Monday, August 27, 2018
The Qualified Business Income Deduction and “W-2 Wages"
The Tax Cuts and Jobs Act (TCJA) created a new deduction for tax years 2018-2025 of up to 20 percent of domestic qualified business income (QBI) from a pass-through entity (e.g., partnership, S corporation or sole proprietorship). Similarly, the deduction is allowed for specified agricultural or horticultural cooperatives. In earlier posts, beginning back in December of 2017, I started detailing various aspects of the new QBI deduction (QBID).
The QBID incorporates a limitation based on wages paid, or on wages plus a capital element. The limitation is phased-in for taxpayers with taxable income above a threshold amount - $157,500 for single filers; $315,000 for all other filing statuses.
For those taxpayers above the applicable income threshold, the definition of “wages” is important. Does it include commodity wages? What about wages parents pay to their children that are under age 18? Do those count for purposes of the limitation?
The definition of “wages” for purposes of the QBID. That’s the focus of today’s post.
The Pertinent Formula
For taxpayers with taxable income exceeding $157,500 (single) or $315,000 (joint), the QBID for a business is (in general) the lesser of 20 percent of the taxpayer’s qualified business income amount (QBIA) from the trade or business, or a “W-2 wages/qualified property limit” (W-2/QP limit). The W-2/QP limit is the greater of 50 percent of the W-2 wages of the trade or business; or the sum of 25% of the W-2 wages of the trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property of the trade or business. I.R.C. §199A(b)(2). So, by the way the formula works, having W-2 wages and/or qualified property can enhance the ultimate QBID that the taxpayer can claim. That is, for those taxpayers over the applicable threshold. For these taxpayers, the QBID is further reduced through a “phase-in” range of the formula. Taxpayers with taxable income beneath the applicable threshold are not subject to the formula. I.R.C. §§199A(b)(3)(A) and (e)(2)(A).
Under the statute, W-2 wages are wages that the taxpayer’s qualified trade or business paid to its employees during the calendar year that ends in the business’s tax year. I.R.C. §199A(b)(4)(A). This Code section references I.R.C. §6051(a)(3) and I.R.C. §6051(a)(8) for the definition of W-2 wages. It is the I.R.C. §6051(a)(3) definition that is pertinent to our discussion, as I.R.C. §6051(a)(8) concerns elective deferrals and other types of deferred compensation.
In particular, I.R.C. §6051(a)(3) specifies that total wages are defined in I.R.C. §3401(a). That definition generally excludes wages paid for agricultural labor, unless it is wages (as defined in I.R.C. §3121(a)) paid for agricultural labor (as that term is defined in I.R.C. §3121(g)). Under the I.R.C. §3121(a) definition of “wages,” agricultural wages paid in-kind are disqualified (I.R.C. §3121(a)(8)(A)), as are cash wages paid to an employee for agricultural labor unless the employee pays at least $150 in cash wages to the employee for the year and the employer’s expenditures for agricultural labor for the year equal or exceed $2,500. I.R.C. §3121(a)(8)(B)(i)-(ii). Wages paid to children under age 18 by their parents are not specified as an exception in I.R.C. §3401(a). However, under IRC §3401(a)(2), commodity (“in-kind”) wages are not included because they are not “wages” under I.R.C. §3121(a)(8)(A). They are specifically excluded from the definition of “wages.”
The bottom line is that wages paid to children under age 18 by their parents count as wages for QBI purposes, but agricultural wages paid in-kind do not. In addition, the wages must be paid for amounts that are properly allocable to producing QBI.
Additionally, under I.R.C. §199A(b)(4)(C) the term “W-2 wages” does not include any amount that is not properly included in a return filed with Social Security Administration (SSA) on or before the 60th day after the due date (including extensions) for such return. Thus, wages, whether they are “required” in a technical sense to be reported, must be reported to count as “W-2 wages” for purposes of I.R.C. §199A. Wages paid to children under age 18 in the employ of their parents are subject to withholding, but are often exempt because the amount is less than the standard deduction. Reporting such wages to SSA on a timely filed return will cause them to count as “W-2 wages” for QBID purposes.
The QBID is a complex provision, for sole proprietors and other business owners that operate in a business form that is something other than a C corporation. That’s especially true for taxpayers with income over the applicable threshold. While ag wages paid in-kind don’t count as “W-2 wages” for purposes of the QBID formula for higher income taxpayers, wages paid to children under age 18 by their parents do count. That can generate a larger QBID for those taxpayers that are subject to the wages/qualified property limitation.