QBI calculation for Sch C - accountants are confused, too

10 Replies

Guys, we know that 20% applies to the Qualified Business Income (QBI). Let's ignore service businesses, phaseouts and all other complications. Let's take a wholesaler netting $100k. So, he just gets a $20k below-the-line break, right? Not that fast!

The problem for me is this language: Reasonable compensation and guaranteed payments. 
Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include any guaranteed payment for services rendered with respect to the trade or business, and to the extent provided in regulations, does not include any amount paid or incurred by a partnership to a partner who is acting other than in his or her capacity as a partner for services.

The intention appears to be to count only K1 "dividend" income and exclude all income subject to SE tax - like reasonable salary under S-corp and guaranteed payments under PShip. Sorta kinda makes sense, even though opens a can of worms. If currently a reasonable salary only affects SE tax, under this concept it will also affect the 20% cut - raising the stakes tremendously.

Here comes my problem. Extending this concept, the entire Sch C should then be excluded from QBI, since it's an equivalent of reasonable compensation for services. In other words, ZERO QBI. No soup for you, Sch C?  That would negate the obvious Congressional intention to include sole proprietorships in this provision. So, that must NOT be the intended result, and nothing in the text indicates that it is.

But... If entire net Sch C is allowed for QBI, but an S-Corp has to establish and subtract a reasonable salary for QBI purposes - this suddenly puts S-Corp at a substantial DISadvantage against Sch C.  Which is also doubtful to be an intention.

Thoughts? @Brandon Hall  @Lance Lvovsky  @Ashish Acharya  @Brian Schmelzlen  @Paul Allen  @Vlad K.  @Basit Siddiqi

Interesting question. Like you said there’s no way that all of Schedule C is going to be considered compensation for services. 

I’m not sure I would agree though that this would give Sched C’s a significant advantage over S Corps. At least not in the scenario you describe above. 

On $100k net let’s say you pay $40k as reasonable salary.  Schedule C would get $8,000 more to write off. Assuming the tax payer is married with no other income that would save them an extra $960 in income. Even if you bump them up to the 22 percent bracket because you assume the spouse works then that still only saves  $1,760. 

The S Corp on the other hand will save SE taxes on the $60k in profits, which will save substantially more than what they lost in QBI deductions. 

It’s definitley going to create more discussion on which entity is best, but it seems in most cases the S Corp is going to come out ahead of the Schedule C option.  It’s definitley going to cause people to push the limits even further on what’s a reasonable salary. 

@Michael Plaks I suspect the Treasury will be issuing Regulations on many of the new tax laws in the coming year(s). Many of the new laws, particularly concerning pass-thru entities are poorly written. It is not up to the Treasury to issue Regulations to provide guidance and ultimately, what the IRS position will be. Hopefully the Treasury priorities pass-through taxation, and we can get some guidance soon.

Regarding your question, I don't expect all of Sch C income to be considered compensation for services... there likely can be an allocation to extract the QBI from the compensation.

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

Originally posted by @Michael Plaks :

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

Originally posted by @Lance Lvovsky :
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

Originally posted by @Michael Plaks :
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

 Without the salary, there will be no deduction for many business owners...

Originally posted by @Michael Plaks :
Originally posted by @Lance Lvovsky :
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

 Yeah the real interesting scenarios are going to come from the small business under the mandated 50 percent of salary requirement for the QBI deduction. The majority of my clients will fall in this level so I’m very interested to see how this develops. 

Originally posted by @Lance Lvovsky :
Originally posted by @Michael Plaks:
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

 Without the salary, there will be no deduction for many business owners...

Lance, there is NO salary limitation under the threshold, that's the whole issue! S-corp could have $0 salary, and the entire $100k will qualify as QBI and allow a $20k deduction! So is Sch C. 

But S-corp has a statutory requirement to pay a reasonable salary - in other words, a statutory requirement to shoot itself in the foot. Sch C does NOT have a similar requirement, with the respect to QBI.

Originally posted by @Michael Plaks :
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

 Without the salary, there will be no deduction for many business owners...

Lance, there is NO salary limitation under the threshold, that's the whole issue! S-corp could have $0 salary, and the entire $100k will qualify as QBI and allow a $20k deduction! So is Sch C. 

But S-corp has a statutory requirement to pay a reasonable salary - in other words, a statutory requirement to shoot itself in the foot. Sch C does NOT have a similar requirement, with the respect to QBI.

 You are forgetting that taxpayers whose income exceed the threshold ($157,500/$315,000) cannot take the deduction unless they meet other requirements, such as the business paying wages. See below:

The qualified business income deduction for noncorporate taxpayer is applied to partnerships and S corporations at the partner or shareholder level. (Code Sec. 199A(f)(1)(A)(i)) Thus, each partner or shareholder must take into account his allocable share of each qualified item of income, gain, deduction, and loss (Code Sec. 199A(f)(1)(A)(ii)), and is treated as having W-2 wages for the tax equal to his allocable share of the W-2 wages of the partnership or S corporation for the tax year (as determined under IRS regs). (Code Sec. 199A(f)(1)(A)(iii)) A partner's or shareholder's allocable share of W-2 wages is determined in the same manner as the partner's or shareholder's allocable share of wage expenses and a partner's or shareholder's allocable share of the unadjusted basis immediately after acquisition of qualified property is determined in the same manner as the partner's or shareholder's allocable share of depreciation. In the case of an S corporation, an allocable share is the shareholder's pro rata share of an item. (Code Sec. 199A(f)(1)(A))

Originally posted by @Lance Lvovsky :
Originally posted by @Michael Plaks:
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:
Originally posted by @Lance Lvovsky:
Originally posted by @Michael Plaks:

@Lance Lvovsky

But do you agree that, until further clarifications, reasonable salary for S-Corp becomes even trickier - i.e. much more incentive to lowball it, leading to more controversy and litigation?

 It depends. S Corp shareholders will want to ensure they get the benefit of the 20% deduction, and for many non-capital intensive businesses, such as mortgage brokers, real estate brokers, attorneys, physicians, etc., it will be important to pay a salary sufficient so to get the 20% deduction.

 No salary is required under the threshold. 

 Without the salary, there will be no deduction for many business owners...

Lance, there is NO salary limitation under the threshold, that's the whole issue! S-corp could have $0 salary, and the entire $100k will qualify as QBI and allow a $20k deduction! So is Sch C. 

But S-corp has a statutory requirement to pay a reasonable salary - in other words, a statutory requirement to shoot itself in the foot. Sch C does NOT have a similar requirement, with the respect to QBI.

 You are forgetting that taxpayers whose income exceed the threshold ($157,500/$315,000) cannot take the deduction unless they meet other requirements, such as the business paying wages. See below:

The qualified business income deduction for noncorporate taxpayer is applied to partnerships and S corporations at the partner or shareholder level. (Code Sec. 199A(f)(1)(A)(i)) Thus, each partner or shareholder must take into account his allocable share of each qualified item of income, gain, deduction, and loss (Code Sec. 199A(f)(1)(A)(ii)), and is treated as having W-2 wages for the tax equal to his allocable share of the W-2 wages of the partnership or S corporation for the tax year (as determined under IRS regs). (Code Sec. 199A(f)(1)(A)(iii)) A partner's or shareholder's allocable share of W-2 wages is determined in the same manner as the partner's or shareholder's allocable share of wage expenses and a partner's or shareholder's allocable share of the unadjusted basis immediately after acquisition of qualified property is determined in the same manner as the partner's or shareholder's allocable share of depreciation. In the case of an S corporation, an allocable share is the shareholder's pro rata share of an item. (Code Sec. 199A(f)(1)(A))

I'm not forgetting. I specifically talk about people BELOW the threshold.

Join the Largest Real Estate Investing Community

Basic membership is free, forever.

By signing up, you indicate that you agree to the BiggerPockets Terms & Conditions.