We were forced to balance our expenses with our income (aka; budgeting).  We got a firm hand on what our business is spending, what we could afford to spend, and what our priorities were.  Small business owners fought hard and adapted quickly to stay open and found new and creative ways to service customers.

If you started a business in the first three months of 2020, you faced the toughest battle you ever could before your business even got off the ground.  You have now joined the ranks of many seasoned business owners who have struggled through some tough times.

This article will point out a few strategies for you to use (if you have not done so already) to help create a better business spending plan.  It may be difficult but not impossible.

Reduce Costs with a Budget Cut

First, let’s review some budget cutting strategies:

• If you are currently carrying a balance on your business credit card, contact the credit card company to request a lower interest rate.  Better yet, apply for a new credit card with 0% interest for the next 12 months and transfer the balance onto that new card.  Tip:  continue to make payments on the 0% interest card to help lower the balance when that introductory period is over.  Also, if you need to use that card, pay the purchases off immediately and add a little towards the existing balance.
• If you have loans from other creditors, request to make interest only payments for at least 3 months while you restructure your budget.
• Shorten your business hours, if possible, to reduce payroll and utility expenses.  Choose the least busiest day of the week.
• Reduce inventory to a minimum but plan for small spikes in customer traffic, especially around holidays.  Keep high demand inventory.
• Request your insurance agent to search for better rates on your business liability, vehicle, and worker’s compensation insurance.
• If you have a copy machine rental contract, contact the representative to adjust the contract to a lower monthly rate.

Breakdown your Small Business Spending

Next, let’s break open the books to review the spending habits and revenue of the past to create a new one for this year.

• For revenue, let’s speculate there will be at least a 7% increase over the total amount made last year.  Take last year’s revenue and multiply by 7%.  Add that total to last year’s sales and that will hopefully be your new revenue this year.  This will be your budget starting point.  (7% is a theoretical figure not based on anything other than the hope that more customers will venture out this year and the economy improves.)
• Hopefully you will be able to save some money from the budget cutting strategies above so you can utilize the savings elsewhere in the better business spending plan you are about to create below.
• Go through each of your expenses on your Profit and Loss statement for the past two years to come up with an average for each expense for the new year.  This will take some thought because two years ago you might have spent too much for a particular expense and in 2020 found out it was actually not a priority and spent half as much.  Plus, you might have achieved some of the budget cutting strategies above and will want to use the new expense amount rather than the average over the past two years.  You will also want to decide what is essential for your business and what is not at this time.

Use a Small Business Budget Template

To help you create this better business spending plan I have listed below two of my favorite templates:

• The Budget Template by Capterra.com is great for small businesses already in operation.  All you have to do is plug in your new yearly budget (see tabs on bottom of the template) and it auto-fills the monthly budget for you!  Click Here for template.
• The Startup Budget Template by Gusto is great for new businesses that are planning to open.  Click Here for template.

If you currently use QuickBooks Pro desktop, it already has a budget template built in to the software that uses your current Profit and Loss items.  At the top menu bar choose “Company”/”Planning & Budgeting”/”Set up Budgets.”  For QuickBooks Online click on the gear icon/Tools/Budgeting.

DMS is committed to making sure your business grows in the coming year.  Please contact us to help you create a better business spending plan for 2021 and beyond.

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How can you file a tax return if you don’t know if the loan will be forgiven, or your bank has not yet “invited” you to file an application for forgiveness by Dec. 31, 2020, or you base your “theory” on anticipating it will be forgiven?   (Yes, my bank was by invitation only, and I was not invited to apply for forgiveness until PPP Round 2 was open for applications.)

The IRS and the Treasury both issued a revenue ruling and a revenue procedure basically stating that since businesses aren’t taxed on the proceeds of a forgiven PPP loan, the expenses aren’t deductible.

In Notice 2020-32 it stated under the LAW section, “On May 2, 2020, the Department of the Treasury and the Internal Revenue Service (IRS) released Notice 2020-32, 2020-21 IRB 837 (May 18, 2020), which clarifies that no deduction is allowed for an eligible expense that is otherwise deductible if the payment of the eligible expense results in forgiveness of a covered loan.”

It further states in Revenue Ruling 2020-27 under the HOLDING section, “A taxpayer that received a covered loan guaranteed under the PPP and paid or incurred certain otherwise deductible expenses listed in section 1106(b) of the CARES Act may not deduct those expenses in the taxable year in which the expenses were paid or incurred [IF], at the end of such taxable year, the taxpayer reasonably expects to receive forgiveness of the covered loan on the basis of the expenses it paid or accrued during the covered period, even if the taxpayer has not submitted an application for forgiveness of the covered loan by the end of such taxable year.”

You can make your own tax decision on the statement shown in the above paragraph.  However, some tax professionals and government officials wanted more clarity and rallied to the cause for more guidance.

On January 6, 2021 the IRS and the Treasury Department issued a notice IR-2021-04, stating they “issued guidance” today, Revenue Ruling 2021-02.  The notice states “[they] are allowing deductions for the payments of eligible expenses when such payments would result (or be expected to result) in the forgiveness of a loan (covered loan) under the Paycheck Protection Program (PPP).”

That is good news…but wait.  All that is forgiven Federally will all be reversed in the State of Wisconsin because it mostly conforms to an outdated version of the Internal Revenue Code (IRC).

Then on February 18, 2021, Governor Evers signed a bill (AB-2) that will conform the State to Federal tax treatment of forgiven PPP loans, among other provisions.  What that means is, if it is an eligible expense on the Federal tax return, then it is treated the same on the State tax return.  Now that’s great news!

The fuss and confusion are now over with.  You are now free to categorize your expenses paid with PPP funds as business expenses.  And, if your PPP loan has not been forgiven yet, keep it categorized as a short-term liability until it is fully or partially forgiven.  The portion that is forgiven should be categorized as other income (nontaxable) and not included in gross business income.

Diversified Management can help your small business manage accurate financial records. For a free consultation or more information contact us by filling in the inquiry form or calling us directly.

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Money management is a critical skill to have as an entrepreneur. Keeping your finances in check and planning ahead can help your small business thrive, today and far into the future. It is also important to create a revision schedule that allows you to maximize income over time Use this guide to master small business budget management.

Benefits of Having a Business Budget

Why take the time and energy to hammer out a small business budget? It can prevent you from going into the red by spending money you don’t have. It enables you to set monthly revenue goals and control cash flow. Sticking to a budget will leave enough room each month to pay your bills and business debts. Budgeting can bring many other benefits to business as well:

• Project overhead costs so you can accurately set your prices
• Compare your prices to competitors and make changes to the budget as necessary
• Adapt to changing conditions, such as slow sales months
• Allocate resources to certain projects
• Monitor your business’s overall performance
• Predict and prevent problems before they occur
• Set goals and encourage staff motivation
• Plan for the future

Managing your money is a key to business success. You need to have open visibility into the resources available to your business to remain profitable. Managing a budget gives you a roadmap to track where your company is going. Your budget does not have to be complicated. You simply need to include the right numbers to keep track of what’s coming in and what’s going out.

What to Include in Your Small Business Budget

Creating a small business budget starts with identifying a few key numbers; mainly, your revenues, expenditures, and profits or cash flow. First, estimate your projected sales for the budget period. Most small businesses plan budgets annually, but you can assign whatever period makes you comfortable. Then, identify the direct costs associated with your sales. This may include the costs of materials and manufacturing. Next, identify fixed costs (overhead costs), such as:

• Rent or mortgage payments
• Utilities
• Costs of staffing (don’t forget to include yourself)
• Vehicle expenses
• Equipment costs
• Printing costs
• Marketing expenses
• Professional costs, such as insurance

If this isn’t your first business budget, analyze your past budget. What were your successes? Failures? How was your performance last year, and how does it align with your targets for this year? Use last year’s figures as a guide, but factor in your current sales plans and business environment. Draw up your budget as realistically as possible. Your budget should let you easily monitor costs, expenses, working capital, sales, and other key numbers.

Use Your Budget to Measure Small Business Performance

A strong, carefully calculated budget gives you a guidelines on which to base future financial plans. It lets you realistically estimate future sales, set limits for expenses, and ultimately evaluate business performance. The difference between your income and expenses gives you a critical insight into how your company is doing. The larger that number, the more profitable your business. If that number starts to shrink, assess what your company could be doing differently to save money. During high points, put money aside to cover the slow seasons. That will keep your business stable year-round.

Managing Your Budget

Once you’ve created your small business budget worksheet, manage your budget by keeping an eye on it regularly. Updated it as needed, and check in on your income vs. expenses regularly. Identify places you may be able to trim expenses, such as office costs, or invest more money into projects that will grow your business during a profitable period. If you do not have the time to dedicate to your budget, hire a dedicated accountant to do so for you. Keeping track of your budget through tight management is critical for the future health of your company.

Why You Should Review Your Budget Often

It is not enough to set your budget and forget it. Your small business budget is something you must review often for optimal financial planning. Evaluating your budget – and your performance through your budget – gives you the information you need to adjust areas of business to improve the way you do things. Your budget can help you find motivation to improve customer service or communication with suppliers, for example. Reviewing your budget often gives you the power to conquer many aspects of business, such as:

• Greater ability to plan.

  You cannot plan for the future if you are in the dark about how much money you will have at that time. Without budget reviews, you could be headed toward bankruptcy and not even know it. Regular reviews put the power in your hands to map out your budget, avoid disasters, and predict the future of your company.

• Transparency with goals.

  Keeping up with a budget lets you and your staff see how far away you are from your sales goals. This lets you map out benchmarks and motivate employees to reach certain numbers each period, and ultimately make more money.

• Visibility into unnecessary expenditures.

  Your small business might have needed a service when you first started, but now you may realize it is an unnecessary expense. Reviewing your budget often gives you opportunities to eliminate expenses, save money, and increase your bottom line.

• Effective cash flow management.

  Using an up-to-date budget helps you successfully manage your business’s cash flow. You and your team can identify what goals you need to hit for the next budgeting period and what you need to do to make them a reality.

• Greater profitability.

  Reviewing your budget gives you the power to be flexible with your expenses and make changes to achieve greater profitability. Keeping track of how your company is faring lets you play with different strategies in each budget period. Then, you can stick with the one that works the best.

Reviewing your small business budget lets you decide whether it’s time to make some revisions. Revising your budget as your business grows, shrinks, or changes gives you the ability to achieve your objectives. In fact, many experts suggest revising your budget monthly. Keeping a close eye on your budget lets you control spending, stay realistic about your company, and plan for the future.

How to Revise a Small Business Budget

Don’t wait until debt swamps your company to make necessary budget cuts. Instead, review and revise your budget often to stay in control of your company’s profitability. Set aside time to revise your finances at every monthly or quarterly business review. If you experience cash flow changes, you should also revise your budget. Once it’s time to make a few revisions, get the whole team involved. If you have multiple departments, a head from each should be in on the budget revisions.

Revise your budget according to the needs of short-term projects and long-term goals. If you recently debuted a new product or service, revise your budget until you have actual numbers for manufacturing costs and sales income. Make allowances for single events, such as a major problem with defective products. Revising for allowances can help your company avoid bankruptcy if an unexpected problem occurs. These types of revisions can keep your company healthy no matter what comes your way.

Budget revision is not a one-time thing. It is an ongoing process. Your small business is dynamic. It needs a flexible, transparent, and up-to-date budget to stay on top. Revising your budget regularly is part of smart money management. If you need professional help with creating, managing, reviewing, and revising a small business budget, partner with the experts at Diversified Management Services, Inc. We can help you follow a business plan and set up important accounting processes, to help you achieve your short- and long-term goals. Contact us today to start with a customized business plan.

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Online Scams

Online scams are not new, but are ever-evolving as scammers think up new ways to scare small business owners into revealing too much information.

• Phishing. Tried-and-true, this scam has been around for years – mainly because it works. A bank, credit card company, or some other reputable service has supposedly sent your business an email. In it, they ask for login credentials, account information, or other sensitive information, and ask that you either reply to the email or click on their supplied link to log in. Once you do, the scammers have all the information they need to access your business accounts.
• Tech support scams. Scammers inundate your business’s computer with popups, locks, or emails which claim your business is in danger due to computer insecurity. Pay them, and they’ll fix the issue, they say. Instead, the scammers now have your money as well as access to critical information on your computer such as passwords and account information.
• Invoice scams. Scammers know your business responds to multiple invoices at a time, and they’re counting on your inattention. Fake email or paper invoices are sent in the name of services you may actually use, in the hope that they’ll be paid.

Phone and Other Scams

Most of these scams have been around for decades, with a few new twists scammers are using to make them believable for 2019.

• Utility company or IRS scams. These phone scams tend to work via a representative claiming to be from the local utility company or a government agency like the IRS phoning the business during prime or rush hours, claiming immediate shutdown of power or IRS penalties if the business owner doesn’t pay up.
• Unordered office supply scams. The scammer calls to confirm a common office supply order or verify your business’s address. Once you say yes to an unrelated question, unauthorized supplies are sent to your business address, complete with a recording of your voice saying ‘yes,’ supposedly to the new order. The supplies come at a high price and with threats for non-payment.
• Government worker impersonation. Scammers appear at your business or send an email or letter claiming to represent government agencies threatening to suspend your business license or impose fees if you don’t make a payment. Other scams involve selling official compliance posters that should be offered free of charge.
• Overpayment scams. Pseudo-potential customers pay by check via mail, only to realize too late they’ve overpaid. Pay them back via wire transfer, and you’ll soon find out their original check is bad.

How Can Your Business Avoid Scams?

These are some of the most common, but certainly not all of the scams targeting small businesses today. Make sure you and any employees are aware of ways your business may be at risk. A reputable bank or government agency will never request full account information via email or by phone, so train employees with access not to give it. Finally, verify all invoices and payments to ensure your money is going where you intend.

Diversified Management can help your small business avoid scams. For a free consultation or more information contact us by filling in the inquiry form or calling the number listed.

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What to Do:

• Do review your statements. Credit card companies are not without fault, and credit card fraud is rampant. Make sure to account for all charges made on your business’s behalf by you or your employees. Missing a statement means you’re missing an entire month of any fraud that may be occurring, and that’s a miss you’ll pay for later.

• Do pay the full balance. Whenever possible, pay off the full balance at the end of the month. Many small business cards allow you to keep 0% interest as long as there isn’t a carryover balance, but rack up some debt and you’ll be paying interest. This can make it harder to pay the full balance the next month and lead to a slide that ends in a huge pile of debt.

• Do pay on time. Even a day-late payment can result in a large service fee and hurt your credit in the process. Since credit cards are just one more in your business’s already large slate of expenditures and receipts, set a reminder or routine that helps you remember to make your payment.

• Do use your rewards. Credit cards for small businesses often come with rewards – contact your provider or read your statement to find out what yours are. Whether it’s cash back or airline miles, make sure you’re using them to get the most out of your cards.

What Not to Do:

• Don’t mix personal and business funds. Commingling is against the law in some cases. In others, it can make tax filing more difficult, or affect your eligibility for grants and contracts. Your safest bet is to keep personal and business finances completely separate.

• Don’t overspend. This sounds obvious, but can be difficult. Formulate a budget by viewing expected revenues, subtracting expenses, and making sure your credit card spending doesn’t put your business in the red.

• Don’t forget card security. Fraud is at an all-time high, so be wary of credit card scammers, employees who may be using a card improperly, and devices such as skimmers and scanners. As mentioned earlier, reviewing your statements is necessary to catching fraud before it becomes unmanageable. In addition, keep track of passwords, access information, and your physical card so it doesn’t fall into the wrong hands.

Business credit cards can be an asset if you manage them well. Follow these tips for handling your credit cards properly, avoiding common pitfalls, and ensuring your business maintains a good credit rating.

Diversified Management has a wealth of financial services geared toward keeping your business healthy. Request a free consultation by filling in the inquiry form or calling the number listed.

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Which Forms Do I Need?

• If your business is a sole proprietorship or a single-member LLC, you’ll need to file Schedule C forms, as well as Schedule SE self-employment forms.
• If your business is a corporation, you’ll need to file form 1120.
• If your business is an S corporation, you’ll need to file form 1120S, as well as Schedule K1 Shareholder’s Share of Income, Loss, Debts, Etc, and Schedule SE self-employment forms.
• If your business is a partnership or multiple-member LLC, you’ll need to file form 1065 as well as a Schedule K1.

What Other Information Should I Collect?

To file Schedule C, make sure you also come prepared with your information regarding cost of goods sold. In addition, you’ll need receipts for all deductions, such as travel, hotels, mileage, and meals. You should gather information for assets purchased for business purposes, as well as the amount of any depreciation. Finally, if you operate your business out of your home, collect receipts for any expenses to that end, such as office furniture, internet, or phone bills.

Corporations should include income information like gross receipts, costs of goods sold, capital gains, dividends, rent and interests. Deductions include the usual travel, meal, and transportation expenses as well as business supplies, legal fees, startup costs, salaries, maintenance, taxes, licenses, and many others. Finally, taxable income and tax from a schedule, fewer payments made and credits earned, are calculated. This is not a complete list, so refer to the 1120 or 1120S for a more comprehensive list of what information you need.

Partnerships or multiple member LLCs should gather beginning of year and end of year balance sheets, profit and loss calculations, and a calculation of the cost of goods sold. In addition, you should prove any deductions such as travel, hotels and mileage with receipts, along with any assets purchased and their depreciation, such as vehicles or equipment. Finally, partnerships must pay state partnership taxes, so check the laws in your state.

What Are My Tax Filing Dates?

• Those filing Schedule C taxes will do so along with personal income taxes, on April 15th. If April 15th falls on a weekend, use the next business day.

• Partnerships or multiple-member LLCs filing partnership taxes must do so on or before March 15th. If March 15th falls on a weekend, taxes are due on the next business day.

• Corporations and S corporation taxes are due, dependent on the corporation’s fiscal year-end. For corporations with years ending December 31st, tax returns are due April 15th, or if the date falls on a weekend, the next business day. For corporations with fiscal years ending on any other date, tax returns are due on the 15th day of the 4th month after the fiscal year-end.

Filing taxes can be complicated, even for seemingly simple Schedule C returns. To ensure accuracy and make sure you’re finding all your potential deductions, consider using a professional tax preparer. Diversified Management has a wealth of tax tips and other business planning information. Reach out via our online form or call for a free consultation today.

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Retirement Plans

Individual Retirement Plans and 401k’s are a great deduction. The IRS allows an individual to deduct up to $18,000 deposited annually into their retirement fund, plus up to 25% of their income. When it comes to employees, there are more opportunities for deductions because the government is actively funding retirement through match funding programs such as SIMPLE (Savings Incentive Match Plan for Employees) IRA and SEP (Simplified Employee Pension) IRA.

Home Office

Most home businesses and self-employed individuals do part or most of their work from home. As a result, there are many deductions associated with having a home office. Remember that the IRS may require documentation that the office is used solely for business and not for personal use. Bills such as the internet, phone lines, mortgage interest, repairs, and utilities are all possible deductions. The IRS may also want the dimensions of your home office and other physical details, so be sure to check the IRS website for details.

Travel Expenses

Use of your personal car for business purposes is deductible. The IRS puts out a standard mileage rate every year, so be sure to check it with each new tax year. Use a log to record the accurate use of the vehicle for work. If you want to claim the actual expenses the car incurs rather than the mileage, you can record and deduct bills such as payments, registration, insurance, repairs, garage rent, licenses, tolls, and depreciation. Train, plane, and bus tickets are also deductible if the travel was for business purposes.

Rent

If you rent a storefront or office for your business, you can claim it as a deduction. However, if you lease the property or make payments toward ownership of the property, the rent is non-deductible. You must be able to prove that this property is for business purposes.

Education

Books, online courses, college classes, and research used to improve the standing of you or your business are tax deductible. This ranges from purchasing e-books to taking seminars on business methods. Furthering your education is a business expense.

Advertising

Any marketing or advertising expenses for the business are good tax deductions. Newspaper or print ads, social media ads, commercials, radio spots, or promotional materials count as advertising. Keep an accurate record of how much you spend on business promotion throughout the year.

Insurance

Any insurance you take out for the business is deductible. That means housing insurance for home businesses, business insurance, car insurance for the company car, event insurance, and many others. If the insurance policy protects part or all of your business, it is applicable to your deductions. Health insurance premiums are not a deduction but are a credit instead.

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1. Relationship selling. Over the last few years, research has shown that people are more willing to buy from brands that they feel a personal connection with. Creating and nurturing relationships with customers makes them feel valued, which in turn makes them want to support your business. The best way to build relationships with customers is to show that a business is run by people, not a faceless corporation.
2. Use the web. Social media can be a gift to small business owners. It is a cost-effective way to begin immediately building relationships with customers, without a middleman. Everything done on social media is free advertising, so take advantage of it. Begin funneling funds for print ads into Facebook, Instagram, and web ads instead.
3. Define your brand. Customers want to connect with businesses that they can easily identify with. That means creating a business brand that people want to be a part of. Selling outdoor supplies? Create an adventure-loving explorer persona and tap into the wanderlust market. Identify and define your brand clearly.
4. Advertise “small business.” These days, people are becoming more aware of how they spend their money. They want to move away from buying from big corporations and instead support small businesses. Don’t be afraid to advertise that you are a small business, especially in your local area. When customers purchase from your business, they will feel like they are supporting a community that they are a part of.
5. Offer deals. Promotional deals and events are an old trick of the trade, but they work just as well today as ever. With the internet and social media, there are more opportunities to publicize deals and entice customers. Don’t be afraid to make a little less on a good deal if it opens your business up to new customers who will come back for more.
6. Give out freebies. Everyone likes to get stuff for free. Create online contests to create a wider customer base and promote your brand. Even if customers don’t win the free prize, you will have a new connection with them and the possibility for future sales.
7. Create a loyalty system. This goes back to relationship selling and helps nurture community. It can be as simple as giving a free product after a certain number of return sales to your business or offering sneak peeks at new products. Give them something that lets them know you appreciate their continued support.
8. Email marketing. Email marketing is one of the most effective marketing approaches today. Once a customer arrives on your landing page, entice them with a discount for signing up for your newsletter. You now have regular and direct contact with those customers.
9. Partner with other businesses. The best way to succeed is to work together. Find another small business whose products complement your own and create a marketing deal. Offer a contest together or put on an event. You have now doubled your potential customer base and sales.

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Section 199A Deduction also known as the Qualified Business Income Deduction arises from the Tax Cuts and Jobs Act of 2017. This new provision allows many owners of sole proprietorships, partnerships, trusts and S corporations to deduct up to 20 percent of their qualified business income (QBI) plus 20% of qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income.

The resulting calculation will go on Page 2, Line 9 of the IRS Form 1040. The amount calculated will be deducted from your adjusted gross income (AGI) to further reduce your taxable income.

The IRS is still working out the kinks in the proposed regulations as well as the methods for calculating the 20 percent deduction of the QBI. The most recent document of the proposed amendments to the Income Tax Regulations under sections 199A and 643 of the code was published in the Federal Register (The Daily Journal of the United States Government) on Aug. 16, 2018. The closing comments for this amendment will be held at a public hearing on Oct. 16, 2018. (All this means to you and me is that the amendment is still under discussion. With that said, some of the information provided in this article may change at the end of this year.)

We’ll begin with the steps needed to help determine whether your business entity is eligible for the up to 20 percent deduction:

Step #1: Determine Taxpayer’s Eligible Taxable Income for Income Limits

• If Single and your Adjusted Gross Income (AGI) is less than $157,500 your QBI Deduction will be up to 20 percent (minus your net capital gains).
• If Single and your AGI is more than $157,500 your QBI Deduction will be phased out incrementally until completely phased out by $207,500.
• If Married (filing jointly) and your Adjusted Gross Income (AGI) is less than $315,000 your QBI Deduction will be up to 20 percent (minus your net capital gains).
• If Married (filing jointly) and your AGI is more than $315,000 your QBI Deduction will be phased out incrementally until completely phased out by $415,000.

Step #2: Determine Your Qualified Trades or Business

Listed below are the types of businesses that qualify:

• Sole Proprietorships
• Partnerships
• Real Estate Investors
• Single Member or Multi-member LLCs
• S Corporations
• Trusts or Estates

Step #3: Determine Specified Service Trade or Business (SSTB)

If you are Single and your AGI is less than $157,500 or Married filing jointly and your AGI is less than $315,000 your business qualifies regardless of the Specified Service Trades or Businesses listed below.

For all other taxpayers above the Income Threshold your deduction will be subject to the SSTB limitation. Limitations such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business. (Yada, yada, yada) (For those of you above the eligible taxable income limit, you are definitely going to need the help of a professional tax preparer!)

According to IRS Provision 11011 Section 199A an SSTB includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.

The definition in the paragraph above is strikingly familiar with the definition of Personal Service Corporations in IRS Publication 542 on Page 3 (2017 version) except they left out the fields of engineering and architecture. Interesting.

Step #4: Determine Your Qualified Business Income

Whether you own one or more businesses they may all qualify for the business income deduction. Once you have determined which of your businesses qualify you will aggregate the total net income allocated to you as a taxpayer for the qualified businesses.

Your qualified business income includes items of income, gain, deduction, and loss (a.k.a. net profit or loss) from your trades or businesses, including income from partnerships, S corporations, sole proprietorships, and certain trusts. (Please see the Draft Instructions for 2018 Form 1040 below for what the qualified business income does not include. Please read instructions for Line 9 starting on Page 34.)

Draft Form 1040 Instructions: https://www.irs.gov/pub/irs-dft/i1040gi–dft.pdf

Step #5: Determine Your Qualified Business Income Deduction

If your taxable income falls below the thresholds stated in Step #3 above, then your Qualified Business Income Deductions will be the lesser of:

• 20 percent of your QBI, plus 20 percent of your qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income
• 20 percent of your taxable income minus net capital gains

If your taxable income is above the thresholds, the deduction may be limited based on whether the business is an SSTB, the W-2 wages paid by the business and the unadjusted basis of certain property used by the business. These limitations are phased in for joint filers with taxable income between $315,000 and $415,000, and all other taxpayers with taxable income between $157,500 and $207,500. (Yep…complicated stuff)

Here are some examples to help you navigate the rough QBI deduction trail:

• Andrea (Single Taxpayer) has a net income from her business as an accountant, operating as an S Corporation, of $100,000 and her taxable income is $80,000 on her tax return due to other deductions such as her itemized deductions. Her Section 199A deduction would be $16,000 since it is limited by the lesser of 20% of $100,000 or $80,000.
  [Even though she operates a specified service trade business, her income falls below the threshold of $157,500 making her fully eligible for the deduction.]
• Dave and Mary (Married filing jointly) have earned gross wages of $275,000. Dave earned $200,000 in wages as an employee of an unrelated company in 2018. Mary owns 100% of the shares of Mary’s Art Consulting Service, an S Corporation. Mary’s Art Consulting Service generated $50,000 in net income from operations in 2018. The company paid Mary $75,000 in wages in 2018. Dave and Mary had no capital gains or losses in 2018. Dave and Mary’s taxable income for 2018 was $225,000 after adjustments and itemized deductions.
  In this example, Mary’s Art Consulting Service’s QBI is the $50,000 in net income from the operations. Because Mary is the sole owner of the company, all of its QBI is attributed to her.
  Taking 20% of the $50,000 gives us $10,000. We then compare that amount to 20% of taxable income less any net capital gains. [Yes, the IRS puts her husband’s income in the mix of the calculations, although not stated specifically in the instructions, but implied that a “taxpayer” is considered one taxpayer when married.] Here taxable income is $225,000 and the couple had no net capital gains. 20% of $225,000 is $45,000. We compare $45,000 to the $10,000 figure and because $10,000 is less, that amount is Mary’s Section 199A deduction for 2018.
  (If Mary’s business was a sole proprietorship, she would have no taxable wages and the entire net profit of $125,000 would put her over the threshold amount of $315,000 for Married filing jointly. Their Section199A deduction would be limited to the lesser of 20% QBI or the greater of (1) 50% of the W-2 wages paid with respect to that business [$0] or (2) 25% of the W-2 wages paid with respect to that business plus 2.5% of the unadjusted basis of qualified property for that business, aka Assets. Mary had no assets [$0]. In this case 20% of QBI is equal to $25,000. Since the business paid no W-2 wages, the Section 199A deduction is limited to $0! She would not qualify for the Section 199A deduction.) Luckily, Mary created an S corporation and paid out W-2 wages to maximize her Section 199A deduction.
• George (Single Taxpayer, Sole Proprietor) owns four rental properties with net incomes of $25,000, $20,000, $15,000, with one losing $5,000 annually. These property incomes would be aggregated to be $55,000. He would deduct 20% of $55,000.
• Kathy (Single Taxpayer, Partner) has 50% ownership in a health nutrition business operated as a partnership with another unrelated individual. Let’s say that the K-1 Kathy received from the partnership tax return indicated that her share of the QBI is $25,000. She also received guaranteed payments of $75,000 for the year. Her total taxable income after the standard deduction would be $88,000. 20% of the $88,000 gives her $17,600. We then compare that to the 20% of the QBI ($25,000), which is $5,000. Her Section 199A deduction would be $5,000.

Section 199A deduction cannot be taken in loss years. If your QBI is less than zero in a year, the amount will be treated as a loss from a qualified business in the next year (Sec.199A(c)(2)).

As you can see by the examples, tax reform does not mean tax simplification!

It took countless hours of reading IRS Publications, draft instructions, draft forms, and interpretation of the IRS Code 26 USC 199A to come up with the above scenarios.  I’m mentally exhausted!

William A. Bailey, CPA, J.D., LL.M. stated, “Much of the Sec. 199A deduction’s complexity comes from congressional concerns of potential abuse.” (Mechanics of the new Sec. 199A deduction for qualified business income, Journal of Accountancy, May 1, 2018)

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Listed below is an overview of some of the changes in the new tax law:

FORM 1040

1. The 2018 draft form of the IRS Form 1040, U.S. Individual Income Tax Return,

   has been reduced to two half-pages.  The first page gathers information about the taxpayer and any dependents and for the taxpayers signature.  The second page gathers information on the taxpayer’s income, deductions (including a new line for the Sec. 199A deduction (known as the Qualified Business Income deduction), credits, and taxes paid.  (The Section 199A deduction will be discussed in Part 2 of this article at a later date…watch for it…you won’t want to miss it.)

2. Many of the items reported on the former 2017 version of the IRS Form 1040 will
   be broken out into 6 separate schedules (here we go again with more pages added to a seemingly endless paperback book tax return). In summary, the former 2-page IRS Form 1040 will now be comprised of 7 pages. The new Schedules are as follows:
   • Schedule 1, Additional Income and Adjustments to Income, includes items from lines 10 through 37 of the 2017 Form 1040, such as taxable refunds, business income, capital gains or losses, and adjustments including health savings account deduction, self-employed health insurance deduction, and student loan interest expense.
   • Schedule 2, Tax, includes items from lines 44 through 47 of the 2017 Form 1040, such as the alternative minimum tax, and any excess premium tax credit that must be repaid.
   • Schedule 3, Nonrefundable Credits, includes items from lines 48 through 55 of the 2017 Form 1040, such as the credit for child and dependent care expenses, education credits, retirement savings contributions credit, and the residential energy credit.
   • Schedule 4, Other Taxes, includes items from lines 57 through 63 of the 2017 Form 1040, such as the self-employment tax, additional tax on IRA’s, household employment taxes, repayment of first-time homebuyer credit, and the health care individual responsibility tax.
   • Schedule 5, Other Payments and Refundable Credits, includes items from lines 65 through 74 of the 2017 Form 1040, such as estimated tax payments, the net premium tax credit, and amounts paid with an extension request.
   • Schedule 6, Foreign Address and Third Party Designee, provides taxpayers who have a foreign address a place to list their country, province, and postal code (formerly these appeared on page 1 of the 1040) and provides all taxpayers with a place to list information for a third-party designee who can discuss the return with the IRS.
3. The new tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. They will phase out in eight years. They replace the old tax rates of 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%.
4. The Standard Deduction Doubles: The standard deduction increased as follows:
   • For Single & Married Filing Separately it increased from $6,350 to $12,000.
   • For Married Filing Jointly and Widows it increased from $12,700 to $24,000.
   • For Heads of Household it increased from $9,350 to $18,000.
5. The Personal Tax Exemption is eliminated. In 2017 it was $4,050 per person.
6. The Child Tax Credit is increased from $1,000 to $2,000 per child (first $1,400 is refundable if the qualifying child is under the age of 17).

Before we move on to the next section let’s take a closer look at the new standard deduction and the elimination of the personal tax exemption to see how that is going to work out.

For the Single individuals: In 2017 their standard deduction and personal exemption combined would have totaled $10,400. In 2018 their new standard deduction is $12,000. That is an increase of $1,600 in deductions.

For Heads of Household with one child: In 2017 their standard deduction and personal exemption would have totaled $17,450. In 2018 their new standard deduction is $18,000. That is an increase of $550 in deductions.

For Married couples with no children: In 2017 their standard deduction and personal exemption combined would have totaled $20,800. In 2018 their new standard deduction is $24,000. That is an increase of $3,200 deductions.

First place goes to…married couples with no children. Second place goes to…single individuals. Last place goes to…Heads of Household with one child!!

One can only hope that the single Mother (or Father) can at least qualify for the Earned Income Credit and the Additional Child Tax Credit, and any other credit available to boost their tax refund to make it through another year. (That is just my biased opinion as a single mother.)

FORM 1040-SCHEDULE A

1. Medical and Dental Expense Tax Deduction Rate is reduced in 2017 and 2018 from 10% to 7.5%. It will rise back to 10% in 2019. You have until the end of 2018 to pack in as many visits to the doctor, dentist, chiropractor, acupuncturist, etc. as humanly possible.
2. The Mortgage Interest Deduction is capped at $750,000 for loans taken out after December 15, 2017 and you can only deduct home mortgage interest to the extent that the loan proceeds were used to buy, build, or substantially improve the home securing the loan. Second mortgages used to pay down credit card debt or to fund a vacation, etc. do not qualify for the deduction.
   Home mortgages taken out on or before December 31, 2017 is capped at $1,000,000 and the new rule applies that second mortgages used to pay down credit card debt or to fund a vacation, etc. do not qualify for the deduction.
3. The State and Local Property Tax Deduction is capped at $10,000.
4. The Miscellaneous Itemized Deductions Subject to the 2% AGI floor is eliminated for eight years.
5. The Moving Expenses Deduction is eliminated. (With the exception of members of the military.) This will expire in 2025.
6. The Tax Deduction for Casualty and Theft Loss is eliminated (except for those losses attributable to a federal disaster as declared by the President) from 2018 to 2025.
7. The Tax Return Preparation Expense Deduction is eliminated.
8. The Home Office Deduction for Employees is eliminated, including the Business Mileage Rates for Un-Reimbursed Employee Travel Expenses.

(This has nothing to do with the Home Office Deduction for Self-Employed Taxpayers. That deduction is still in effect on Form 8829, Expenses for Business Use of Your Home.)

There are several more changes, that can not all be covered in this article due to space (and time) limitations. Individuals with capital gains will need to refer to the new Tax Form Instructions and/or their Tax Return Preparer.

For more information on the newly revised draft Tax Forms please click on the link below if you are a geek for hard evidence like me (Tip: to put the forms in numerical order click on the Product Number heading):

https://apps.irs.gov/app/picklist/list/draftTaxForms.html

If I haven’t lost you yet…please stay tuned for Part 2 when it is published. Small business owners will not want to miss it!

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