Preparing for 2021: Tax Planning Strategies for Small Business Owners

If you are a small business owner, every penny of your income counts. This means that you want to optimize your revenue and minimize your expenses and your tax liability. Unfortunately, far too many entrepreneurs are not well-versed in the tricks and tools available to them and end up paying far more than they need to. You don’t need an accounting degree to take advantage of tax-cutting tips. Here are a few of our favorites. 

Think About Changing to a Different Type of Tax Structure 

When you started your business, one of the first decisions you needed to make was whether you wanted to operate as a sole proprietor, partnership, LLC, S corporation, or C corporation. But as more time goes by, the initial reasons for structuring your business the way that you did may no longer be applicable or in your best interest from a tax perspective. There is no requirement that you stick with the business structure you initially chose. 

Ever since the Tax Cuts and Jobs Act of 2017 (TCJA) changed the highest corporate income tax rate from 35% to 21%, sole proprietorships, LLCs, partnerships, and S corporations can realize significant tax savings by electing to be taxed as a C corporation. This simple change can make sense if these pass-through businesses’ owner is taxed at a high tax bracket. If so, all you need to do is fill out and file Form 8832. Before doing so, make sure that the tax savings you can realize are a reasonable tradeoff for the other reasons that you may have initially selected the structure you are currently in. 

Pass-Through Businesses Can Get a 20% 

One of the most impactful changes that the TCJA made for pass-through businesses whose income is passed-through for taxation as their owners’ income is a valuable tax break known as the qualified business income (QBI) deduction. For eligible recipients, this deduction is worth a maximum 20% tax break on the income they receive from the business – but determining whether or not you qualify can be a challenge. 

There are several restrictions on taking advantage of the deduction, particularly regarding specified service trade or businesses (SSTBs) whose owners either earn too much income or rely specifically on their employees’ or owners’ reputation or skill. Though architecture and engineering firms escape this limitation, other business models – including medical practices, law firms, professional athletes and performing artists, financial advisors, investment managers, consulting firms, and accountants – fall into the category that loses out of their income is too high. In 2019 single business owners of SSTBs began phasing out at $160,700 and are excluded once their income exceeds $210,700, while those who are married filing a joint return phase out at $321,400 and are excluded at $421,400. To calculate the deduction, use Part II of Form 8995-A

Businesses that are not SSTBs are eligible to take the deduction even when they pass the upper limits of the thresholds, but only for either half of the business owners’ share of the W-2 wages paid by the business or a quarter of those wages plus 2.5% of their share of qualified property. 

These limitations and specifications for what type of business is and is not eligible are head-spinning. Though it is tempting to take the deduction simply, it’s a good idea to confirm whether you qualify and how to claim it with our office before moving forward. 

Know How You’re Going to Pay Your Taxes

It is gratifying to live the dream of owning your own small business, but the hard work required to generate revenue makes paying taxes extra painful. This is especially true because of the “pay as you go” tax system that the United States uses, asking business owners to make estimated quarterly payments. While employees pay their taxes ahead via payroll deductions withheld by their employers, no such automatic system is set up for small business owners. That leaves many with the temptation of delaying making payments to maintain liquidity. 

Unfortunately, failing to pay taxes quarterly can put you in the uncomfortable position of still having to pay at one point, with the additional burden of penalties and interest resulting from your delay. Though setting aside the money to pay taxes requires discipline, doing so will save you from the penalties charged by the IRS. These are calculated based on the amount you should have paid each quarter multiplied by your shortfall and the effective interest rate during the specific quarter (established as 3 percent over the federal short-term rate – C corporations pay a different rate). Even if you don’t calculate your quarterly estimated rates correctly, the safe harbor rule allows small businesses to pay the lower amount, which is either 90% of the tax due on your current year return or 100% of the tax shown on your last filed tax return. For those whose AGI was over $150,000 in the previous tax year, the safe harbor percentage is 110% of the previous year’s taxes. 

It is always a good idea to increase the amount you send in if you have a higher-income year. By doing a simple calculation of your safe harbor number and dividing it by four, you have a reasonable quarterly payment that you can safely send in on the due dates (April 15th, June 15th, September 15th, and January 15th of the following year). By setting aside the appropriate percentage that you will owe from each payment you receive, you can easily set aside the money you will need to pay and entirely avoid concerns about penalties or interest. Payment is most easily submitted using the online link for IRS Direct Pay, though many people opt for sending in the paper vouchers for IRS Form 1040-ES, along with a check. There is also an EFTPS system available for C Corporations’ use. 

Choose Your Accounting Method Carefully

Each small business owner calculates their income and revenue differently, with many using a method of accounting that is based on when money is received rather than when an order is placed and counts expenses when they are paid rather than the item or service ordered. This is known as the cash method of accounting. 

Whatever method of accounting you use, smart business owners can strategically adjust their approach—reporting their annual income based on cash receipts to reduce their end-of-year revenues, especially if there is reason to believe that next year’s income will be lower or they anticipate being in a lower tax bracket. 

An example of how this approach would be helpful can be seen in a business that expects to add new employees in the new year. Between that expense and other improvements planned, it makes sense to anticipate that net income will be down. The tax bracket for the business will be lower, so any work is done or orders placed towards the end of the current tax year should be accounted for when payments arrive so that the income can be taxed at a lower rate. The contrast to this is if you anticipate your business revenue to increase and be forced into a higher tax bracket in the new year. In that case, it makes sense to try to collect monies for work done in the current year early so that you can take advantage of your current, lower tax rate. This can be done for business expenses such as office supplies and equipment, which can be deferred and accelerated in the same way so that you can take advantage of tax deductions in the most advantageous way. 

Establish and Make Deposits Into a 401(k) or SEP 

One of the smartest ways to lower your taxable income is to contribute to a retirement account. Not only does doing so reduce your business’ tax liability, but it also ensures a more secure future. As a small business owner, either a 401(K) plan or a Simplified Employee Pension (SEP) plan will do the trick while benefiting both you and those who work for you in the future. 

While a 401(k) that is established before year-end will let you deduct any contributions you make (with contributions limited to the lower of $57,000 or the employee’s total compensation), business owners who fail to set up this type of plan by December 31st can still turn to the SEP as an alternative. Though SEP contributions are restricted to 25% of the business owner’s net profit, less the SEP contribution itself (technically 20%), a SEP can be established, and contributions made up until the extended due date of your return. Suppose you obtain an extension for filing your tax return. In that case, you have until the end of that extension period to deposit the contribution, regardless of when you file the return.

If You Took Out a PPP Loan, Plan on it Being Forgiven 

Many small businesses took advantage of the PPP loans that were offered by the government in the face of the COVID-19 crisis. While these loans were attractive because they are forgivable and gave businesses a chance to survive the dire circumstances, in April of 2020, the IRS issued Notice 2020-32, which indicated that even though the forgivable loans can be excluded from gross income, the expenses associated with the money received cannot be deducted. This effectively erases the tax benefit initially offered because losing the employee and expense deduction increases the business’ income and profitability. 

There is some chance that this issue will be resolved by Congress, as it contradicts the original intent of the tax benefit that accompanied the PPP funds, but that action has not yet been taken. It’s a good idea to talk to our office about this as soon as possible. Having to pay taxes on expenses incurred may be particularly challenging in the face of the difficulties the pandemic has imposed. Being financially prepared to pay more taxes than you originally intended may be a bitter pill to swallow. However, it will still be better than paying penalties and interest if you fail to pay what the government says that you owe. 

Though all of these strategies can be helpful, they may not all be appropriate for your situation. Keep them in mind as you go into the end of the year, and be prepared to ask questions to determine which apply to you when you speak with our office. Contact us to discuss tax planning for your business today.

Gambling and Tax Gotchas

Article Highlights: 

  • Winnings 
  • Losses 
  • Social Security Income 
  • Health Care Insurance Premium Subsidies 
  • Medicare B & D Premiums 
  • Online Gambling Accounts 

Gambling is a recreational activity for many taxpayers, and as one might expect, the government takes a cut if you win and won’t allow you to claim a loss above your winnings. There are far more tax issues related to gambling than you might expect, and they may impact your taxes in more ways than you might believe. Here is an overview of the many issues and the “gotchas,” that can affect you. 

Reporting Winnings – Taxpayers must report the full amount of their gambling winnings for the year as income on their 1040 returns. Gambling income includes, but is not limited to, winnings from lotteries, raffles, lotto tickets and scratchers, horse and dog races, and casinos, as well as the fair market value of cars, houses, trips, or other non-cash prizes. The full amount of the winnings must be reported, not the net, after subtracting losses. The last statement’s exception is that the cost of the winning ticket or winning spin on a slot machine is deductible from the gross winnings. For example, if you put $1 into a slot machine and won $500, you would include $499 as the number of your gross winnings, even if you’d previously spent $50 feeding the machine. 

Frequently, taxpayers with winnings only expect to report those winnings included on Form W-2G. However, while that form is only issued for “Certain Gambling Winnings,” the tax code requires all winnings to be reported. All winnings from gambling activities must be included when computing the deductible gambling losses, which is always an issue in a gambling loss audit. 

GOTCHA #1 – Since you can’t net your winnings and losses, the full amount of your winnings ends up in your adjusted gross income (AGI). The AGI is used to limit other tax benefits, as discussed later. So, the higher the AGI, the more your other tax benefits may be limited.

Reporting Losses – A taxpayer may deduct gambling losses suffered in the tax year as a miscellaneous itemized deduction (not subject to the 2% of AGI limitation), but only to the extent of that year’s gambling gains. 

GOTCHA #2 – If you don’t itemize your deductions, you can’t deduct your losses. Thus, individuals taking the standard deduction will end up paying taxes on all of their winnings, even if they had a net loss. 

Social Security Income – For taxpayers receiving Social Security benefits, whether those benefits are taxable depends upon the taxpayer’s income (AGI) for the year. The taxation threshold for Social Security benefits is $32,000 for married taxpayers filing jointly, $0 for married taxpayers filing separately, and $25,000 for all other filing statuses. If the sum of AGI (before including any SS income), interest income from municipal bonds, and one-half the amount of SS benefits received for the year exceeds the threshold amount, 50–85% of the SS benefit is taxable. 

GOTCHA #3 – If your gambling winnings push your AGI for the year over the threshold amount, your gambling winnings—even if you had a net loss—can cause up to 85% of your Social Security benefits to become taxable.

Health Insurance Subsidies – Lower-income individuals who purchase their health insurance from a government marketplace are given a subsidy in the form of a tax credit to help pay the cost of their health insurance. Most people eligible for the tax credit use it to reduce their monthly health insurance premiums. That tax credit is based upon the AGIs of all members of the family. The higher the family income, the lower the subsidy becomes. 

GOTCHA #4 – The addition of gambling income to your family’s income can result in significant reductions in the health insurance subsidy, requiring you to pay more for your family’s health insurance coverage for the year. If your subsidy was based upon your estimated income for the year, your premiums were reduced by applying the subsidy in advance. If you subsequently had some gambling winnings, then you could get stuck with paying back some or all of the subsidy when you file your return for the year.

Medicare B & D Premiums – If you are covered by Medicare, the amount you are required to pay (generally withheld from your Social Security benefits) for Medicare B premiums is normally $144.60 per month and is based on your AGI two years prior. However, if that AGI was above $87,000 ($174,000 for married taxpayers filing jointly), the monthly premiums can increase to as much as $491.60. If you also have prescription drug coverage through Medicare Part D, and if your AGI exceeds the $87,000/$174,000 threshold, your monthly surcharge for Part D coverage will range from $12.20 to $76.40 (2020 rates). 

GOTCHA #5 – The addition of gambling winnings to your AGI can result in higher Medicare B & D premiums.

Online Gambling Accounts – If you have an online gambling account, there is a good chance that the account is with a foreign company. All U.S. persons with a financial interest or signature authority over foreign accounts with an aggregate balance of over $10,000 anytime during the prior calendar year must report those accounts to the Treasury by the April due date for filing individual tax returns or face draconian penalties. 

GOTCHA #6 – Regardless of whether you are a gambling winner or loser, if your online account was over $10,000, you will be required to file FinCEN Form 114 (Report of Foreign Bank and Financial Accounts), commonly referred to as the FBAR. For non-willful violations, civil penalties up to $10,000 may be imposed. The penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the violation time. The $10,000 and $100,000 penalty amounts are subject to adjustment for inflation, and after February 19, 2020 are $13,481 and $134,806, respectively.

Other Limitations – Those as mentioned above are the most significant “gotchas.” Numerous different tax rules limit tax benefits based on AGI, as discussed in gotcha #1. These include medical deductions, certain casualty losses, child and dependent care credits, the Child Tax Credit, and the Earned Income Tax Credit, to name a few. 

If you have questions related to gambling and taxes, please contact us.

There is More to Deducting Health Insurance than Meets the Eye

Article Highlights: 

  • Itemized Deduction 
  • AGI Limitations 
  • What Insurance is Deductible 
  • Above-the-Line Deduction for the Self-Employed 
  • Income Limitation 
  • Subsidized Limitation 

Health insurance premiums, especially in the wake of the Affordable Care Act, have risen dramatically and are one of the highest expenses that most individuals pay. Although the cost of health insurance is allowed as part of an individual’s medical deductions when itemizing deductions, only the amount of total medical expenses that exceed 7.5% of the taxpayer’s adjusted gross income (AGI) is deductible. The 7.5% limitation is increased to 10% for years after 2020. 

This article’s purpose is twofold: to remind you what can be included as a medical deduction and inform you of an alternate means of deducting health insurance for specific self-employed individuals—a means that avoids the AGI limitation and allows for deduction without itemizing. 

Let’s start by looking at what classifies as deductible health insurance. It includes the premiums you pay for coverage for yourself, your dependents, and your spouse, if applicable, for the following types of plans: 

  • Health care and hospitalization insurance 
  • Long-term care insurance (limited based on age) 
  • Medicare A in some circumstances* 
  • Medicare B 
  • Medicare C (aka Medicare Advantage plans) 
  • Medicare D 
  • Dental insurance 
  • Vision insurance 
  • Premiums paid through a healthcare marketplace net of the Premium Tax Credit 

*Most workers, and any government employees who pay Medicare tax, have a portion of their wages deducted for contributions to Medicare A. This payroll tax isn’t a deductible medical expense. However, those not covered under Social Security, and government employees who didn’t pay Medicare tax, can voluntarily enroll in Medicare A. In that case, Medicare A premiums are a medical expense.

Premiums paid on your or your family’s behalf by your employer aren’t deductible because their cost is not included in your wage income. Or, if you pay premiums for coverage under your employer’s insurance plan through a “cafeteria” plan, those premiums aren’t deductible either because they are paid with pre-tax dollars. 

Special Rule for Self-Employed Taxpayers 

If you are a self-employed individual, you can deduct 100% (no AGI reduction) of the premiums paid on behalf of yourself, your spouse, your dependents, and your children who were under age 27 at the end of the year without itemizing your deductions. This above-the-line deduction is limited to your net profits from self-employment, less the deductible part of your SE tax and contributions to SEP, SIMPLE and qualified retirement plans. 

No above-the-line deduction is permitted for any month when the self-employed individual is eligible to participate in a subsidized health plan which is maintained by an employer of the taxpayer, taxpayer’s spouse, any dependent, or child of the taxpayer who has not attained age 27 as of the end of the tax year. The plan is considered subsidized when 50% or more of the employer pays the premium. This rule is applied separately to plans that provide coverage for long-term care services. Thus, if you are a self-employed individual eligible for employer-subsidized health insurance, you may still be able to deduct long-term care insurance premiums as long as you aren’t eligible for employer-subsidized long-term care insurance. 

If you are a partner who performs services in the capacity of a partner and the partnership pays health insurance premiums on your behalf, those premiums are treated as guaranteed payments deductible by the partnership and are includible in your gross income. In turn, you may deduct the cost of the premiums as an above-the-line deduction under the rules discussed in this article. 

This above-the-line deduction is also available to more-than-2% S corporation shareholders. For purposes of income limitation, the shareholder’s wages from the S corporation are treated as his or her earned income. 

If you have any questions about deducting health insurance premiums, whether as an itemized deduction or an above-the-line deduction for self-employed individuals, please contact us.

Solar Tax Credit is Sunsetting Soon

A federal tax credit for the purchase and installation costs of a residential solar system is fading away. After 30% of the value for several years through 2019, the credit amount drops to 26% in 2020 and then to 22% in 2021, the credit’s final year. 

The credit is nonrefundable, meaning it can only reduce an individual’s tax liability to zero. However, the credit portion that is not allowed because of this limitation may be carried to the next tax year and added to the credit allowable for that year. The tax code infers that any credit carryover can be added to the credit allowed in the subsequent year. However, it’s unclear whether any carryover will be allowed to 2022 once the credit expires at the end of 2021. In addition to the credit reducing the regular tax, it also reduces the alternative minimum tax should a taxpayer be subject to it. 

Qualifying Property – Only the following solar power systems are eligible for the credit: 

  • Qualified solar electric property – a property that uses solar energy to generate electricity for use in a home that is the taxpayer’s primary or second residence. 
  • Qualifying solar water heating property – qualifies if used in a dwelling located in the U.S. operated by the taxpayer as a primary or secondary residence where at least half of the energy used to heat water is derived from the sun. Heating water for swimming pools or hot tubs does not qualify for the credit. The solar equipment must be certified for performance by the Solar Rating Certification Corporation or a comparable entity endorsed by the state government where the property is installed.

When Is the Credit Available? The credit may be claimed on the year’s tax return in which the installation is completed. If a taxpayer has purchased and paid for a system and it is completed in 2020, the credit will be 26% of the cost. But if the project isn’t completed until 2021, the credit will only be 22%. This becomes an even bigger issue for systems being installed during 2021 that aren’t completed before 2022 when the credit rate will be zero. If you plan to purchase a solar system in 2021, the purchase should be made early enough in the year to ensure the installation is completed before 2022. 

Who Gets the Credit – It may come as a surprise, but the taxpayer does not need to own the residence where the solar property is installed to qualify for the credit, as the taxpayer need only be a “resident” of the home. The tax code does not specify that an individual has to own the home, only that it is the taxpayer’s residence. For example, a son lives with his mother, who owns the home. The son pays to have the solar system installed; the son is the one who qualifies for the credit. 

Multiple Installations – The credit is available for numerous installations. For instance, after the initial installation, if a taxpayer adds additional panels to increase capacity, these would be treated as original installations and qualify for credit at the credit rate applicable for the year the additional installation is completed, provided that the installation is done before 2022. On the other hand, if a taxpayer had to replace damaged panels or perform other maintenance on the system, these items would not be an original system, and their costs would not qualify for the credit. 

Battery – A battery qualifies for the credit if charged only by solar energy and not off the grid. This has become popular in areas where there are frequent power outages. However, this may be more of a convenience than a necessity, so carefully consider the cost. A software-management tool—whether part of the original installation or added later (before 2022)—also qualifies for the credit in cases in which the software is necessary to monitor the charging and discharging of solar energy from a battery attached to solar panels. 

Installation Costs – Amounts paid for labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit. For piping or wiring, connecting the property to the residence are expenditures that qualify for the credit. This includes expenses relating to a solar system installed on a roof or ground-mounted installations. 

Basis Adjustment – The term basis is generally the cost of the home plus improvements and is the amount subtracted from the sales price to determine the gain or loss when the house is sold. The cost of a solar system adds to a home’s basis, and the credit reduces the basis. This will generally create a different basis for federal and state purposes where a state does not provide a solar credit, or it differs from the federal solar credit amount. 

Association or Cooperative Costs – A taxpayer who is a member of a condominium association for a condominium they own, or a tenant-stockholder in a cooperative housing corporation, is treated as having paid their proportionate share of any qualifying solar system costs incurred by the condo or cooperative association or corporation. 

Mixed-Use Property – In cases where a portion of a residence is used for deductible business use or is rented to others, the expenses must be prorated. Only the personal part of the qualified solar costs can be used to compute the credit. There is an exception when less than 80% of the property is used for non-business purposes, in which case the full amount of the expenditures is eligible for the credit. 

Newly Constructed Homes – If you plan to purchase a newly constructed home that includes a solar system, you may be entitled to claim the solar credit. However, to do so, the solar system’s costs must be separate from the home construction costs, and certification documents must be available. 

Utility Subsidy – Some public utilities provide a nontaxable subsidy (rebate) to their customers to purchase or install energy-conservation property. In that case, the cost of the solar system that’s eligible for the credit must be reduced by the amount of the nontaxable subsidy. 

Solar Installations are Not for Everyone – There are TV ads, telemarketing phone calls, and salespeople at your front door, all promoting solar power benefits. One of the key considerations and a frequently mentioned benefit is the federal tax credit. 

What isn’t included in the ads—and something most potential buyers are unaware of—is that the solar credit is a nonrefundable tax credit, meaning the credit can only be used to offset your tax liability. This can come as a very unpleasant surprise and is often a financial hardship when the purchaser of a home solar system finds out that the credit is nonrefundable and won’t benefit from the full credit. 

For example, a married couple with three children, all under age 17, and an annual income of $80,000 installed a solar system costing $20,000 in 2020, expecting a $5,200 ($20,000 x 26%) credit on their tax return. Their standard deduction in 2020 is $24,800, leaving them with a taxable income of $55,200. The tax on the $55,200 is $6,229. They are also entitled to a $2,000 child tax credit for each child, which reduces their tax liability by $6,000 and results in a tax liability of $229. Since the solar credit is nonrefundable, the only portion of the credit they can use is $229, not the $5,200 they had expected. 

On top of that, the family is probably financing the solar system, which significantly adds to its cost. If a 5% home equity loan financed the entire $20,000 price for 20 years, then the interest on that loan over its term would be $11,678, bringing the total cost of the solar system to $31,678 or a monthly fee of $132.

Instead of purchasing a solar system, some homeowners opt to lease a system. This arrangement is not eligible for the solar credit. 

As you can see, there is a lot to consider before making the final decision to install a solar system. Is it worth it, and is it the right financial move for you? Please contact us before signing any contract to make sure a solar system is appropriate for you.

Charity Volunteer Tax Breaks

Article Highlights:

  • Away-from-home travel
  • Lodging and meals
  • Entertaining for charity
  • Automobile travel
  • Uniforms
  • Substantiation requirements

If you volunteered your time for a charity or governmental entity during the COVID-19 pandemic, you probably qualify for some tax breaks. These rules apply to all charity volunteers, not just COVID-19 volunteers. Although no tax deduction is allowed for the value of services performed for a qualified charity or federal, state, or local governmental agency, some deductions are permitted for out-of-pocket costs incurred while performing the services. In this article, we address some examples:

  • Away-from-home travel expenses while performing services for a charity, including out-of-pocket round-trip travel costs, taxi fares, and other costs for transportation between the airport or station and hotel, plus 100% of lodging and meals. These expenses are only deductible if there is no significant element of personal pleasure associated with the travel or if your services for a charity do not involve lobbying activities.
  • The cost of entertaining others on behalf of a charity, such as taking a large potential contributor out for dinner. The costs of your own entertainment and meals are not deductible.
  • If you use your car or another vehicle while performing services for a charitable organization, you may deduct your actual unreimbursed expenses that are directly attributable to the services, such as gas and oil costs. Or, you may deduct a flat 14 cents per mile for the charitable use of your car. You may also deduct parking fees and tolls.
  • You can deduct the cost of the uniform you wear when doing volunteer work for the charity, as long as the outfit has no general utility. You can also deduct the cost of cleaning the uniform.

There are some misconceptions as to what constitutes a charitable deduction, and the following are frequently encountered issues:

  • No deduction is allowed for the depreciation of a capital asset as a charitable deduction. This includes vehicles and computers.Example: Kathy volunteers as a member of the sheriff’s mounted search and rescue team. As part of volunteering, Kathy is required to provide a horse. Kathy is not allowed to deduct the cost of purchasing her horse. She also cannot depreciate the value of her horse. She can, however, deduct uniforms, travel, and other out-of-pocket expenses associated with the volunteer work.

    However, a taxpayer may deduct the cost of maintaining a personally owned asset to the extent that its use is related to providing services for a charity. Thus, for example, a taxpayer is allowed to deduct the fuel, maintenance, and repair costs (but not depreciation or the fair rental value) of piloting his or her plane in connection with volunteer activities for the Civil Air Patrol. Similarly, a taxpayer—such as Kathy in our example, who participated in a mounted posse that is a civilian reserve unit of the county sheriff’s office—could deduct the cost of maintaining a horse (shoeing and stabling).

  • A taxpayer who buys an asset and uses it while performing volunteer services for a charity can’t deduct its cost if he or she retains ownership of it. That’s true even if the asset is used exclusively for charitable purposes. So, for example, this rule would knock out a deduction for COVID-19 personal protective equipment such as face coverings and gloves that an individual purchased and used while volunteering at a food bank if the volunteer retains these items after performing the volunteer work. But if that individual purchased and donated PPE to the county for use by medical personnel at a coronavirus testing site, the cost of the items would be allowed.

No charitable deduction is allowed for a contribution of $250 or more unless you substantiate the gift with a written acknowledgment from the charitable organization (including a government agency). To verify your donation:

  • Obtain written documentation from the charity about the nature of your volunteering activity and the need for related expenses to be paid. For example, if you travel out of town as a volunteer, request a letter from the charity explaining why you’re needed at the out-of-town location.
  • You should submit a statement of expenses to the charity if you are paying out of pocket for substantial amounts, preferably with a copy of the receipts. Then, arrange for the charity to acknowledge the value of the contribution in writing.
  • Maintain detailed records of your out-of-pocket expenses—receipts plus a written history of the time, place, amount, and charitable purpose of the expense.

There are also other special charitable provisions for the 2020 tax year, including:

  • Taxpayers that do not itemize their deductions can deduct up to $300 of cash contributions.
  • Cash contributions for those that do itemize their deductions are not limited to 60% of their adjusted gross income in 2020.
  • Employees (where their employer participates) can contribute the value of unused paid vacation and leave time to qualified charities and not have to include the leave payments in income.

For additional details related to expenses incurred as a charity volunteer or the special 2020 charitable provisions, please contact us.

2019 Standard Mileage Rates Announced

The Internal Revenue Service (IRS) computes standard mileage rates for business, medical and moving each year, based on a number of factors, to determine the standard mileage rates for the following year.

As it does annually around the end of the year, the IRS has announced the 2019 optional standard mileage rates. Thus, beginning on Jan. 1, 2019, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:

  • 58 cents per mile for business miles driven (including a 26-cent-per-mile allocation for depreciation). This is up from 54.5 cents in 2018;
  • 20 cents per mile driven for medical or moving* purposes. This is up from 18 cents in 2018; and
  • 14 cents per mile driven in service of charitable organizations.
    * For years 2018 through 2025, the deduction for moving is only allowed for members of the armed forces on active duty who move pursuant to a military order. 

The business standard mileage rate is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs determined by the same study. The rate for using an automobile while performing services for a charitable organization is statutorily set (it can only be changed by Congressional action) and has been 14 cents per mile for 20 years).

Important Consideration: The 2019 rates are based on 2018 fuel costs. Based on the potential for substantially higher gas prices in 2019, it may be appropriate to consider switching to the actual expense method for 2019 or at least to keep track of the actual expenses, including fuel costs, repairs and maintenance, so that the option is available for 2019.

Taxpayers always have the choice of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act may make using the actual expense method worthwhile during the first year when a vehicle is placed into business service.

However, the standard mileage rates cannot be used if you used the actual method (using Section 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.

Employer Reimbursement – When employers reimburse employees for business-related car expenses using the standard mileage allowance method for each substantiated employment-connected business mile, the reimbursement is tax-free if the employee substantiates to the employer the time, place, mileage and purpose of the employment-connected business travel.

The Tax Cuts and Jobs Act eliminated employee business expenses as an itemized deduction, effective for 2018 through 2025. Therefore, employees may no longer take a deduction on their federal returns for unreimbursed employment-related use of their autos, light trucks or vans. Members of a reserve component of the U.S. Armed Forces, state and local government officials paid on a fee basis and certain performing artists continue to be allowed to deduct unreimbursed employee travel expenses, including the business standard mileage rate, because they are deductible from gross income rather than as an itemized deduction.

Faster Write-Offs for Heavy Sport Utility Vehicles (SUVs) – Many of today’s SUVs weigh more than 6,000 pounds and are therefore not subject to the limit rules on luxury auto depreciation. Taxpayers who purchase a heavy SUV and put it into business use in 2019 can utilize both the Section 179 expense deduction (up to a maximum of $25,500) and the bonus depreciation (if the Section 179 deduction is claimed, it must be applied before the bonus depreciation) to produce a sizable first-year tax deduction. However, the vehicle cannot exceed a gross unloaded vehicle weight of 14,000 pounds. Caution: Business autos are 5-year class life property. If the taxpayer subsequently disposes of the vehicle before the end of the 5-year period, as many do, a portion of the Section 179 expense deduction will be recaptured and must be added back to the taxpayer’s income (self-employment income for self-employed individuals). The future ramifications of deducting all or a significant portion of the vehicle’s cost using Section 179 should be considered.

If you have questions related to the best methods of deducting the business use of your vehicle or the documentation required, please call us.

Rejoice — Business Meals Are Still Deductible

f you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, you were no doubt saddened by part of the tax reform that passed last December. A part of the tax reform did away with the business-related deductions for entertainment, amusement or recreation expenses, beginning in 2018. You can still entertain your clients; you just can’t deduct the costs of doing so as a business expense.

While the ban on deducting business entertainment was quite clear in the revised law, a lingering question among tax experts has been whether the tax reform’s definition of entertainment also applied to business meals, such as when you take a customer or business contact to lunch. Some were saying yes, and others no. Either way, both sides recommended keeping the required receipts and documentation until the issue was clarified.

The IRS recently issued some very business-friendly guidance, pending the release of more detailed regulations. In a notice, the IRS has announced that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business, including business meals, provided:

  1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying out any trade or business;
  2. The expense is not lavish or extravagant under the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
  4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and
  5. Food and beverages provided during or at an entertainment activity are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS notice also included the following interesting examples related to #5: The taxpayer invites a business contact to a baseball game. The tickets to the game are entertainment and not deductible. However, the taxpayer also purchased hot dogs and a beverage for himself and the business contact. Because the food and drinks were purchased separately, they are not disallowed as entertainment and are deductible if they otherwise qualify as an ordinary and necessary business expense. Had the ticket price included the hot dogs and beverages, they would be treated as non-deductible entertainment. If the ticket price separately stated the ticket price and the food and beverage price, then the food and beverage portion would not be disallowed as entertainment.

Of course, the substantiation requirements still apply. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, an account book, digital files or similar records with this information and record the details within a short time of incurring the expenses. If the meal expense is $75 or more, documentary proof (receipts, etc.) is also required.

If you are an employee, starting in tax year 2018, you will not be able to deduct your unreimbursed employee business expenses, including the cost of client meals. These expenses have been deductible as miscellaneous itemized deductions when you itemized deductions and when your total deductions in that category exceeded 2% of your adjusted gross income. Under the tax reform, this category of deductions is not deductible for years 2018 through 2025. So, unfortunately, the IRS’s expansive definition of meal expenses will not benefit you.

If you have questions related to business meals, substantiation, or the ban on entertainment expenses, please give us a call.

Surrogacy Fees and Taxes

Articles about the taxability and deductibility of surrogacy fees are rare because there are far fewer surrogacies than conventional births. Surrogacy is a legal arrangement in which a surrogate mother, new parents and (often) a surrogacy agency enter into a binding contract. In the event of a breach of that contract, any party can be held to the terms of the agreement.

Tax Treatment for the Surrogate
The Internet contains a wide variety of opinions related to the taxability of the surrogacy fee to the surrogate mother. Some authors classify this fee as a gift; however, a U.S. Supreme Court decision (Commissioner vs. LoBue, Philip (1956, S Ct)) stated that, for tax purposes, gifts must be made out of detached or disinterested generosity. Any payment that parents make to a surrogate mother cannot reasonably be considered detached or disinterested, so surrogate fees are not gifts.

On the other hand, many surrogacy agencies advise their clients that surrogacy payments are for pain and suffering and thus are exempt under Sec 104 of the Internal Revenue Code (IRC). This section is about “compensation for injury or sickness”; however, the term “pain and suffering” does not appear anywhere in that section. Surrogacy does not meet the definition of an excludable physical injury under IRC Sec 104 such as an injury associated with a car accident, bungled surgery or other accident. Thus surrogacy fees do not fall under the compensation exclusion for injury or sickness.

IRC Sec 61 states, “Except as otherwise provided, gross income means all income from whatever source derived.” There is no exception in the code for surrogacy fees, so such fees are considered taxable income for the surrogate mother. To complicate matters, the surrogate mother is providing a personal service and thus may be subject to the self-employment (Social Security and Medicare) taxes in addition to income tax if such a fee is received in the course of business.

To be subject to Social Security taxes, the surrogacy arrangement would have to rise to the level of a trade or business. The determination of whether that is the case is dependent on the facts and circumstances of the individual surrogacy. For instance, if a surrogate has entered into such an arrangement previously or intends to do so again, the fee will likely be considered self-employment income. However, if the surrogacy is a one-time activity, an argument could be made that this act is not a business—in which case the surrogacy fee would not be subject to Social Security taxes.

If the fee is considered self-employment income, it may be offset with benefits that are available to any self-employed taxpayer, including the ability to deduct health insurance above the line rather than as an itemized deduction and the ability to make deductible contributions to a self-employed retirement plan or IRA. Although there are not many deductible business expenses in such a situation, the legal or other costs associated with drafting and executing the surrogacy contract are deductible.

A self-employment surrogacy activity would fall into the category of a specified service business for the purposes of the new, self-employed and pass-through business deduction that will be available in 2018 through 2025. Thus, provided that the surrogate mother’s return has taxable income that does not exceed $157,500 (or $315,000 if she is married and files a joint return with her spouse), she would be eligible for the new IRC Sec 199A pass-through deduction, which is equal to 20% of the net self-employment income. However, this deduction phases out at taxable incomes between $157,500 and $207,500 (or $315,000 and $415,000 if filing jointly). The income from self-employment surrogacy can be used to determine the earned income tax credit if a surrogate mother is otherwise qualified.

Unfortunately, tax novices on the Internet are creating their own interpretations of the tax code, and many of them are attempting to justify their preferences instead of instead of describing the actual rules.

As a result, many – dare we say, most – surrogate mothers are not reporting their surrogacy income. The IRS is not catching up with them because neither the parents nor the agencies are issuing 1099-MISC forms to surrogate mothers. The parents are under no obligation to issue a 1099-MISC because, for them, the payment is not related to a business. The agency, on the other hand, is a business, so if the surrogacy fee passes through it, the agency is obligated to issue a 1099-MISC.

Tax Treatment for the Parents
Surrogate mothers’ expenses are not specifically addressed in the IRC or in other regulations. Under current tax law, the only place that a surrogate fee could be deducted is as a medical expense. However, consider the following:

  • Medical deductions are allowed only for the medical care of the taxpayer and his or her spouse and dependents (IRC Sec 213(a)).
  • These expenses must be for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body (IRC Sec 213(a)(1)(A)).

A surrogate mother is, by definition, neither the taxpayer nor the taxpayer’s spouse, and she is typically not a dependent, either. An unborn child is also not a dependent (Cassman v. United States, 31 Fed. Cl. 121 (1994)). Thus, medical expenses paid to a surrogate mother and her unborn child do not qualify for a medical deduction.

This fee also cannot be construed as a treatment for a female taxpayer’s inability to conceive.

Thus, the new parents cannot deduct the surrogacy fee or any agency fees, legal fees, and medical expenses for the surrogate mother and unborn fetus.

Please call us if you have questions about surrogacy fees and taxes.

Disabled Taxpayer Tax Benefits

Taxpayers with disabilities may qualify for a number of tax credits and other tax benefits. Parents of children with disabilities may also qualify. Listed below are several tax credits and other benefits that are available if you or someone else listed on your federal tax return is disabled.

Increased Standard Deduction – Tax reform substantially increased the standard deduction for 2018 to $12,000 for single filers, $18,000 for those filing as head of household and $24,000 for married filing joint returns. Tax reform also retained the standard deduction add-on for taxpayers who are legally blind. Thus, if a taxpayer is filing jointly with a blind spouse, they are able to add an additional $1,300 to their standard deduction; if both spouses are blind, the add-on doubles to $2,600. For other filing statuses, the additional amount is $1,600. While being age 65 or older isn’t a disability, it should be noted that the “elderly” add-on of $1,300 or $1,600, depending on filing status, has also been retained. These add-ons apply only to the taxpayer and spouse, and not to any dependents.

  1. Exclusions from Gross Income – Certain disability-related payments, Veterans Administration disability benefits, and Supplemental Security Income are excluded from gross income (i.e., they are not taxable). Amounts received for Social Security disability are treated the same as regular Social Security benefits, which means that up to 85% of the benefits could be taxable, depending on the amount of the recipient’s (and spouse’s, if filing jointly) other income.

    Impairment-Related Work Expenses – Individuals who have a physical or mental disability may deduct impairment-related expenses paid to allow them to work.

    Employee – Although the tax reform eliminated most miscellaneous itemized deductions, it retained the deduction for employees who have a physical or mental disability limiting their employment. As a result, they can still deduct, as an itemized deduction, the expenses that are necessary for them to work.

    Self-employed – For those who are self-employed, impairment-related expenses are deductible on Schedule C or F.

    Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at the individual’s place of work as well as other expenses in at the place of work that are necessary for the individual to be able to work. An example is when a blind taxpayer pays someone to read work-related documents to the taxpayer.

  2. Financially Disabled – Under normal circumstances, one must file a claim for a tax refund within 3 years of the unextended due date of the tax return. For example, for a 2015 tax return, the due date was April 15, 2016, which is the date when the 3-year clock started running. Thus, the IRS will not issue refunds for an amended 2015 or a late-filed original 2015 return submitted to the IRS after April 15, 2019. However, if a taxpayer is “financially disabled,” the time periods for claiming a refund are suspended for the period during which the individual is financially disabled.

    An individual is financially disabled if they are unable to manage their financial affairs because of a medically determinable physical or mental impairment that can be expected to result in death or that has lasted or can be expected to last for a continuous period of not less than 12 months.

    For a joint income tax return, only one spouse has to be financially disabled for the time period to be suspended. However, financial disability does not apply during any period when the individual’s spouse or any other person is authorized to act on the individual’s behalf in financial matters.

  3. Earned Income Tax Credit – The EITC is available to disabled taxpayers and to the parents of a child with a disability. To be eligible for the credit, the taxpayer must receive earned income, which generally is wages or self-employment income. However, if an individual retired on disability, taxable benefits that were received under their employer’s disability retirement plan are considered earned income until the individual reaches a minimum retirement age. If the disability benefits being received are nontaxable, as would be the case if the disabled individual paid the premiums for the disability insurance policy from which the benefits come, then the benefits are not considered earned income. The EITC is a tax credit that not only reduces a taxpayer’s tax liability but may also result in a refund. Many working individuals with a disability who have no qualifying children but are older than 24 and younger than 65 may qualify for the EITC. Additionally, if the taxpayer’s child is disabled, the qualifying child’s age limitation for the EITC is waived. The EITC has no effect on certain public benefits. Any refund that is received because of the EITC will not be considered income when determining whether a taxpayer is eligible for benefit programs such as Supplemental Security Income and Medicaid.
  4. Child or Dependent Care Credit – Taxpayers who pay someone to come to their home and care for their dependent or disabled spouse may be entitled to claim this credit. For children, this credit is usually limited to the care expenses paid only until age 13, but there is no age limit if the child is unable to care for himself or herself.

    Special Medical Deductions When Claiming Itemized Deductions – In addition to conventional medical deductions, the tax code provides special medical deductions related to disabled taxpayers and dependents. They include:

    Impairment-Related Expenses – Amounts paid for special equipment installed in the home, or for improvements, may be included as medical expenses deductible as part of itemized deductions, if their main purpose is medical care for the taxpayer, the spouse, or a dependent. The cost of permanent improvements that increase the value of the property may only be partly included as a medical expense.

    Learning Disability – Tuition paid to a special school for a child who has severe learning disabilities caused by mental or physical impairments, including nervous system disorders, can be included as medical expenses eligible for the medical deduction when itemizing deductions. A doctor must recommend that the child attend the school. Fees for the child’s tutoring recommended by a doctor and given by a teacher who is specially trained and qualified to work with children who have severe learning disabilities might also be included.

    Drug Addiction – Amounts paid by a taxpayer to maintain a dependent in a therapeutic center for drug addicts, including the cost of the dependent’s meals and lodging, are included as medical expenses for itemized deduction purposes.

  5. Exclusion of Qualified Medicaid Waiver Payments – Payments made to care providers caring for related individuals in the provider’s home are excluded from the care provider’s income. Qualified foster care payments are amounts paid under the foster care program of a state (or political subdivision of a state or a qualified foster care placement agency). For more information, please call.
  6. ABLE Accounts – Qualified ABLE programs provide the means for individuals and families to contribute and save for the purpose of supporting individuals with disabilities in maintaining their health, independence, and quality of life.

    Federal law authorizes the states to establish and operate an ABLE program. Under these ABLE programs, an ABLE account may be set up for any eligible state resident – someone who became severely disabled before turning age 26 – who would generally be the only person who could take distributions from the account. ABLE accounts are very similar in function to Sec. 529 plans. The main purpose of ABLE accounts is to shelter assets from the means testing required by government benefit programs. Individuals can contribute to ABLE accounts, subject to per-account gift tax limitations (maximum $15,000 for 2018). The 2017 tax reform added a provision allowing working individuals who are beneficiaries of ABLE accounts to contribute limited additional amounts to their ABLE accounts, beginning in 2018. Distributions to the disabled individual are tax-free if the funds are used for qualified expenses of the disabled individual. These accounts are established at the state level.

For more information on these benefits available to disabled taxpayers or dependents, please give us a call.

Do You Own a Specified Service Trade or Business? If So, Your 20% Pass-Through Tax Deduction May Be Limited

As part of its recent tax reform, Congress included a new 20% deduction of pass-through income for trades or businesses other than C-corporations. This pass-through income is referred to as qualified business income (QBI); for trades or businesses, it generally includes bottom-line profits, and for S-corporations and partnerships, it includes K-1 flow-through income. This new law was added as tax code section 199A, so the deduction is often referred to as the 199A deduction.

Congress added this deduction to benefit sole proprietors, partners, and S-corporation shareholders (among others); the goal is to allow for benefits equivalent to the substantial tax-rate cut that the same reform provided to C-corporations. However, this new deduction is not applied uniformly to all types of trades and businesses, for which there are two categories:

  • qualified trades or businesses (QTBs) and
  • specified service trades or businesses (SSTBs).

This deduction is limited by the taxpayer’s filing status and 1040 taxable income, and it differs depending on whether the business is a QTB or a SSTB. Although the main purposes of this article are to define SSTBs and to describe how they are taxed differently from QTBs, if one is to understand why an SSTB may not qualify for the deduction, whereas a QTB might qualify, it is necessary to first understand the basic differences between the deductions for SSTBs and QTBs.

Apparently, Congress considered the income from service businesses to be akin to wages and didn’t want taxpayers who provide services to have the benefit of the 20% deduction instead of paying taxes on that income as ordinary wages. This change was primarily aimed at deterring high-income people from becoming independent contractors or setting up pass-through businesses so that they could turn their wages into business income and get the 20% deduction. The result is a phase-out of the deduction for high-income taxpayers who have income from SSTBs.

The table below provides an overview of the tax treatment for each type of business. As you will note, the SSTB deduction phases out for higher levels of 1040 taxable income, but the QTB deduction does not. This type of phase-out is called a wage limitation.

Example of How to Use the Table: Two married people who are filing jointly have 1040 taxable income (before the 199A deduction) of $469,000; they also have a SSTB. They would first select the box with their filing status (“Married Filing a Joint Return”), then move to the right to the correct range of 1040 taxable income (which is the adjusted gross income after removing either the standard deduction or the itemized deductions; in this case, “Greater than $415,000”), and finally follow that column down to the cell aligned with the correct type of business (“SSTB”). In this case, the trade or business does not qualify for the 199A deduction.

Taxpayer’s Filing Status

Taxable Income
(Before the 199A deduction)

Married Filing a Joint Return
Less Than $315,000
Between $315,000 and $415,000

Greater than $415,000

Other filing Statuses
Less Than $157,500
Between $157,500 and $207,500

Greater than $207,500

Type of Business
The 199A Deduction
SSTB
20% of QBI
Deduction phased out
No deduction allowed
QTB
20% of QBI
Wage limitation phased in
Deduction equal to the lesser of 20% of QBI or the wage limitation

Specified Service Trades or Businesses (SSTBs)
The IRS describes SSTBs as being in the following fields:

  • Health – The health category includes the provision of services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and similar health care professionals who provide medical services directly to patients. However, this excludes the provision of services that are not directly related to a medical field, even when those services purportedly relate to the health of the service recipient. For example, this category excludes the operation of health clubs or spas that provide physical exercise or conditioning; health-related payment processing; or the research, testing, manufacture, and/or sales of pharmaceuticals or medical devices.
  • Law – The law category refers to the provision of services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals in their capacities as such. The category excludes the provision of services that do not require skills unique to the field of law, such as the printing, delivery, and stenography services provided to lawyers.
  • Accounting – The accounting category includes the provision of services by accountants, enrolled agents, tax-return preparers, financial auditors, and similar professionals in their capacities as such. This category is not limited to services that require state licensure as a certified public accountant. This category also excludes payment processing and billing analysis.
  • Actuarial Science – The actuarial science category refers to the provision of services by actuaries and similar professionals in their capacities as such. This category only includes the services provided by analysts, economists, mathematicians, and statisticians if they are engaged in analyzing or assessing financial costs due to risk or uncertainty.
  • Performing Arts – The performing arts category includes the performance of services by individuals who participate in the creation of the performing arts, including actors, singers, musicians, entertainers, directors, and similar professionals in their capacities as such. It excludes services that do not require skills that are unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities. Similarly, the dissemination of video or audio of performing-arts events to the public is not considered to be a service in the performing arts.
  • Athletics – The athletics category refers to the performance of services by individuals who participate in athletic competitions, including athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing. This category excludes the provision of services that do not require skills that are unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events. It also excludes the provision of services by persons who disseminate video or audio of athletic events to the public.
  • Consulting – The consulting category refers to the provision of professional advice and counsel to clients to assist them in achieving goals and solving problems. Consulting professionals include lobbyists and similar professionals, but this category focuses on their capacities as such and excludes the minor consulting that accompanies the sale of a product. A trade or businesses cannot be an SSTP if less than 10% of its gross receipts are from consulting (or 5% if the company’s gross receipts are greater than $25 million).
  • Financial services – The category of financial services applies to services that are typically performed by financial advisors and investment bankers, including the following financial services: managing wealth; advising clients with respect to their finances; developing retirement and wealth-transition plans; providing advisory and other services regarding valuations, mergers, acquisitions, dispositions, and restructurings (including in title 11 bankruptcies and similar cases); and raising financial capital through underwriting or by acting as a client’s agent in the issuance of securities. This includes the services provided by financial advisors, investment bankers, wealth planners, retirement advisors, and similar professionals but excludes banking services such as deposit-taking or loan-making.
  • Brokerage Services – The brokerage services category includes services in which a person arranges transactions between a buyer and a seller with respect to securities and in exchange for a commission or fee. This includes services provided by stock brokers and similar professionals but excludes services provided by real estate or insurance agents and brokers.
  • Reputation or Skill – The original legislation’s list of SSTBs included trades or businesses for which the principal asset was the reputation or skill of one or more of employees or owners. However, it was unclear if this meant, for example, that a self-employed plumber who provided his skill to the business would be eligible for the 199A deduction. The taxpayer-friendly interpretation of these tax regulations has generally defined “reputation and skill” to mean:(1) The receipt of income in exchange for endorsing products or services for which the individual provides endorsement services;
    (2) The receipt of licensing income in exchange for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbol associated with that individual’s identity; or
    (3) The receipt of appearance fees or income (including fees or income paid to reality performers who appear as themselves on television, social media, or other forums; radio, television, and other media hosts; and video game players).

The amount of pass-through deduction that is ultimately available due to an SSTB is entirely dependent upon the taxpayer’s 1040 taxable income. Thus, in some cases, pension contributions and the expensing of business assets can lower a taxpayer’s taxable income enough that he or she benefits from an increase in the pass-through deduction. In this scenario, married couples who are not living in community-property states could benefit from filing separately rather than jointly.

If you have questions related to whether your business qualifies for this new deduction, whether it is classified as an SSTB, or how SSTB income fits into your overall tax picture, please give us a call.