Earlier in August, the IRS issued proposed regulations concerning the deduction for qualified business income under section 199A of the Internal Revenue Code.
Section 199A was enacted at the same time as the Tax Cuts and Jobs Act (TCJA). The IRS also issued Notice 2018-64, which provides guidance on how to compute W-2 wages for the deduction, with frequently asked questions.
The regulations will affect individuals, partnerships, S corporations, trusts and estates engaged in domestic trades or businesses. The proposed regulations also contain an anti-avoidance rule under section 643 of the Internal Revenue Code to treat multiple trusts as a single trust in certain cases. The proposal also includes a notice of a public hearing with necessary contact information in the body of the document.
The deduction, which is in effect for the first time in 2018, allows owners of sole proprietorships, partnerships, trusts and S corporations to deduct 20 percent of their qualified business income (QBI). Written or electronic comments must be received 45 days after publication in the Federal Register.
Outlines of topics to be discussed at the public hearing scheduled for Oct. 16 at 10 a.m. also must be received 45 days after publication in the Federal Register. If no outlines of topics are received within the 45-day deadline, the public hearing will be cancelled.
The Treasury Department and the IRS request comments on the assumptions, methodology, and burden estimates related to this proposal. The collection of information required by the proposal is in Section 1.199A-4 and 1.199A-6.
The information proposed in Section 1.199A-4 is required for taxpayers that choose to group two or more trades or businesses. The information in Section 1.199A-6 is required for pass through entities that report Section 199A information to their owners or beneficiaries.
It’s necessary to report the information to the IRS to ensure that taxpayers properly report in accordance with the rules of the proposed regulations the correct amount of deduction under Section 199A. The information is necessary for tax compliance, the proposal states.
The likely respondents are individuals with qualified business income from more than one trade or business as well as most partnerships, S corporations, trusts and estates that have qualified business income. A Section 199A deduction is unavailable for wage or business income earned through a C corporation.
So just what will these rules require?
Section 1-199a-1 (Operational rules): These operational rules include how to figure out the deduction for taxpayers with incomes at or below threshold amounts and for those with incomes above those thresholds. It also defines aggregated trade or business, applicable percentage, phase-in range, qualified business income, QBI component, qualified PTP income, qualified real estate investment trust (REIT) dividends, reduction amount, relevant pass-through entity (RPE), specified service trade or business (SSTB), threshold amount, total QBI amount, unadjusted basis immediately after acquisition (UBIA) or qualified property, and W-2 wages.
The IRS also included the definition of trade or business in this category because the definitions of those entities under Section 162 is taken from a large amount of court cases (otherwise known as case law) and administrative guidance (we’re assuming that means ‘rulings’) that interpret what ‘trade’ or ‘business’ mean in the broad range of “industries.” The IRS believes this will cut back on compliance costs, burden and administrative hassles.
Section 1.199A-2: This one includes rules for figuring W-2 wages and the UBIA of qualified property, both of which are necessary in figuring limits on the deduction. The rules for computing W-2 wages are based on the rules under the repealed Section 199 deduction for qualified domestic production activities – except that, unlike Section 199, the Section 199 W-2 wages are calculated separately for each trade or business.
Section 199A-3: This one restates the definitions in Section 199A(c) and gives additional guidance on the determination of QBI, qualified REIT dividends and qualified PTP income. (Forgot what the acronyms mean? See Section 199a-1.
Section 1.199A-4: Includes aggregation rules that allow separate trades or businesses to be grouped when applying the Section 199 rules. The IRS didn’t allow comments that suggested the application of grouping rules under Section 469 (the passive-loss proviso) and instead, proposed a flexible method that considers common ownership, shared services and other commonality – but expressly excludes SSTBs from being aggregated under the rules.
The regulations require a “duty of consistency” that in turn requires that once multiple trades or businesses are aggregated into a single aggregated trade or business duty of consistency” that requires those multiple trades or businesses to be aggregated into a single aggregated trade or business under Section 199a, taxpayers must then consistently report the group in following tax years,” the proposal states. “Aggregation allows for ease of administration and was one of the American Institute of CPAs’ recommendations in a February letter to the IRS.”
Section 1.199A-5: This defines specified service trades or businesses and the trade or business of performing services as an employee. That includes an anti-abuse rule intended to prevent taxpayers from separating parts of what otherwise would be an aggregated SSTB, such as administrative functions, in an attempt to qualify those separated parts for the Section 199A deduction.
Section 1.199A-6: This includes special rules for RPEs, PTPs, trusts, and estates that these entities may need to follow to compute the entities’ or their owners’ Sec. 199A deductions.
Section 1.643(f)-1: Addresses concerns regarding the abusive use of multiple trusts by confirming the applicability of Section 643(f), which permits the IRS to issue regulations to prevent taxpayers from establishing multiple non-grantor trusts to avoid federal income tax.
Notice 2018-64: Issued with the proposed regulations, contains a proposed revenue procedure with three methods for calculating W-2 wages:
1. For purposes of the limitation based on W-2 wages to the amount of the deduction for qualified business income under Sec. 199A
2. For purposes of the reduction to the Sec. 199A deduction based on W-2 wages for certain specified agricultural and horticultural cooperative patrons.
About Terry Sheridan
Terry Sheridan is an award-winning journalist who has covered real estate, mortgage finance, health care, insurance, personal finance, and accounting and taxation issues for newspapers, magazines, and websites. A Chicago native and former South Florida resident, she now lives in New England.