I’m going to throw one piece of information into the section 162 issue which may provide a better understanding.
Certain types of passive income including interest income, dividend, capital gains and rental income luckily only have income taxes assessed. This is because this income is deemed not earned like that from a regular trade or business.
Sole Proprietorships (filed on schedule C) include both income taxes PLUS self-employment taxes on the net income. Even though many sole proprietorships (whether it’s selling on eBay, sub-contract work, etc.) often do not employ anyone yet the IRS still determines that these are businesses or trades and that the net income earned is subject to employment taxes, just like that of w-2 employees of a company. For those not aware Employers match the employment taxes that their employee pays. Employment taxes (Social Security & Medicare taxes combined) are 7.65%. When you are self-employed you pay this twice for a total of 15.3% since you are considered both the employee and the employer. 92.35% of self-employment income is subject to these employment taxes so the net rate is about 14.3% of net income. This is a large % of additional taxes which I’m glad I don’t have to pay on my rental income.
Keep in mind that Real estate professionals claim business income which is also subject to employment taxes.
Now if one were to claim the QBI deduction without safe harbor but rely on section 162 they would argue that they have a legitimate business which entitles them to the deduction. But understand that the IRS previously determined that your rental income is passive income due to lack of active involvement and because of that did not require the 15.3% employment taxes. So basically you would be arguing that your rental activity is business activity to claim the QBI deduction but not business activity to avoid self-employments taxes.
