Ch. 10 - Sole Proprietorships, Partnerships, LLCs, & S Corps Flashcards
For tax purposes, what categories of business structures are non-taxable (aka pass through entities)?
-Sole proprietorships
-Partnerships
-Limited liability companies (LLCs)
-S corporations
What is a Sole proprietorship, and what is its defining characteristic?
An unincorporated business owned by one individual–it has no legal entity separate from its owner
Where is taxable income from a sole proprietorship reported?
Schedule C (Profit or Loss From Business) on the proprietor’s Form 1040 (U.S. Individual Income Tax Return)
The Schedule C is the income statement for the sole proprietorship for the year
Where is tax on net profit from sole proprietorships computed/reported?
Net profit carries to the first page of Form 1040 as ordinary income and combined with all other income items recognized during the year. It is NOT computed on Schedule C
What is the common name for Section 199A?
The Qualified Business Income Deduction
What is the goal of the QBI deduction?
To lower the effective tax rate on the business profit earned by pass-through entities
Define qualified business income
It is ordinary income associated with a qualified trade or business
Is the QBI deduction a for AGI deduction or a from AGI deduction?
From AGI deduction
Modified taxable income and what is it’s basic formula?
taxable income is calculated before accounting for the qualified business income deduction and after subtracting any net capital gain
Modified taxable income = taxable income (before QBI) - net capital gains - qualified dividends
Qualified Business Income
Difference between ordinary income and ordinary deductions that a taxpayer receives from a “qualified trade or business” operating in the US
–Additionally, QBI includes the taxpayers proportional share of these amounts from any partnership or S corporation interest they hold
-Deductions include self-employment tax, self-employment health insurance, and any deduction qualified retirement plan
What is the QBI exclusion?
Qualified business income excludes specific investment income types, including:
1. capital gains or capital losses
2. Dividends
3. Interest income (except when “properly allocable” to a trade or business, like lending) and
4. Certain other investment items
ALSO, QBI does not include:
1. The “reasonable compensation paid to the taxpayers in relation to any qualified trade or business
2. Guarenteed payments made to a partner for services rendered provided
True or false: all income characteristics are included in QBI
False – only ordinary income associated with a qualified trade or business is included in QBI
What is QBI reduced by?
QBI is reduced by:
- The deductible portion of self-employment taxes
- the self-employed health insurance deduction
- the deduction for contributions to qualified retirement plans, to the extent the individuals trade or business income is taken into account in calculating the allowable deduction
What percentage is the QBI deduction, and what limitations apply to it?
The QBI deduction is 20% of QBI. However, it cannot exceed the greater of:
- 50% of W-2 wages paid by a qualified trade or business or
- The sum of 25% of W-2 wages + 2.5% of the unadjusted basis of qualified property used by the business.
- The final QBI deduction is subject to an overall limitation based on taxable income. The final deduction cannot exceed 20% of taxable income computed without regard to the QBI deduction and any net capital gain.
What types of businesses are EXCLUDED from the QBI deduction?
A qualified business does not include services businesses in the fields of:
-health
-law
-accounting
-actuarial science
-performing arts
-consulting
-athletics
-financial services
-brokerage services
-investing
-investment management
Qualiifed business income also excludes investment-related income, gains, losses, and deductions, as well as amounts earned as an employee or received from a partnership by a partner in exchange for services (guaranteed payments)
True or false: there is an exemption exempting high income earners from the W-2 Wage limitation and the exclusion of service businesses.
False – this is true, but it exempts lower-income taxpayers from the W-2 wage limitation and the exclusion of service businesses.
For taxpayers whose income exceeds the threshold up to $100,000 (50,000 for all others besides MFJ), the deduction for service businesses is phased down by 1% for reach $1,000 of taxable income over the threshold amount.
For both service and non service businesses, the W-2 limitation is phased in when taxable income is within the phase-in range. This phase-in also equals 1% of every thousand dollars of taxable income over the threshold amount (2% for everyone besides MFJ)
Summarize the QBI deduction
-Known as Section 199A in the IRC
-Meant to even the playing field between the corporate tax rate (21%) and pass-through entities
-In general, it is 20% of QBI
-QBI does not apply to businesses in the following fields:
-health
-law
-accounting
-actuarial science
-performing arts
-consulting
-athletics
-financial services
-brokerage services
-investing
-investment management
QBI also excludes:
-investment related income
-gains, losses, and deductions as well as amounts earned by employee or received from a partnership in exchange for services (guaranteed payments)
However, lower-income taxpayers are somewhat exempt from the W-2 wage limitation and the service business exclusion:
In 2023, if the taxable income before the QBI deduction is less than $364,200 (MFJ), QBI is simply 20% of business income
But if taxable income exceeds the $364,200 threshold by not more than 100,000, the deduction for service businesses in phased down by 1% for every 1000 of taxable income over the threshold
The W-2 wage limitation is phases in when taxable income is within the phase-in range. This phase in equals 1% of every 1,000 of taxable income over the threshold amount
QBI is also reduced by:
1. the deductible portion of self-employed taxes
2. The self-employed health insurance deduction
3. the deduction for contributions to qualified retirement plans, to the extent the individual’s trade or business income is taken into accounting in calculating the allowable deduction
The QBI deduction cannot exceed the greater of:
1. 50% of W-2 wages paid by a qualified trade or business
2. the sum of 25% of W-2 wages + 2.5% of the unadjusted basis of qualified property used by the business
The final QBI deduction is also subject to an overall limitation based on taxable income. The final deduction cannot exceed 20% of taxable income computed without regard to (1) the QBI deduction and (2) any net capital gain
Where does the QBI deduction appear?
it is a from AGI deduction (reducing final taxable income). It is NOT found on Schedule C and does NOT reduced the taxpayers AGI
True or false: excess business losses of a noncorporate taxpayer are deductible
False – they are currently NOT deductible
If a sole proprietorship operates at a loss, is it deductible? Where is it found?
It may be but is limited to $578,000 (MFJ) or $289,000 (all other individuals) in 2023.
If a sole proprietorship operates at a loss and that loss is deductible , it carries to the first page of Form 1040.
IF a deductible business loss (for a sole proprietor) exceeds other income, the individual (can/cannot) carry the excess loss forward as a NOL deduction
They can (but the deduction is future years is limited to 80% of taxable income in each carryforward year)
True/false: of an owner disposes of an asset used in a sole proprietorship, recognized gains and losses are reported on Schedule C
False– only the results of the sole proprietorships routine operations are reported on Schedule C.
Instead, asset disposal is recorded on Form 4797
True or false: if an individual borrows money for a business purpose relating to their sole proprietorship, the interest paid on the debt is deductible (subject to the net business interest limitation)
True!
To qualify for a home office deduction, the home office must ______ ______ _______ on a regular basis as the principal place of any business operating by the homeowner or as a place to meet with patients, clients, or customers
be exclusively used
Explain the home office deduction (the basics)
Add up total expenses, figure out what percentage of square footage is used exclusively for business activities, then multiply total expenses by the percentage.
True of false: a sole proprietor has only the one person working in business
False! It can have any number of employees
employer identification number
A number assigned to an employer by the IRS to identify the employer for employment tax purposes.
Employers must pay both a state and federal unemployment tax based on the ___________________
compensation paid to their employees during the year
employee payroll tax
The FICA tax (Social Security and Medicare tax) levied on employees who receive compensation during the year.
Beginning in 2013, individuals whose wages exceed a threshold amount must bay an extra ____% Medicare tax on a portion of their wage income, in addition to the 1.45% Medicare tax withheld on all wages
.9%
The threshold amount for this tax is $250,000 (MFJ), $125,000 MFS, and 200,000 for unmarried individuals
This only applies to employees, not employers
What ___ components make up self-employment taxes?
Two components;
- a Social security tax of 12.4% of a base amount of net earnings from self employment and
-a Medicare tax of 2.9% total net earnings
