Question

• Why has Congress moved toward credits rather than deductions in recent years?

• What do you know about tax provisions that might encourage small business?

• How C Corporation may be different from S Corporation? Are there other types of corporations? How they are treated?

• What is Qualified Business Income? How to determine taxpayer deductions for qualified business income/

Answer 1

Deductions and tax credits

Deductions reduce taxable income and thus they are more valuable to someone with high tax bracket than a person who pays a low tax rate

Deduction of $ 10000 reduces tax by $ 1500 for someone in 15% bracket but by $ 3500 for a person in 35% bracket

Deductions are treated as lost revenue to the government

Tax credits are different. They directly reduce tax liability instead of taxable income. $ 2000 credit is worth the same to a person in 15% bracket or someone in 35% bracket. A refundable credit can be obtained as refund regardless of tax liability

Refundable tax credits is counted as a spending by the government

Thus, there is a difference in distribution of benefit in both the scenarios. Deductions tend to be worth more to high income tax payers whereas credits are more-likely to benefit low and moderate income households

The Congress being more focused on upliftment of lower tax payers it made a shift

Tax provisions for encouragement of small business

Small business includes self-employed sole proprietor or independent contractor

The new tax reforms have brought various changes for small business

1. Lower tax rates: Tax rate for small business pass through entities earlier used to be same as individual tax rate. With the change in tax law, that income is now subject to 20% deduction exception $157500 for individual and $ 31500 for joint filers

2. Entertainments expenses: NO deduction for membership dues to club or recreation, any activity considered as amusement, entertainment or recreation or use a facility for entertainment purpose as many small business owners weren’t buying skyboxes or golf trips it was the big ones that were benefitted

3. Higher bonus depreciation: Machinery equipment can now claim up to 100% as bonus depreciation

4. Net operating losses: When expenses exceed income small businesses can now carry this deduction forward and deduct it from income on another year

5. A qualifying small business can use cash method instead of accrual method and don’t have to have hassles of book keeping

C Corporations and S corporations

C Corporation is Standard Corporation under IRS whereas S corporation is a corporation who as elected a special tax status with IRS and has some tax advantages

C corporations are taxed under subchapter C and S corporations are taxed under subchapter S

Difference

C corporations are separately tax entities and file a corporate tax return and pay taxes at corporate level whereas S corporations are pass through tax entities who file an information federal return but no income tax is paid at corporate level. The profit and loss are reported through owner’s personal tax returns

S corporations are restricted to no more than 100 shareholders who shall be US citizens

Other corporate structure is LLC i.e. limited liability company whereby members of the company cannot be personally held liable for company’s debts or liabilities

Qualified business income

Sole proprietorship, partnership, S corporation and some trusts and estates are eligible for qualified business income deduction

Income earned through C corporations or providing services as an employee are not eligible

The deduction is over and above itemised or standard deduction

The deduction has two parts

1. Qualified business income: 20% of qualified income from a domestic business limited to amount of W2 wages paud by business or trade and unadjusted basis immediately after acquisition

2. Real estate investment trust dividends and qualified publically traded partnership: 20% of REIT/PTP

Qualified business income is the net amount of qualified items on income, gain, deduction and loss form any qualified business or trade