President Biden’s agenda includes a $3.5 trillion budget plan that provides for investments in the environment, healthcare, childcare, education, and a host of other social programs labeled “human infrastructure” by the White House. Moderate Democrats, whose votes are needed to pass any legislation, are asking how we pay for this massive proposal. One small piece of the payment plan is a proposed change to the Qualified Business Income (QBI) deduction.
The Small Business Tax Fairness Act, S. 2387, has been introduced in the U.S. Senate by Sen. Ron Wyden (D-OR) and referred to the Committee on Finance. This legislation proposes changes to §199A, the deduction for qualified business income.
The bill introduces a simplification of QBI calculations by raising the “threshold amount” substantially, for example, from $157,500 for a single taxpayer to $400,000, eliminating the criteria related to specified service trades or businesses (SSTB), and eliminating the formulas using wages and unadjusted basis in qualified property immediately after acquisition (UBIA) for SSTBs and non-SSTBs to calculate the QBI deduction for taxpayers above the threshold limits.
Modification of the Threshold Amount
The bill proposes replacing §199A (e)(2), which currently states, “The term ‘threshold amount’ means $157,500 (200% of such amount in the case of a joint return),” with “The term ‘threshold amount’ means $400,000.” Presumably, the double amount for married taxpayers with joint filing would be $800,000, but this could be wishful thinking. We may have another marriage penalty arising from this bill if the married filing jointly (MFJ) threshold is raised to say $600,000, rather than $800,000.
This proposed change for the threshold amount has the effect of limiting the QBI deduction to a maximum of $80,000 (20% of $400,000) for single taxpayers (also head of household, or HOH) and hopefully $160,000 for married taxpayers filing jointly. Married who file separately would get a zero QBI deduction under this bill.
Revised Amount of Deduction for QBI
A proposed change, rewriting the amount of deduction for QBI by striking all existing text in subsection (a) and inserting “an amount equal to 20% of the least of:
“(1) the qualified business income of the taxpayer,
“(2) the threshold amount, or
“(3) the taxable income of the taxpayer for the taxable year reduced by the net capital gain (as defined in section 1(h)) of the taxpayer for such taxable year.”
The current calculation is generally the lesser of 20% of QBI or 20% of taxable income less capital gains income. And though the threshold does limit the QBI deduction for higher-income taxpayers, computations using wages and UBIA support the QBI deduction for SSTBs and other very high-income taxpayers who do not operate SSTBs.
If enacted, the changes to the QBI deduction under S. 2387, the Small Business Tax Fairness Act, would be applicable for tax years beginning after the bill’s enactment.
New Limitations on the Deduction for QBI
In addition to raising the threshold and eliminating the additional calculations related to wages and UBIA, the new bill also proposes a new phase-out. This phase-out is stated as: the amount of the deduction is reduced (but not below zero) by an amount which bears the same ratio to such amount as (A) the excess of the taxable income over the threshold amount bears to (B) $100,000.
For example, a single taxpayer with taxable income of $450,000 would have $50,000 more than the threshold, and $50,000 is 50% of $100,000, so the QBI deduction in this example would be reduced by 50% of the deduction calculated under the new rules. Under the proposal, QBI would phase out entirely for a single taxpayer making $500,000 or more.
Changes to Eligibility for QBI
Married Filing Separately Not Eligible for QBI
The proposed changes also mandate that married couples must file a joint tax return to take the QBI deduction. The new text states, “Section 199A(f) shall only apply if a married taxpayer files a joint tax return with their spouse.” It does not address issues related to QBI loss carry-overs related to this change. The IRS and tax preparers will have work to do managing QBI carry-over losses if this bill passes. One example that comes to mind is the proposed plan for a married taxpayer, filing separately one year, with a QBI net loss who then either files jointly the following year or gets divorced and files single. May this taxpayer ignore the carry-over net “non-QBI loss” from the prior year because §199A would not have applied by filing MFS?
Trusts May Not Take QBI at the Trust Level, Only for K-1 Pass-Through Income
Eligibility changes are also proposed for filers of Form 1041, adding the following text “no deduction will be allowed under Section 199A to estates and trusts.” Business and rental income taxed at the trust level would no longer be permitted to file Form 8995 or Form 8995-A and take the QBI deduction. If applicable, trust and estate pass-through income and losses reported on the beneficiaries’ Schedule K-1 would still be eligible for the QBI deduction.
Cost of Proposed Modifications & Limits to QBI
According to the Tax Policy Center analysis of President Biden’s tax proposals limiting the QBI deduction to taxpayers earning more than $400,000 would generate an estimated $143.4 billion through 2030.
Applicable Date of Changes to the QBI Deduction
If enacted, the changes to the QBI deduction under S. 2387, the Small Business Tax Fairness Act, would be applicable for tax years beginning after the bill’s enactment.
Sharon Kreider, CPA has been helping thousands of tax preparers get ready for tax season each year for the past two decades. With a keen ability to demystify complex individual and business tax legislation, Kreider instructs Western CPE tax seminars and presents regularly for the AICPA, the California Society of Enrolled Agents, and A.G. Edwards. She gained her detailed, hands-on tax knowledge through her extremely busy, high-income tax practice in Silicon Valley.
Jane Ryder, EA, CPA is the owner of Brass Tax Ryder Professional Group Inc., a full-service tax and accounting firm that has been providing tax and accounting services since 1980. Ryder received a BS in Business Administration (Accounting) from SDSU and is currently licensed with the California State Board of Accountancy and with the IRS as an enrolled agent. She also specializes in IRS and state agencies’ collection problems, payment plans, audit appeals, offers in compromise, and other compliance-related issues.
For more information, contact Western CPE at (800) 822-4194 or wcpe@westerncpe.com. ©2021 Sharon Kreider
