Shouldn't QBI be reduced by Sec 179 depreciation on a pass through entity. It is not happening with an S Corporation on the partners K-1?

[PatS5]

The Lacerte program is showing the QBI at the shareholder level without regard for the Sec 179 expense.

[Kathi_at_Intuit · Accepted solution]

Hi thanks for stopping by the community. This was reported and is currently being researched by our tax development team.  They expect to update the calculations to include Section 179 in a release scheduled later this week. Please visit our Unexpected Behaviors section of Accountants Community for more information and to sign up to receive alerts on this an any other issue being researched.

Unexpected Behaviors Center

https://accountants-community.intuit.com/browse/lacerte-unexpected_behaviors

Have a great day.

[itonewbie]

@Kathi_at_Intuit This is not working in PTO either.  Probably because it uses the same tax logic.  Could you please take a look?  Seems to be ok with 1065 though.  Thanks!

[Kathi_at_Intuit]

@itonewbie I would think that this would be the case. I am checking on this.

[itonewbie]

Thanks!

[Kathi_at_Intuit]

@itonewbie I have checked and since PTO's tax engine is based off of Lacerte's tax engine (which I am sure you know), it is the same case for PTO. The ETA for Lacerte is this week with PTO following shortly thereafter.

[itonewbie]

Sounds good! Thanks, Kathi!

[mneath]

Lacerte also needs to account for charitable deductions--not just section 179--in the QBI calculation.

[itonewbie]

@mneath Perhaps I'm missing something. Why charitable contribution?

[mneath]

Because it passes through to the shareholder on the K-1.  It is attributable to the business and thus deducted from QBI.

[mneath]

...not the case for Schedule C of course--just 1065 and 1120S

[itonewbie]

I would respectfully disagree with that.

Final regulations state that "deductions attributable to a trade or business are taken into account for purposes of computing QBI to the extent that the requirements of section 199A and this section are otherwise satisfied."  That subsection then goes on to specify deductions for 1/2 SE tax, SE health insurance, and qualified retirement plan contributions are to be taken into account.

As explained on pages 43 and 44, the Treasury Department and IRS are relying on existing code sections that govern the respective deductions to determine whether such deductions are attributable to the conduct of a trade or business.  Those deductions that are specifically listed have a history of being treated as such even prior to the enactment of §199A.  Charitable contributions, on the other hand, are merely flow-through items from an RPE and not attributable to the conduct of a trade or business - none of the limitation based on business income, at-risk rules, etc. even apply.

[mneath]

How is a pass-through charitable deduction not a deduction "attributable to a trade or business?  My understanding is that ALL deductions attributable to the business must be deducted from QBI.  It is merely a quirk of tax law that charitable deductions are separately reported on the K-1.  They are certainly attributable to the business.

[mneath]

The only reason that charitable deductions are flow through items on the K-1 is so that the AGI limit can be applied at the individual level.  But for that, it would just be a normal business expense and reflected in a reduction of box 1 income on the K-1.  Doesn't that mean that it is "a deduction . . .with respect to any trade or business of the taxpayer" (Reg. 1.199A3(b)(1))?

[itonewbie]

Suggest that you take a look at page 31 of the preamble about why guaranteed payment for the use of capital under §707(c) is not attributable to a trade or business even though it part part of the flow-through.  There are people who argue in response that it should be but take a look at pages 45 and 46 why that position is not accepted.  How then would you argue that flow-through for charitable contributions, which are determined without regard to the income of an S-corp or partnership, are attributable to a trade or business.

Of course, the IRS would likely not reject the return where a position is taken to reduce the QBI for charitable contribution flowing through a K-1 but your client would be disadvantaged because of that.

[itonewbie]

Just saw your second response coming through. Will take a second look and reconsider.

[mneath]

I just read the preamble discussion regarding guaranteed payments for the use of capital that you pointed to.  I agree that it is interesting.  The key sentence in the preamble is, "The Treasury Department and the IRS believe that guaranteed payments for the use of capital are not attributable to the trade or business of the partnership because they are determined without regard to the partnership’s income."  I assume that what IRS means by that is that guaranteed payments are a legal obligation that exists regardless of the income  of the business, since that is the definition of a "guaranteed payment."  Other deductions (including charitable) would not, in my opinion, fall within this exclusion.  The amount of those deductions is dependent on the income of the business, as the partnership would not incur the expense if it did not have the income to do so.

[itonewbie]

Just wish the Treasury Department and IRS would be more upfront with their guidance... sigh!

[itonewbie]

I thought this through again and still believe that charitable contributions would not be consider a QBI item attributable to a trade or business.

There is no question that it is a flow-through from the S-corp and would otherwise be deductible, subject to limitations, to the corporation in computing its taxable income had it not been an S-corp.  However, if we were to refer to §1366(b) and §1.1366-1(b), it is clearly stipulated that "the character of any item... is determined for the S corporation and retains that character in the hands of the shareholder."

It is accepted and recognized that the mere existence of an S-corp does not automatically equate to the operation of a trade or business.  For example, an S-corp could be engaged in rental activities and the rental income passed through to the shareholder(s) must still be characterized as passive income subject to §469 unless those activities rise to the level of §162 trade or business.  It is, therefore, entirely possible that an s-corp item is not attributable to a trade or business.

In determining the amount deductible for charitable contributions and gifts, §162, which governs deductions for trade or business expenses, does not refer to §170 just for the limitation but specifically ***excepted*** charitable contributions and gifts from subsection (a).  In contrast, §179(b)(3) stipulates that "the amount allowed as a deduction... shall not exceed the aggregate amount of taxable income of the taxpayer for such taxable year which is derived from the active conduct by the taxpayer of any ***trade or business*** during such taxable year."

In conclusion, IMHO, we should differentiate the treatment of charitable contributions flowing through from an S-corp, as being an item not attributable to a trade or business, from §179 allowed which retains the character of being a trade or business expense and, therefore, constitute a QBI item.

[itonewbie]

@mneath Please feel free to share your thoughts.

[mneath]

That is great logic.  In the absence of further guidance from IRS, I agree and plan to advise my team to exclude charitable donations.  Thanks for your research on this!

[itonewbie]

NP, @mneath.  This is all new to us, so, it's always good to test our thinking.

[rbynaker]

A round of applause to both of you.  Great discussion.

Rick

[itonewbie]

Thanks, dorm father! :smile:

[Frogman]

@itonewbie Thanks so much for your in depth explanation on this. I too was not understanding why charitable contributions by an S-Corp should in any way affect QBI. But until now I couldn't find anything to support that. One question I have been trying to find an answer for and the main cause of so much confusion is that if charitable contributions are not to be included in QBI, then why do all the new tax form instructions specifically include "charitable contributions" in their list of items to include when reporting QBI items to the shareholder? (See Question #2 on the QBI Flowchart at the top of page 39 in the 2019 Form 1120S Instructions and page 5 of Form 8995 Instructions). After doing some further research after reading your messages here, I think I finally found my answer. I noticed that the wording on the Flowchart Question #2 in the 1120S Instructions say the list of items "may include", emphasis being on the "MAY" (although that word "may" is left out of the Form 8995 Instructions). And with my further research I learned that some types of corporations CAN deduct certain charitable contributions AS business expenses. This relates to what you were saying about how §162 states that charitable contributions are not to be treated as business expenses. But from an article I ran across (www.perlmanandperlman.com/irs-says-benefit-corporations-may-treat-payments-charity-business-expense) I learned that if a corporation is a "benefit corporation" they can treat charitable contributions as regular business expenses because those types of companies receive some benefit in connection with their contribution. So I am concluding that S-Corps that are benefit corporations SHOULD include charitable contributions in their QBI, since it is a normal business deduction for them. Otherwise, any other S-Corp should NOT include charitable contributions in their QBI because those contributions are not attributable to the trade or business (the company receives no direct benefit for their contribution). This finally explains to me why charitable contributions are included in the tax form lists, because there are instances (although rare) where it would be included. To quote you earlier, I too wish the IRS would be more upfront with their guidance! 😀 Could save a lot of confusion and headaches for all of us! Thanks again for your insight and please let me know if you agree with my thought process on this.

[rjskal]

Great discussion!  I agree with the theory that most donations are not Sec 162 items.

However, technically, my take is that because the 8995 instructions clearly state that charitable contributions MUST reduce QBI and the 1120S QBI Flowchart states basically the same thing (the use of the term “MAY” seems to be a qualifier that the list is not all-inclusive, not that some of the listed expenses may not be attributable to a T or B), S-corp and P/S donations still need to reduce QBI.

IRS definitely needs to clarify this, though!

[rjskal]

I believe if charitable donations are made by the Sch C business (i.e., out of its bank account), QBI must be reduced.

[Frogman]

@rjskal thanks for your reply and input. True, wording can be interpreted in many ways. I would still hold the position that the charitable contributions the 8995 flow chart instructs to include would be charitable contributions that are business expenses (again, affecting companies like benefit corporations). The sentence on the 8995 flowchart you are referring to begins with "Is the item from a trade or business?" As @itonewbie pointed out, §162 states that traditional charitable contributions are NOT a trade or business item. So the answer to that flowchart question for a typical company then, in my opinion, is no. The answer for a benefit corporation would be yes.

Also keep in mind the 8995 form is the second phase of reporting the item, to be reported on the shareholder's personal tax return, so the instructions there do not need to be as extensive as the 1120S flowchart instructions, which could explain why the word "may" was omitted in the 8995 flowchart. In other words, the rules are pretty cut and dry by that point. If the item is passed through to the shareholder by the S-Corp, the determination has already been made at the S-Corp level that it is an includable item, and should therefore be included on the personal return.

But at that first phase, if the S-Corp follows the 1120S flowchart instructions there, the charitable contribution figure would not even be passed through to the shareholder on the Schedule K-1 statement for him to report. The instructions at the S-Corp level specifically state to not include activities that are not engaged in for profit. A typical company does not contribute to charity for the purpose of gaining any profitable benefit, and therefore should not include it on the K-1 statement. Benefit corporations, on the other hand, would gain a benefit from their charitable contributions, in the form of goodwill, etc., so they would be one example of when charitable contributions would be included. This is why I believe the word "may" is used in the instructions at the S-Corp level, as there are situations where it may be included and situations where it may not be included.

Again, this is just my opinion. Would enjoy further discussion as well as input from others too. But it is the only conclusion that makes any sense, as there is no logical reason why traditional charitable contributions should reduce QBI.

[Frogman]

I understand where your logic is coming from on this but it is based on something that is not an actual real life situation. The IRS does not recognize a sole proprietorship reported on Schedule C as an entity of its own. It is one and the same as the taxpayer in their eyes. There is nothing that says a taxpayer even has to have a separate checking account for his Schedule C business. The taxpayer would not include charitable contributions on his Schedule C no matter which checking account he paid them from, and they would never be deducted as a business expense. They would be reported on his personal Schedule A (if he itemized) whether or not he had a Schedule C business.

[rjskal]

I see your point.  However, I could see the IRS determining that if donations are paid out of the business, QBI needs to be reduced.  Let's hope not.

[rjskal]

Good argument...let's hope the IRS sorts this out soon.

[Frogman]

This is where @itonewbie's posts above were so helpful in getting me to my conclusion. He points out several other examples of items that are specifically not attributable to a trade or business, even though they may be paid by the S-Corp.

[Frogman]

Amen to that! 😀

Sadly, the folks that are taking the real hit on this are the charity organizations themselves. Giving to charities has always had tax benefits. Or at worst case, for someone that doesn't itemize, at least it has a neutral effect on their taxes. But to actually penalize someone and INCREASE their taxes for donating to a charity (which is what happens if QBI is reduced by a charitable donation), something is wrong with that picture, and it certainly can't be what the IRS intended, as it will lead to fewer people donating to charities.

[taxlady2008]

I noticed that Lacerte actually adds the charitable contribution (not subtracts) when the individual does NOT itemize and doesn't  benefit from the charitable contribution deduction.  It appears that an S-corp has to deduct it from QBI because they are already benefiting from the Sch A deduction.  If you didn't deduct it, you would be double dipping.  Does this sound right?

[Frogman]

No, this doesn't sound right. Even if the taxpayer itemizes, it would not be double dipping. It would be single dipping. The taxpayer should have the right to deduct his full charitable contribution on his Schedule A, which would be the case if QBI is not reduced by the amount of the charitable contribution. If his QBI is reduced by the charitable contribution, his benefit for making the charitable contribution is essentially reduced by 20%. If the taxpayer doesn't itemize, the situation would be even worse. In this case, the mere fact that he made a charitable contribution actually INCREASES his taxes because his QBI deduction is reduced (and thus his taxable income increased) even though he is receiving no tax benefit for the charitable contribution if he uses the standard deduction.

This is why I agree with @itonewbie about this, and also why I believe the rule of reducing QBI by the amount of charitable contributions only applies to those types of charitable contributions that are regular business expenses, like in the case of a "benefit corporation". Typical charitable contributions are not a normal business expense and just get passed through to the taxpayer. QBI should not be reduced by these types of charitable contributions by the S-corp. Read @itonewbie's and my other posts closely on this thread and the pieces will fall into place to support this conclusion.

[itonewbie]

@FrogmanHere's the latest thread on the development... Thought you might be interested.

https://proconnect.intuit.com/community/lacerte-discussions/discussion/re-qbi-and-charitable-contrib...

[Frogman]

Thanks for the update on the new thread, @itonewbie! It sounds like we are on the same page with all of this. Please see my additional question on that thread.

[Frogman]

@itonewbie, @taxlady2008 @rjskal @mneath FINALLY some light at the end of the tunnel on this!

https://www.mhmcpa.com/insights/article/charitable-contributions-now-excluded-from-section-199a

[itonewbie]

@FrogmanThanks again for the update!

@Kathi_at_Intuit @IntuitAustin @IntuitBettyJo Could you please liaise with the developers and confirm the tax logic will be updated?  Thanks!