Although many businesses providing services in the field of performing arts are not eligible for the qualified business income (QBI) deduction, some entertainment businesses that do not fall in this category have taken the position that they do qualify.  Recent indicators from the IRS, however, suggest that taxpayers claiming the QBI deduction may be subject to increased audit risk in the near future.

By way of background, the QBI deduction was introduced in 2017 as part of the Republican tax overhaul known as the Tax Cuts and Jobs Act (TCJA).  The TCJA was perhaps most known for reducing the corporate tax rate to 21%; the QBI deduction was an effort by Congress to provide parity to flow-through taxpayers (e.g., LLCs and S corporations) who were not able to take advantage of the lower corporate rate.  Simply, the QBI deduction allows a 20% deduction for the net amount of domestic income derived from a non-service-based trade or business.[1]  This deduction eventually flows through to the individual level for taxpayers who hold an interest in such flow-through entities (e.g., partners in a partnership).

Although it’s not yet certain, there are many telltale signs of increased audit risk in this area.  Douglas O’Donnell, head of the IRS’s Large Business and International Division, recently confirmed that the IRS will be increasing its auditing efforts with respect to high-wealth taxpayers beginning July 15, 2020.[2]  Mr. O’Donnell further confirmed that several hundred exams will begin for high-wealth taxpayers between July 15 and September 30, 2020.  The IRS has also recently announced that it will begin a compliance campaign focused on new legislation introduced as part of the TCJA, with emphasis on flow-through entities.  Further, a recent report released by the Treasury Inspector General for Tax Administration, an organization that provides oversight over the IRS, urged it to focus audit efforts in 2020 in several areas, including taxpayer compliance with the requirements of the QBI deduction.  These factors, as well as others, have led to speculation that the IRS will be targeting taxpayers who claimed QBI deductions.

Venable stands ready to advise with respect to any QBI planning.

[1] For a more in-depth discussion of the QBI deduction and other entertainment tax issues, see “Entertaining Taxes” in Los Angeles Lawyer, Entertainment Edition.

[2] This is also when 2019 tax returns are due for calendar-year taxpayers (absent an extension) as well as when numerous deadlines previously suspended by the IRS begin to run again and come due.