Not All Deductions Reduce QBI

Published on: 15:43PM Sep 08, 2019

In our last post we mentioned that the IRS had finally released the draft instructions for the new Form 8995 (used to calculate the Section 199A Qualified Business Income deduction).

In the instructions, there were various deductions that show up on Form 1040 that will reduce the final QBI deduction.  One of those deductions is self-employment tax.  Farmers are allowed in most cases to deduct 1/2 of the self-employment tax that they pay on their Form 1040 (the excess .9% Medicare tax is not allowed).  This means that any of this deduction associated with QBI has to reduce QBI.  But not always.  Let's look at some examples:

Betty is a farmer and a vet.  She generates $400,000 of income from her Vet practice and $100,000 from her farm.  Let's assume the total SE tax deduction is $15,000.  Since the Vet income is a Specified Service Trade or Business income, no QBI deduction is allowed.  Therefore, she only needs to reduce her farm QBI by $3,000 (20% of $15,000)

Sam is a partner in the ABS farm partnership.  He receives a guaranteed payment of $50,000 (which includes his health insurance of $15,000).  He also generates $200,000 of income on Line 1 of his K-1.  The $50,000 guaranteed payment is not QBI.  The SE tax deduction associated with the guaranteed payment is ignored and only the SE tax deduction on the $200,000 of line 1 income is used to reduce QBI.  The SE health insurance deduction of $15,000 does not reduce QBI since it is included as part of the guaranteed payment which is not QBI.

The FAQ released on July 16, 2019 by the IRS indicates in Q.33 that you may need to reduce QBI by the health insurance deduction (this was for an S corporation).  However, we believe that only the SE health insurance deduction for Schedule C and Schedule F taxpayers should reduce QBI.  We hope the IRS will update their FAQ to reflect that any health insurance treated as a guaranteed payment or included as part of S corporation compensation will not reduce QBI.

Finally, the final regulations indicated that the deduction for business interest for purchasing a partnership interest or S corporation stock was not addressed by those regulations.  However, the instructions clearly state that QBI is reduced by this deduction. 

As the IRS provides additional guidance in this area, we will keep you posted.