One of the blockbuster items contained within the Tax Cuts and Jobs Act (TCJA) was the new Section 199A Deduction – or Qualified Business Income (QBI) deduction. In short, this allowed for a 20% deduction against qualified flow-through (e.g. S Corp and partnership) income at the individual taxpayer level. In 2018, the rules surrounding the calculation fit neatly into what tax geeks like me affectionately refer to as the “Wild Wild West”…which means (just about) anything goes. For 2019, the IRS gave us some parameters around how to calculate the deduction and actually gave us a form and some instructions (for better or for worse). The problem was, there was one line in one paragraph of the instructions that threw everyone for a loop. It read:
“To figure the total amount of QBI, you must consider all items that are related to the trade or business. This includes, but isn’t limited to, charitable contributions…”
For those of you who don’t live in this world, that simply means that individuals would lose 20% of their businesses’ charitable contributions as tax deductions. On its face, this really seems like an issue that the IRS would not want to take flak over. Dig a little deeper, and best case it’s contradictory, and worst case it’s illegal. Let me explain…
Internal Revenue Code Section 162(a) defines business expenses as all ordinary and necessary expenses paid or incurred in carrying on any trade or business. Rather benign, right? But if you hit page down (because I know you all randomly read the Internal Revenue Code), you get to subparagraph (b), which states that NO deduction shall be allowed for ANY contribution that would be allowable as a deduction under IRC Section 170. Cutting to the chase…IRC Section 170 covers charitable contributions and says everything that you’d think it would. So what does this mean? This means that – BY DEFINITION – charitable contributions are NOT business expenses, and therefore – BY DEFINITION – cannot be related to a trade or business.
On top of this, there’s this little problem with charitable contributions and itemized deductions on all of our 1040s where, if you don’t have enough itemized deductions, you just get the standard deduction – in which case the portion of charitable contributions that gets lumped in with QBI are lost forever.
Fast forward to 2020, where the IRS has recently released DRAFT instructions for the 2020 Form 8995. There are two words conspicuously missing from the paragraph referencing how to calculate the deduction. You guessed it – there’s no mention of charitable contributions.
So what does this mean? As with many changes when it comes to taxes, we don’t know yet. Was this just an oversight (probably not – since that would have to be a rather egregious cutting and pasting error)? Was it an error in 2019? It’s hard to say. What we do know is that, at least for 2020 (assuming the draft instructions for 2020 go final as is), there’s a very strong case to be made for not reducing QBI by the business’ charitable contributions. We also see this as a potential opportunity to amend 2019 tax returns to increase QBI deductions. This approach, however, is not without peril. IRS forms instructions are able to be relied upon to form tax positions. This means that, if you go contrary to forms instructions, you’d better have a really good reason. Is this a really good reason? If the tax benefit is big enough, you just might get there.
In the end, regardless of potential past, current, and future tax savings, we view any decision that incentivizes charitable contributions as a good thing. This is a good thing.