Chapter 2 – Problem 28 – LO.3,4 Scott and Laura are married and will file a joint tax return.

Laura has a sole proprietorship (not a

“specified services” business) that generates qualified business income of $300,000. The proprietorship pays W–2 wages of
$40,000 and holds property with an unadjusted basis of $10,000. Scott is employed by a local school district. Their taxable
income before the QBI deduction is $386,600 (this is also their modified taxable income).
- Determine Scott and Laura’s QBI deduction, taxable income, and tax liability for 2020.
- After providing you the original information in the problem, Scott finds out that he will be receiving a $6,000 bonus in
December 2020 (increasing their taxable income before the QBI deduction by this amount). Redetermine Scott and
Laura’s QBI deduction, taxable income, and tax liability for 2020.
- What is the marginal tax rate on Scott’s bonus?
Taxable Income before QBI deduction 386600
Initial QBI Amount 300000
Wage/Capital Investment Limitation 40000
- W2 Wages
Wage/Capital Investment Limitation 10000
- Unadjusted basis for property
Is the QTB ‘specified service’ business? No
MFJ Threshold
Phase In: 326600
Phase Out: 426600
- Determine Scott and Laura’s QBI deduction, taxable income, - After providing you the original information in the problem,
and tax liability for 2020. Scott finds out that he will be receiving a $6,000 bonus in
December 2020 (increasing their taxable income before the
QBI deduction by this amount). Redetermine Scott and Laura’s
QBI deduction, taxable income, and tax liability for 2020.
Modified Taxable Income: 386600 x 20% = 77320  no great Modified Taxable Income: 386600 + 6000 = 392600 x 20% =
than this amount 78520  no great than this amount
Determine Initial QBI amount (20% x QBI): General 20% of QBI Determine Initial QBI amount (20% x QBI): General 20% of QBI
deduction amount: 300000 x 20% = 60000 deduction amount: 300000 x 20% = 60000
Wage/Capital Investment Limitation amount (*greater of the Wage/Capital Investment Limitation amount (*greater of the
two*) – two*) –
50% of W2 Wages: 40000 x 50% = 20000 50% of W2 Wages: 40000 x 50% = 20000
or or
25% of W2 Wages: 40000 x 25% = 10000 25% of W2 Wages: 40000 x 25% = 10000
+ +
2.5% of Unadjusted basis for property: 10000 x 2.5% = 250 2.5% of Unadjusted basis for property: 10000 x 2.5% = 250
= 10250 = 10250
Taxable Income before QBI deduction (386600) exceeds MFJ Taxable Income before QBI deduction (392600) exceeds MFJ
Threshold Phase In (326600) but less than Phase Out (426600) Threshold Phase In (326600) but less than Phase Out (426600)
and Wage/Capital Investment Limitation portion of the and Wage/Capital Investment Limitation portion of the
computation is capping the deduction, the general 20% QBI computation is capping the deduction, the general 20% QBI
deduction amount is used but reduced (see next line) deduction amount is used but reduced (see next line)
Determine the difference between the general 20% QBI Determine the difference between the general 20% QBI
deduction amount and the (greater of) Wage/Capital deduction amount and the (greater of) Wage/Capital
Investment Limitation amount to get the Excess Amount: Investment Limitation amount to get the Excess Amount:
60000 – 20000 = 40000 60000 – 20000 = 40000
Determine the Reduction Ratio (Taxable Income Amount Determine the Reduction Ratio (Taxable Income Amount
before QBI – Threshold Phase In = Reduction Ratio): before QBI – Threshold Phase In = Reduction Ratio):
386600 – 326600 = 60000 / 100000 = 60% 392600 – 326600 = 66000 / 100000 = 66%
Determine the Reduction Ratio in Wage/Capital Investment Determine the Reduction Ratio in Wage/Capital Investment
Limitation (Excess x Reduction Ratio = Reduction Amount): Limitation (Excess x Reduction Ratio = Reduction Amount):
40000 x 60% = 24000 40000 x 66% = 26400
Determine Final QBID Amount (general 20% QBI deduction Determine Final QBID Amount (general 20% QBI deduction
amount – reduction in Wage/Capital Investment Limitation = amount – reduction in Wage/Capital Investment Limitation =
Final QBID Amount): 60000 – 24000 = 36000 Final QBID Amount): 60000 – 26400 = 33600
 Determine Taxable Income (Taxable Income – Final QBID = Net Determine Taxable Income (Taxable Income – Final QBID = Net
Taxable Income Amount): Taxable Income Amount):
386600 – 36000 = 350600 392600 – 33600 = 359000
MFJ Minimum Tax + [(Net Taxable Income Amount – MFJ MFJ Minimum Tax + [(Net Taxable Income Amount – MFJ
Phase In) x MFJ Tax Rate] = Tax Liability Phase In) x MFJ Tax Rate] = Tax Liability
66543 + [(350600 – 326600) x 32%] 66543 + [(359000 – 326600) x 32%]
66543 + (24000 x 32%) 66543 + (32400 x 32%)
66543 + 7680 = 74223 66543 + 10360 = 76911
QBID: $36000 QBID: $33600
Taxable Income: $350600 Taxable Income: $359000
Tax Liability: $74223 Tax Liability: $76911
- What is the marginal tax rate on Scott’s bonus?
Tax Liability before bonus: $74223
Tax Liability after bonus: $76911
= 2688 / 6000 = 44.8%

Married Filing Jointly or Qualifying Widow (Widower)

If taxable income is over— but not over— the tax is:
$0 $19,750 10% of the amount over $0
$19,750 $80,250 $1,975 plus 12% of the amount over $19,750
$80,250 $171,050 $9,235 plus 22% of the amount over $80,250
$171,050 $326,600 $29,211 plus 24% of the amount over $171,050
$326,600 $414,700 $66,543 plus 32% of the amount over $326,600
$414,700 $622,050 $94,735 plus 35% of the amount over $414,700
$622,050 no limit $167,308 plus 37 % of the amount over $622,050
Chapter 2 – Problem 37 – LO.3,4 Elliot operates his clothing store as a single member LLC (which he reports as a sole
proprietorship). In 2020, his proprietorship generates qualified business income of $280,000, he pays W–2 wages of $170,000,
and he has qualified business property of $140,000. Elliot’s wife, Julie, is an attorney who works for a local law firm and receives
wages of $90,000. They will file a joint tax return and use the standard deduction. What is Elliot’s qualified business income
deduction?

Initial QBI Amount 280000

Wage/Capital Investment Limitation 170000
- W2 Wages
Wage/Capital Investment Limitation 140000
- Property unadjusted basis
Is the QTB ‘specified service’ business? No
MFJ Threshold
Phase In: 326600
Phase Out: 426600
Determine Initial QBI amount (20% x QBI): General 20% of QBI deduction amount: 280000 x 20% = 56000
Wage/Capital Investment Limitation amount (*greater of the two*) –
50% of W2 Wages: 170000 x 50% = 85000
or
25% of W2 Wages: 170000 x 25% = 42500
+
2.5% of Unadjusted basis for property: 140000 x 2.5% = 3500
= 46000
Is taxable income before QBI deduction over MFJ Threshold Phase Out (422600)? No
Is General 20% of QBI deduction amount less than Wage/Capital Investment Limitation? Yes  QBI Amount is General 20% of
QBI deduction amount: $56000
*Do we factor in Julie’s salary (90000)?
Chapter 2 – Research Problem 1. A client has asked you for guidance on selecting the best type of entity for her new business. Using the internet as your sole research source,
prepare an outline detailing the advantages and disadvantages of the entity forms available to a sole owner. Include both tax and nontax issues in your analysis.

ENTITY ADVANTAGES DISADVANTAGES TAX REPORTING NOTES

Sole Proprietorship - Easiest to form - Unlimited liability –Owner is - Not a separate - Most common form of business
- Low fees and - Complete control of business personally liable for all business entity – ownership
varies - Not as heavily regulated financial obligations as entity individual and - Does not require any formation
depending on - Pays personal tax ONLY (see Tax does not offer the business income documents or annual reports
state. Reporting) separation/protection of are considered the with Federal or State
Generally, just - Do not pay corporate taxes personal/professional assets same - Easy to dissolve
license and - Can claim QBI deduction - Pays self-employment taxes - Reports business - Can employ others has easier
business fees - Business continuity ends with income/losses on payroll requirements (no
the death/departure of Form 1040 payroll set-up is required to pay
owner as there are no Schedule C (Profit yourself)
separation or Loss from a
- Difficult to raise capital since Business)
business cannot issue stocks
or other investment income
Limited Liability - Hybrid benefits of corporation/sole - Complex formation – need to - Pays self- - If not taxed at normal
Companies (LLC) proprietorship/partnership business have extensive paperwork employment tax LLC/corporation, owners are
- Fees vary structures (taxes are also similar) because LLC is a separate and personal tax not considered employees
depending on - Limited liability entity - Not taxable like (cannot receive compensation
state (can - Passthrough entity - Necessary compliance – salary – taxed in the form of wages/salaries)
range from - Can hire yourself as an independent required o complete various strictly on - Owners must take money out
$40-$500) contractor (subject to self- compliance forms to remain percentage of of share from profits
employment tax) in good standing profit/loss of the - Profits and losses do not have
- Recognized in all 50 states and DC - Pays self-employment taxes company even if to be divided equally among
- Can claim QBI deduction money is kept in members
company without - Entity Classification –Check-
withdrawing the-Box Regulations
(earned, not
received)
Benefit Corporation - Limited Liability - Novel entity – may not be - Pays corporate tax - Extensive qualification – not
(B Corporation) - Effective marketing device – B recognized in every state; – IRS Form 1120 every organization qualifies for
Corporation is formed to solve uncertainty on how courts - Can elect to be this classification
specific social/environmental issues will interpret mandates taxed as a C or S - Built-in requirements that must
- Can apply for 501c3 status - No corporate tax benefits Corp be followed
unless tax-exempt status is - Random audits to ensure that
obtained all standards must be met
- Investments made are not - Must be transparent
tax deductible - State-regulated
- Allows corporation to be
socially responsible while still
generating profits
Close Corporation - Can operate business like a - Most common structure for - Can elect to be - Similar to B Corporation but has
partnership while also offering veil piercing taxed as a C or S less corporate structure –
incorporation benefits such as - Not available in all states Corp depending on your state of
limited liability incorporation, your statutory
- Advantages of the corporate close corporation may not need
structure while dispensing with the to file an annual report or have
need to adhere to certain corporate a board of directors
formalities - Shares are not publicly traded
- Can be run by a small group of
shareholders without a board
of directors
Nonprofit - Limited Liability - Comply with the provisions of - IRS Form 990 – IRS - Formed under state law, and as
Corporation - Tax-exempt the statute under which they uses this form to a result are subject to state
- Also exempt from paying sales tax were formed – need to file gather information rules and regulations
and property tax (does pay annual reports, draft bylaws, about tax-exempt - Uses surplus revenues to
employee taxes: Social Security and retain certain books and organizations, achieve goals rather
Medicare) records, and make filings educating distributing
- Can apply for 501c3 status with the state upon certain organizations about
- Access to grants/discounts important changes to the tax law
company requirements and
- No lobbying/political promoting
campaigning compliance
- Corporate profits cannot be
distributed
*Passthrough Entity – profits/losses can be passed through to individual income (avoiding double taxation by not paying corporate tax)

*Limited Liability – owners/stockholders are not personally liable for claims against your corporation; they are only liable for their personal investments

*Unlimited Liability – owner is liable for all costs and debts of the business

*QBI deduction – effective during TCJA period

*Tax-exempt – may be exempt from federal, state, and local taxes

Chapter 2 – Research Problem 4. Some states automatically conform to any Federal tax changes, but
others require special legislation to conform. Generally, states do not conform to rate changes because
state income tax systems have their own rate structure (generally at rates well below the Federal tax
rates). Find out if your state conformed to the deduction for qualified business income. Explain why
the state did or did not conform. Do you agree? Explain.

New York State does not allow for the qualified business income deduction (QBID), also known as the
pass-through income deduction.

New York State (as well as most states) income tax start with the federal adjusted gross income (AGI)
line. Federal QBID is not included in determining federal AGI – QBID is a ‘below-the-line’ deduction
taken after determining federal AGI. If New York State should adopt this deduction, adjustments would
need to be made by either conforming or creating a similar state-level deduction tied to the federal
code.

I am disappointed that New York State does not allow for the QBID. New York City is the epicenter of the
world’s economy (and home to many pass-through entities). This would have incentivized current and
prospective businesses by allowing QBID at the state level.