On August 9, 2018 the IRS released guidance on new Code Section 199A, commonly referred to as the “pass-through entity deduction”. Code Section 199A allows business owners to deduct up to 20% of their qualified business income (QBI) from partnerships, S corporations, trusts and sole proprietorships.
The following summarizes some of the clarity provided by the proposed regulations:
Trade or Business
The proposed regulation incorporate the Code Section 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 Code Section 469 rules to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:
- Each one is itself a trade or business;
- The same person or group owns a majority interest in each;
- None is a specified service trade or business; and
- They are actually part of a larger, integrated trade or business
Specified Service Business
Income from a specified service business generally cannot be qualified business income. These specified service businesses include any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners.
The regulations clarify that the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners only when the business is engaged in:
- Endorsing products or services;
- Licensing the use of an individual’s image, name, trademark, etc.; or
- Receiving appearance fees
The specified service business exclusion does not apply when the taxpayer’s taxable income is below the threshold amount ($315,000 for joint filers, $157,500 for other filers).
A new de minimis exception allows some businesses to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:
- Gross receipts do not exceed $25 million, and less than 10% is attributable to services; or
- Gross receipts exceed $25 million, and less than 5% is attributable to services.
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% 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% common ownership.
A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:
- W-2 wages that are allocable to QBI; and
- Unadjusted basis in qualified property immediately after acquisition
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 Section 199 domestic production activities deduction.
The proposed regulations also address unadjusted basis immediately after acquisition, or 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.
Taxpayers may generally rely on the proposed regulations and Notice 2018-64, I.R.B. 2018-34, until they are issued as final. The regulations and the proposed revenue procedure will be effective for tax years ending after they are published as final. However:
- Several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
- Anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
- If a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer's tax year during which business’s tax year ends.
Should you have any questions regarding new Code Section 199A or the related proposed regulations, please contact one of RubinBrown's Tax Services Group professionals.
Readers should not act upon information presented without individual professional consultation.
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