The 2017 tax reform act (the Act) has intertwined S corporation ‘reasonable compensation’ with the new Section 199A deduction in that the amount of compensation paid to S corporation shareholder-employees can impact the extent to which the Section 199A deduction is allowed. As a result, the IRS may increase its focus in both areas, especially in the context of smaller S corporations. In response, S corporations and their shareholder-employees may want to take an integrated approach to analyzing reasonable compensation and the Section 199A deduction.
The Act has intertwined S corporation ‘reasonable compensation’ with the new Section 199A deduction in that (1) an S corporation deducts reasonable compensation in computing its QBI, but the reasonable compensation does not provide a corresponding increase in the shareholder-employee’s QBI, and (2) reasonable compensation constitutes W-2 wages and may increase the W-2 wages/UBIA limitation and QBI taken into account with respect to a shareholder-employee above the taxable income threshold amount, and, thus, may increase the amount of the Section 199A deduction. S corporations and their shareholder-employees should analyze the impact of these factors on their specific facts and circumstances as they work through compliance obligations and planning opportunities with respect to the Section 199A deduction.
For additional information about the Section 199A deduction, please refer to the following PwC Tax Insights:
Tax readiness: Issues under the final Section 199A regulations (February 19, 2019)
Final regulations provide guidance on the Section 199A passthrough deduction (February 1, 2019)
Tax reform readiness: Deeper dive on Section 199A proposed regulations (October 16, 2018)
Tax reform readiness: Understanding the Section 199A proposed regulations (September 10, 2018)
Proposed regulations provide guidance on computing the Section 199A deduction (September 5, 2018)
Private Company Services, Mid-Central Region Team Leader, PwC US