Jacqueline N. Feliciano, Attorney, Cotney Construction Law
When President Trump announced his plan to reduce corporate tax rates for C corporations, a tax advantage was similarly introduced for sole proprietorships, S corporations, trusts, estates, and partnerships. As construction businesses are generally set up as S corporations and limited liability companies, this deduction can be a huge tax advantage. With what has become one of the most highly discussed provisions in the Tax Cuts and Jobs Act, § 199A of the Internal Revenue Code (the “Code”) provides up to a 20 percent deduction for qualified business income. While this is a generous deduction, the new provision is riddled with limitations and exclusions that leave business owners wondering whether they qualify.
Before determining how much of a deduction is warranted, the taxpayer must decide if and what qualifies in determining the deduction amount, if any. There are two crucial preliminary steps to consider:
1. Whether the taxpayer has a qualified trade or business; and
2. Whether the taxpayer has qualified business income.
This article will discuss whether a qualifier and their business may be entitled to take the deduction.
Under § 199A, one of the first questions to determine is whether the taxpayer has a qualified trade or business (“QTB”). QTB is defined in § 199A(d)(1) as any trade or business that is not a (1) specified service trade or business, or (2) trade or business of performing services as an employee. Thus, while the definition of QTB is broad, the two exclusions must be analyzed carefully. Employees are self-explanatory, but a specified service trade or business is more expansive than it appears.
A specified services trade or business (“SSTB”) is defined under § 199A(d)(2) to include:
A. Any trade or business involving the performance of services in the fields of health, law, [excluding engineers and architects], accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees; or
B. The performance of services that consist of investing and investment management, trading, or dealing in securities.
Further explanation in § 199A(d)(2)(A) provides that the term “employees” is to be read as “employee or owners” which unfortunately broadens the definition. Upon plain reading of the Code, the language “reputation or skill of 1 or more of its employees” creates a problem for contractors as it appears to directly target contractors. Arguably, the principal asset of a roofing or construction company’s business is the reputation or skill of the qualifier.
This language has caused a great deal of debate. Fortunately, the Internal Revenue Service (the “Service”) has provided guidance through regulations that were recently finalized. Although we were initially worried roofing contractors would be disqualified from the deduction, Reg. § 1.199A-5(b)(2)(xiv) has limited the meaning of “the principal asset of such trade or business is the reputation or skill of one or more employees or owners,” for purposes of § 199A to:
A. A trade or business in which a person receives... income for endorsing products or services;
B. A trade or business in which a person licenses or receives... income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity; and
C. Receiving... income for appearing at an event or on radio, television, or another media format.
Thus, guidance released by the Service has provided a clearer answer that abates previous concerns for contractors. Absent additional facts, the new regulations point to construction as a QTB that is not a SSTB for the purposes of § 199A. This is an important distinction because if a roofing contractor were considered a SSTB and made over $415,500 for married taxpayers filing jointly, or $207,500 for all other taxpayers, they would not be entitled to the deduction.
Once it is determined that the taxpayer has a qualified trade or business, the next question becomes how much of that QTB is qualified business income (“QBI”). QBI is defined under § 199A(c) as “qualified items of income, gain, deduction, and loss” which is further defined in § 199A(c)(3) as items “effectively connected” with a domestic trade or business that are “included or allowed in determining taxable income.” This determination becomes a number-intense analysis for which a taxpayer should seek professional advice.
In addition to the obstacles mentioned above, there are additional phase-in limits. Under § 199A(b)(3)(B), if you exceed the threshold amount of $315,000 for married taxpayers filing jointly, or $157,500 for all other taxpayers, the deduction is subject to limitations. These complex limitations should be reviewed with your tax expert as an analysis of your taxable income would take place.
Tom is a roofing contractor whose operations consist solely of re-roofing. His reportable taxable income is $200,000. For ease of example, Tom’s share of the qualified business income is $200,000; 20 percent of which is $40,000. Tom’s share of wages of the qualified trade or business is $70,000, 50 percent* of which is $35,000. Because Tom is a single taxpayer with income above $157,500 but below $207,500, phase-in limits under § 199A(b)(3) kick in. Thus, our deduction is reduced by 20 percent of the difference between $40,000 and $35,000 which equals $1,000, so $40,000 – $1,000 = $39,000.
* See § 199A(b)(3) explaining phase-in limitations for taxpayers exceeding the threshold amount.
As you can see from the example above, the limitations in § 199A bring complexities that contractors should be cautious of. With proper guidance and planning, contractors may utilize § 199A to take advantage of this 20 percent deduction.
Disclaimer: The information contained in this article is for general educational information only. This information does not constitute legal advice, is not intended to constitute legal advice, nor should it be relied upon as legal advice for your specific factual pattern or situation.
Jacqueline N. Feliciano is an attorney at Cotney Construction Law who practices tax law and other transactional matters. Cotney Construction Law is an advocate for the roofing industry, General Counsel of FRSA, NWIR, TARC, TRI, RT3, WSRCA, and several other local roofing associations. For more information, contact the author at 866-303-5868 or go to www.cotneycl.com.
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