Can You Use the QBI Deduction for a Trust?
The Qualified Business Income (QBI) Deduction has been a popular incentive for businesses and their owners following the Tax Cuts and Jobs Act. One question that many people ask is, can the QBI deduction be used for trusts? We’ve been analyzing businesses and individuals to see how to maximize the deduction, and below we dive into how trusts can utilize the QBI deduction.
Treatment of Trusts and QBI
Typically, a trust will function the same as a business with QBI. Any ordinary income will be defined as “qualified income” or “service business income”, and flow through to the individual, or be taxed at the trust level. However, trusts have their own special rules under the QBI. Under the anti-abuse rules, if a trust is formed for the sole purpose of receiving a QBI deduction, the deduction will be disallowed and aggregated with the funding entity.
To help avoid abuse of the QBI deduction for trusts, two or more trusts will be treated as one if the trusts have substantially the same grantors or primary beneficiaries and the principal purpose of the trust is to avoid income tax. There would need to be a significant non-tax purpose to separate the trusts, in order to prove income tax avoidance wasn’t the purpose of the trust.
Planning Opportunities to Utilize the QBI Deduction for a Trust
Under the new increased trust tax rates as of 2018, a 20% QBI deduction is extremely beneficial at the trust level. However, the rules above limit individuals from breaking up trusts in order to stay below the income threshold of $207,500.
Income Distribution Deduction
The income distribution deduction will reduce trust income to get below the income threshold. This is important to note, so at year-end the trust is examined to make sure they have distributed enough to be below the income thresholds and able to utilize the full 20% deduction.
Treatment by Type of Trust
Grantor trusts are more popular for QBI as all of the income will flow through to the individual. This is beneficial if the grantor is married because their deduction is increased to $415,000. Electing small business trusts do qualify for the QBI deduction, so all S Corporation income will be reduced by the QBI deduction before tax is paid at the trust level.
Determining if and how to use the QBI deduction for trusts can be complicated. The Anders Family Wealth and Estate Planning Services Group can help. If you have any questions related to trusts or QBI, please contact an Anders advisor.