IRS Releases 199A Passthrough Deduction GuidanceBy Mark R. Baran | August 13, 2018
The much-anticipated guidance from the IRS regarding implementation of the so-called 20% passthrough deduction under new Internal Revenue Code Section 199A (199A) has been released. This past week, the IRS issued the following items:
1. IRS Proposed Regulations - Qualified Business Income Deduction,
2. IRS Notice 2018-64 - Methods for Calculating W-2 Wages for Purposes of Section 199A, and
3. Tax Cuts and Jobs Act, Provision 11011 Section 199A - Deduction for Qualified
Business Income FAQs
199A was included in the Tax Cuts and Jobs Act that was signed into law on December 22, 2017. Effective January 1, 2018, 199A provides a deduction to non-corporate taxpayers of up to 20 percent of the taxpayer’s qualified business income (QBI) from qualified trades or businesses.
Qualified trades or businesses include those operated through a partnership, S corporation, sole proprietorship, trust or estate. However, qualified trades or businesses do not include a specified service trade or business (SSTB). 199A broadly defines a SSTB as a business in fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees.
The deduction is generally equal to the lesser of 20% of the taxpayer’s QBI plus 20% of the taxpayer’s qualified real estate investment trust dividends and qualified publicly traded partnership income, or 20% of the excess of taxable income over the net capital gain for the taxable year. For taxpayers that exceed certain thresholds ($157,500 single filers and $315,000 joint filers), the deduction is subject to limitations such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition (UBIA) of qualified property held for use in the trade or business. These limitations do not apply to taxpayers with taxable income under the $157,000/$315,000 thresholds.
Due to uncertainties and confusion regarding application of 199A, taxpayers have been anxiously awaiting implementing guidance. All non-corporate businesses will be impacted by 199A. However, businesses with the most at stake include those with multiple or diverse service lines, owners who utilize tiered or complex non-corporate structures or employment arrangements, and businesses involved in multiple business activities with varying degrees of profits or losses.
New 199A Guidance
The proposed regulations and related guidance are voluminous, and cover many operational, computational and interpretive areas. Below are a few highlights contained in the new guidance:
- SSTB –The proposed rules do provide helpful guidance in determining the meaning of services provided in certain related fields that might otherwise have been considered a SSTB. For example, the performance of services in the legal field does not include stenographer services though it is arguably part of the field of law. The proposed rules also provide guidance in determining whether a business is a SSTB in other areas including healthcare, performing arts, athletics, financial services and consulting. More importantly, trades or businesses where the principal asset is the reputation or skill of one or more of its employees has been limited to fact patterns in which the individual or relevant passthrough entity is engaged in (1) endorsing products or services, (2) licensing or receiving income for an individuals image, name, trademark, etc., or (3) appearance fees or income.
- De minimus rule – A trade or business will not be a SSTB if it provides a small amount of services in a specified service activity. The proposed rules provide that a business is not a SSTB if it has gross receipts of $25 million or less and less than 10% of the gross receipts are attributable to the performance or services in an SSTB. For businesses with gross receipts of over $25 million, the amount that must be attributable to the performance of services in a SSTB is reduced to 5%.
- Trade or business definition – The proposed regulations clarify that the business of performing services as an employee is not a trade or business for 199A purposes. Also, since the term “trade or business” is defined in more than one provision of the tax code and there is no definition of “trade or business” under the new law, the proposed rules provide that the “trade or business” definition in IRC §162 will govern for 199A purposes.
- UBIA - UBIA generally will be the property’s cost as of the date it is placed in service. The proposed rules provide UBIA guidance for qualified property contributed to an S corporation or a partnership, inherited from a decedent and immediately placed in service by the heir, or for short tax years.
- W-2 wages – W-2 wages are computed separately for each trade or business. Notice 2018-64 describes a proposed revenue procedure outlining alternative methods for taxpayers to calculate W-2 wages for purposes of the limitation and deduction amounts.
- Aggregation rules – Under the proposed regulations, an individual may aggregate trades or businesses provided that the same person or group or persons, directly or indirectly, own 50% or more of each trade or business for the majority of the taxable year and none of the trades or businesses are an SSTB. The aggregated businesses must provide similar products or services, share facilities or significant business elements (i.e., accounting, HR or legal) or operate in coordination or reliance on each other business in the aggregated group (i.e., supply chain).
- Anti-abuse provisions -The guidance contains several anti-abuse provisions including, but not limited to, measures to prevent conversions of independent contractor to employee status to increase tax deductions, bifurcation of qualified services from a SSTB (sometimes referred to as “cracking’), or the abusive use of multiple trusts.
- Other computational and operational issues – The new guidance provides helpful information to assist taxpayers with in many other areas including the computation of QBI, potential netting of losses, QBI carryforwards, and the treatment of suspended or carryover losses.
While portions of the 199A guidance may not be helpful to all taxpayers, the release is welcome relief to affected taxpayers and tax practitioners who may rely on such guidance to more effectively advise clients, make calculations and prepare tax returns. Marks Paneth LLP will be providing more detailed information soon on each of the above-referenced areas, compliance matters and important industry-specific 199A issues.
About Mark R. Baran
Mark Baran, JD LL.M., is a Principal in the Tax Department at Marks Paneth LLP. He has more than 25 years of specialized tax, transactional and legal experience advising publicly-traded and private companies, regulated financial institutions, investors, high net worth individuals, and government agencies. Mr. Baran provides specialized tax consulting and transactional services to a broad spectrum of clients and industries including the public sector. He routinely provides tax opinions on the tax implications of... READ MORE +