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The Internal Revenue Service (IRS) has released long-awaited Code Section 199A guidance, commonly known as the “pass-through deduction” or the “qualified business income (QBI) deduction.” Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.
Code Section 199A allows business owners to deduct up to 20 percent of their QBI from sole proprietorships, partnerships, trusts and S corporations, and the deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act.
In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.
The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity.
Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:
Income from a specified service business generally cannot be QBI, although this exclusion is phased in for lower-income taxpayers.
A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if one of the following applies:
The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in either:
In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50 percent common ownership.
A higher-income taxpayer’s QBI may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:
The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.
The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, “immediately after acquisition” is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.
The proposed regulations also address several other issues, including:
Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:
Doeren Mayhew’s tax advisors continue to follow tax reform news and its potential impact on middle-market businesses. For assistance in navigating tax reform, including Sec. 199A, contact our tax advisors today.
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