Republicans’ 2017 overhaul of the tax code created a new Section 199A 20-percent deduction of qualified business income (QBI). This new Section 199A QBI deduction, subject to certain limitations, is available for pass-through entities (sole proprietorships, partnerships, limited liability companies, or S corporations). The controversial QBI deduction, also commonly referred to as the pass-through deduction, has remained an ongoing topic of debate among lawmakers, tax policy experts, and stakeholders.
TCJA Creates New Section 199A QBI Deduction
The Tax Cuts and Jobs Act (TCJA) (P.L. 115-97), enacted at the end of 2017, created the new Section 199A QBI deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, under current law the QBI deduction will sunset after 2025. In addition to the QBI deduction’s impermanence, its complexity and ambiguous statutory language created many questions for taxpayers and practitioners.
IRS Issues Guidance for Section 199A QBI Deduction
The IRS is expected to issue additional regulations on the Section 199A deduction this year. However, the IRS has released the following guidance for Section 199A to date:
- Proposed regulations for Section 199A, NPRM REG-107892-18, released August 8, 2018;
- Proposed regulations published in the Federal Register August 16, 2018;
- Final regulations, TD 9847, and notice of additional proposed rulemaking released January 18, 2019, followed by a revised version of the final regulations on February 1, 2019;
- Rev. Proc. 2019-11, I.R.B. 2019-9, 742, issued concurrently to provide further guidance on the definition of wages; and
- Proposed Revenue Procedure, Notice 2019-7, I.R.B. 2019-9, 740, was issued concurrently providing a safe harbor under which certain rental real estate enterprises may be treated as a trade or business for purposes of Section 199A.
Wolters Kluwer recently interviewed Tom West, a principal in the passthroughs group of the Washington National Tax practice of KPMG LLP, on the Section 199A QBI deduction and related regulatory guidance. Notably, West formerly served as tax legislative counsel at the U.S. Department of the Treasury’s Office of Tax Policy.
This blog post highlights some of the interviewee’s answers and reflects the views of the author only. It does not necessarily represent the views or professional advice of KPMG LLP.
W-2 Wages and QBI
Tom West: Other than for small taxpayers, there is only a benefit under Section 199A if the limitations are met. It does not do any good to have QBI but then have insufficient W-2 wages and qualified property to meet the limitations. So when taxpayers are evaluating what constitutes a qualified trade or business (or whether to aggregate qualified trades or businesses) they will need to determine the amount of W-2 wages with respect to each QTB. Aligning the W-2 wages with the QTB will be important – but the salary expense will also result in a reduction in the amount of QBI and therefore the amount of any Section 199A benefit – so modeling becomes critical. Consideration should also be given to any collateral consequences – for instance the impact of the alignment on allocation and apportionment for state taxes.
Complex v. Majority Calculations for Section 199A QBI Deduction
Tom West: For taxpayers under the Section 199A income thresholds ($157.5K single, $315K joint), the deduction is very easy to calculate and claim. Those taxpayers don’t need to worry about being in an SSTB, how much wages they paid, or the basis of their property. Once those taxpayers hit those income thresholds though, even in the phase-out range, things very quickly get complex – and that’s as a consequence of the statute; it is not something that the regulators can change.
Specified Service Trades or Businesses (SSTBs): Questions Linger
Tom West: I think many taxpayers who have both SSTB and non-SSTB activities were hoping for more clarity, either in rules or examples, on how to acceptably segregate business lines or on when (or if) certain activities are inextricably tied together. There are also still lingering questions regarding when a trade or business is an SSTB – particularly in the field of health.
“Biggest Positive in Terms of the SSTB Final Rules”
Tom West: The biggest positive in terms of the SSTB final rules is the carryover from the proposed regulations of the treatment of the skill or reputation provision. Had Treasury and the IRS gone in a different direction, there was a risk of that provision swallowing the rest of the 199A regime–not to mention how much more subjective the already sometimes difficult SSTB determinations would have become.
Additional Section 199A Guidance
Tom West: I think part of the government’s motivation in finalizing these regulations so quickly was providing guidance to taxpayers ahead of the tax-filing season. And while for the majority of taxpayers who are below the 199A cap there is probably now sufficient guidance, I think there are still a lot of questions for those with more complex situations. Given the number of taxpayers who are eligible for this deduction, and the importance of Section 199A as the big benefit to non-corporate businesses in what the Administration views as a signature legislative achievement, I have to believe that the government will be responsive to taxpayers’ requests for additional help on this provision. However, given that the provision is due to sunset, it will be important that any guidance is forthcoming in fairly short order to be of any usefulness to taxpayers.
Recommendations for Taxpayers Moving Forward
Tom West: As people are going through their tax filings this year, I’d keep a list of issues, questions, and areas where additional guidance would be helpful. It often happens that problems with new legislation or regulations don’t reveal themselves until taxpayers have to put pencil to paper and track their real-world numbers through returns. We’ll all have that experience this year and, with those lists of issues and questions in hand, there may be an opportunity to approach the IRS and Treasury in the hopes of getting resolution going forward. Keeping that list could also help identify areas for tax planning and perhaps ease the complexity of filing for 2019.
By Jessica Jeane, J.D.