everyone who has taxable income under 157,500 single and 315,000 married.   20% of the Qualified Business Income (net income from your business).

So for example in this bucket it is the lessor of 20% of TI or 20% of QBI.

 

II.  Specific Service and Trade Business.   Lawyers, Doctors, Consultants who make over the 157,500 single and 315,000 married.  Phase out until 207,500 for single and 415,000 for married.  After the phase out of 207,000 and 4150,000 no deduction.

 

III.  Non Specific Service and Trade Business over 157,500 single and 315,000 married.    Lessor of:

20% of QBI

or

the greater of 50% of wages vs 25% of wages + 2.5% of assets.

For example a roofer does not have that much in the way of equipment.  So I think 50% of wages is most likely to be the greater number.  Of course you should do the 25% + 2.5% of asset test.

So it comes down to the lessor of

20% of QBI

50% of wages.

 

IF you are an employee of a S corp you should consider taking a year end bonus to increase your 50% number. Or consider hiring your spouse if you are a Sole proprietor or and LLC.

For example  your QBI (net income ) is 100,000

So 20% of $100,000 is $20,000.  But what if you wages are only 5,000.  Then 20% of 5,000 is 1,000 and so you end end with just 1,000 as the 20% qualif

Now for example, you pay yourself  a bonus of 23,000.    Let’s see what happens.

100,000 -23,000 = 77,000 x .2 = 15,400.

compared to 23,000 + 5,000 = 28,000 X 5 =14,000  So now the QBD is 14,000( the lessor of 15,400  or 14,000)

Okay so the 14,000 X your tax rate (IRS and state) is for example .35 = 4,900.

What is the payroll cost of the additional salary ?   23,000 X .153 = 3,519

So you save roughly 1,400.

The use of the salary bonus works best when the employee is over the SS limit already.

So for example maybe  you have already paid yourself from the company over the social security limit, or your spouse works for the government and makes over 128,400 for 2018.  Then the business is only paying the employer side and the benefit of the bonus is improved.

Of course the IRS could ask what your spouse did for the company for 23,000 salary.

This is just a general discussion.  See your tax preparer for any questions.

Depreciation recapture on conversion of business asset to personal use

Recapture of deprecation for business property
converted to personal use.

Do you have to recapture the 179 depreciation and special depreciation allowance (bonus depreciation) on a simply conversion from business use to personal use? Let’s discuss the issue of recapture.

Here is an example. Bob, an airplane pilot, has an office in his home and buys a computer. He is self employed and is using the computer 100% for business in the first year and take 179 or special allowance depreciation in the first year. In year three he decides to change his focus, and gets a job with an airline as an employee and only flies for his own clients part time. Now he uses the computer 10% of the time for business. The other 90% he uses the computer to do emails with family and friends.

So we have a self employed individual who starts a company and takes full advantage of code section 179 and special depreciation allowance provisions of the tax code. The businessman is allowed to do this because the property is being used more than 50% for the business purpose vs. personal use.

What happens to all the bonus deprecation and 179 deduction when the property is converted back to personal use. Not sold, not disposed of, but simply now used for personal use.

The issue comes down to whether the property is “listed property”. If the property is listed property, then on the conversion there is a recapture of depreciation taken in prior years.

If the property is not listed property, then the mere conversion from business to personal use creates no recapture. But if after the conversion, the property now being used personally is sold, then there could be recapture of the 179 or bonus depreciation. There is a difference between how the computer is being used vs. the sale of the computer.

What is listed property?

26 US Code §280F(d)(4) defines it as:

(4) Listed property
(A) In general Except as provided in subparagraph (B), the term “listed property” means—
(i) any passenger automobile,
(ii) any other property used as a means of transportation,
(iii) any property of a type generally used for purposes of entertainment, recreation, or amusement, and
(iv) any other property of a type specified by the Secretary by regulations.

Here is an exception for companies transporting people or property:

(B) Exception for property used in business of transporting persons or property
Except to the extent provided in regulations, clause (ii) of subparagraph (A) shall not apply to any property substantially all of the use of which is in a trade or business of providing to unrelated persons services consisting of the transportation of persons or property for compensation or hire.

Not looking so good for Bob at this point is it? But hold on, see that provision under (iv) about regulations.

If you look at Regulation §1.280F-6(b), “listed property” is further defined as

(b)Listed property –

(1)In general. Except as otherwise provided in paragraph (b)(5) of this section, the term listed property means:

(i) Any passenger automobile (as defined in paragraph (c) of this section),

(ii) Any other property used as a means of transportation (as defined in paragraph (b)(2) of this section),

(iii) Any property of a type generally used for purposes of entertainment, recreation, or amusement, and

(iv) Any computer or peripheral equipment (as defined in section 168(i)(2)(B)), and

(v) Any other property specified in paragraph (b)(4) of this section.
(b)(5) there is another exception!!! Let’s take a look at (b)(5),

(5)Exception for computers. The term listed property shall not include any computer (including peripheral equipment) used exclusively at a regular business establishment. For purposes of the preceding sentence, a portion of a dwelling unit shall be treated as a regular business establishment if (and only if) the requirements of section 280A(c)(1) are met with respect to that portion.

Bob is using his computer at his regular business establishment. And he is also okay having used his home office as his regular business establishment.

So good news for Bob. His computer is not listed property and no recapture on the simple conversion. If however he sold the computer in year 3 at a gain, then yes he would have to get out his MACRS depreciation schedule and calculated the recapture. He would report the excess depreciation on his year 3 tax return as ordinary income on form 4797.

How much is the recapture when listed property is converted from business use to personal use?

IRC §280F(b)(2)(A) says it is the difference between the “excess depreciation”.

(2) Recapture
(A) Where business use percentage does not exceed 50 percent If-
(i) property is predominantly used in a qualified business use in a taxable year in which it is placed in service, and
(ii) such property is not predominantly used in a qualified business use for any subsequent taxable year,
then any excess depreciation shall be included in gross income for the taxable year referred to in clause (ii), and the depreciation deduction for the taxable year referred to in clause (ii) and any subsequent taxable years shall be determined under section 168(g) (relating to alternative depreciation system).
(B) Excess depreciation For purposes of subparagraph (A), the term “excess depreciation” means the excess (if any) of-
(i) the amount of the depreciation deductions allowable with respect to the property for taxable years before the 1st taxable year in which the property was not predominantly used in a qualified business use, over
(ii) the amount which would have been so allowable if the property had not been predominantly used in a qualified business use for the taxable year in which it was placed in service.

See you own tax preparer for your specific issue, as this is a generic discussion.

A final thought. Now that we have a better understanding of depreciation recapture, how did we capture it in the first place?

How the 20% deduction rule works

                                         How the 20% deduction rule works
Specific Service Industries                                          All other industries
(CPAs, attorneys, brokers, Drs, etc –
But not engineers nor architects)
___________________________________________
LESSER of:                                                                       | LESSER of:
A. 20% of net business income                               A. 20% of net business income

B. 20% of taxable income                                          B. 20% of taxable income

                                                     UNDER TAXABLE INCOME

          ****TAXABLE INCOME   157,500 single 315,000 Married  ****

                                                            OVER TAXABLE INCOME

Then phase out of benefit over these levels
50,000 for single and 100,000 for Married

No 20% deduction over phase out                          LESSER of these 3 numbers:

                                                                                                                                                                                                  A. 20% of net business inc.

                                                                                                B. 20% of taxable income

                                                                                                   C.  Which is Greater?

                      1.  25% of wages + 2.5 % X cost basis  of assets

2.   50% of wages

                                                                       No 20% deduction over phase out
Taxable income greater than:
Single 207,500
Married 365,000

Converting your SEP or traditional IRA to a ROTH

Considering converting your SEP or traditional IRA to a ROTH?

Here is an example of why it may not make a difference?  It all depends on your tax rate when you retire.

  For example say your taxable income  is 170,000 for 2017.

    For 2018, if everything remains the same you will be in a 24% tax bracket (2018 24% bracket is 165,001 to 315,000).

     So  you convert 100,000 to a ROTH from your SEP.  If the tax is paid out of the converted funds (24% +6% VA), now there is 70,000 starting in the ROTH.  Notice that if you converted instead 200,000 to a ROTH,  this would put you in a 32% bracket.

      So the choice is leaving the 100,000 in the SEP and growing to be taxed at a later date,

OR

paying the tax now and having 70,000 to invest tax free.  Assume the same rate of return of 6% for both options.   Assume you and spouse are 79 and will live another 12 years per the joint annuity IRS table.

70,000   in 12 year  is worth 140,854

Leaving in SEP the 100,000 is worth 201,220.  Pay the tax at 30% =  60,366. So after taxes the amount is 140,854 (201,220 – 60,366)..  If you or you beneficiary are still in a 30% (IRS and VA) bracket, then no difference.  If you or your beneficiary are in a lower bracket then leaving the money in the SEP is best. 

 

The $64 dollar questions is what will be you  tax bracket when your retire or for your beneficiaries when you die ( for 2018 the rates are  22% 77,401 – 165,000  and the 12% bracket is 19,051 – 77,400).

Why people recommend converting is they assuming that the cash to pay the immediate tax bill will come from another source of funds and the ROTH account will start out with the 100,000.