The IRS released long-awaited guidance on new IRC §199A, commonly known as the “pass-through deduction” or the “qualified business income deduction.” Taxpayers can rely on these rules for tax years beginning after 2017.
The deduction allows business owners to deduct up to 20% of their qualified business income (QBI) from:
- sole proporietorships;
- trusts; and
- S corporations.
The pass-through deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act (TCJA).
In addition to providing definitions and computational rules, the proposed regs clarify several particularly troubling issues.
Trade or Business For 199A Pass-Through Deduction
The regs incorporate the IRC §162 rules for determining what is a trade or business under IRC §199A. 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 IRC §469 rules for grouping 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 Trade or Business
Income from a specified service business generally cannot be qualified business income, though this exclusion is phased in for lower-income taxpayers.
However, a new de minimis exception allows some businesses to escape being designated as a specified service trade or business. A business qualifies for this de minimis exception if its:
- 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.
What is a Service?
The regs also largely adopt existing rules for what activities constitute a service. However, a business receives income due to an employee/owner’s reputation or skill 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.
Splitting a Service Business
In addition, the regs try to limit taxpayers from spinning off parts of a service business and treating them as qualified businesses. Thus, a service business includes any trade or business that provides 80% or more of its property or services to a related 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.
Wages/Capital Limit on Qualified Business Income
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 regs and a proposed Rev. Proc. provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the IRC §199 domestic production activities deduction.
Unadjusted Basis After an Acquisition
The proposed regs also address unadjusted basis immediately after acquisition, or UBIA. The regs 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.
Other Rules Under 199A
Finally, the proposed regs address several other issues, including:
- basic computations
- loss carryovers
- Puerto Rico businesses
- coordination with other IRC section
- special basis rules
- previously suspended losses and net operating losses
- other exclusions from qualified business income
- allocations of items that are not attributable to a single trade or business
- anti-abuse rules