Aggregation & Netting Under Section 199AFebruary 18, 2019
By: Anthony Delvalle, CPA & Shmuli Fromovitz, CPA
When the Tax Cuts and Jobs Act passed on December 22 there were many questions that arose, especially in regard to the new qualified business income (QBI) deduction. One issue that was raised was whether the deduction would need to be determined separately for each trade or business, or if the IRS would allow taxpayers to aggregate different trades or businesses into one basket.
To understand why it would be beneficial to aggregate trades or businesses for QBI purposes, we really need to take a step back and understand how the QBI deduction works. When an individual taxpayer has qualified business income from a trade or business, the taxpayer is generally allowed a deduction equal to 20% of the qualified business income. However, assuming the trade or business is not considered a Specified Service Trade or Business (SSTB) and that the taxable income for the year is above a certain threshold amount ($207,500 for a single taxpayer and$415,000 for a taxpayer filing a joint return), the deduction is limited to the lesser of:
- 20% of the QBI from that trade or business, or
- The greater of:
- 50% of W-2 wages with respect to that trade or business, or
- The sum of 25% of W-2 wages with respect to that trade or business plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property.
Allowing taxpayers to aggregate separate trades or businesses offers taxpayers a means of combining their trades or businesses for purposes of applying the W-2 wage and UBIA of qualified property limitations. This in turn could potentially maximize the QBI deduction under Section 199A. Disallowing such aggregation, however, could force taxpayers to undergo a legal restructuring of their business operations which may prove costly. In addition, there is the risk that such restructuring would not be permitted due to business and other non-tax law requirements.
The IRS has issued regulations to help clarify many of the issues that were raised in connection with the new QBI deduction. Included in these regulations is specific guidance on the aggregation of trades or businesses under Section 199A.
When an individual or a RPE (Partnership or an S Corporation) is engaged in more than one trade or business, these trades or businesses are considered separate entities for purposes of the Section 199A limitations unless certain requirements are met. Once these hurdles are cleared, the separate trades or businesses may be combined to form a single trade or business for purposes of applying the Section 199A limitations. Note that aggregation is completely optional – there is no requirement to aggregate.
So, what are the rules and requirements for aggregating?
The same person, or a group of persons, must directly
– or by attribution through Sections 267(b) or 707(b)
– own a majority interest of 50% or more in each trade or business to be aggregated. Examples of family attribution include the individual’s spouse, children, siblings, ancestors and lineal descendants.
For trades or businesses owned by an S Corporation, this would mean that 50% or more of the issued and outstanding shares of the S Corporation are owned, directly or indirectly, by the same person or group of persons. Similarly, if such trades or businesses are owned by a Partnership, the same person or group of persons must own, directly or indirectly, 50% or more of the capital and profits in the Partnership.
It is important to note that the electing owner does not need to own 50% or more of each trade or business. Rather, the individual or RPE must simply establish that a group of persons own 50% or more of all the entities that the taxpayer wishes to aggregate. Note that a C Corporation may constitute part of this group for the purposes of establishing common ownership. Non-majority owners may benefit from the common ownership and are permitted to aggregate. In fact, any one owner may opt to aggregate while another owner may choose not to do so.
In meeting the common ownership test, the trades or businesses to be aggregated must exist for a majority of the taxable year (including the last day of the taxable year), share the same tax year and cannot be SSTBs under Section 199A.
Once the common control test has been met, the individual owner must also establish that the trades or businesses to be aggregated satisfy two of the following three factors:
- The trades or businesses provide products, property or services that are the same or customarily offered together;
- The trades or businesses share facilities or other significant centralized business elements, such as common personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources; or
- The trades or businesses are operated in coordination with, or reliance upon, other trades or businesses in the aggregated group.
AGGREGATION BY RPES AND INDIVIDUALS
An RPE may aggregate multiple trades or businesses operated directly or through a lower-tier RPE after computing QBI, W-2 wages and UBIA of qualified property for all trades or businesses. The RPE must then provide its owners with this information. Similarly, if an individual taxpayer chooses to aggregate several trades or businesses that satisfy the aggregation rules above, the individual will first need to compute the QBI, W-2 wages and UBIA of qualified property of each trade or business before aggregating. The individual can then combine the QBI, W-2 wages and UBIA of qualified property of the trades or businesses being aggregated before applying the QBI deduction limitations.
REPORTING AND CONSISTENCY
Once an individual owner or Relevant Passthrough Entity elects to aggregate two or more trades or businesses, this election cannot be revoked in subsequent tax years. Additionally, an individual or upper-tier RPE may not separate the trades or businesses aggregated by a
lower-tier RPE. However, the taxpayer can add new trades or businesses to the aggregated group if all of the requirements are met. If facts or circumstances change in subsequent tax years so that the trades or businesses no longer qualify for aggregation, the previously aggregated group will automatically disband.
An RPE is required to provide information annually to its owners for each of the aggregated trades or businesses. Likewise, individuals must attach a statement to their tax return each year disclosing required information for trades or businesses aggregated. Failure to attach such a statement may result in the aggregated grouping being disallowed by the IRS.
NETTING OF QUALIFIED BUSINESS INCOME
Another issue addressed in the regulations is the netting of QBI losses with positive QBI for purposes of calculating the Section 199A deduction.
If an individual has negative QBI from one trade or business, but has overall positive QBI when all of the individual’s trades or businesses are taken together, then the individual must offset the net income in each trade or business with positive QBI with the net loss from each trade or business with negative QBI before applying the QBI deduction limitations. This is done by allocating the net loss to the trades or businesses with positive QBI in proportion to their respective positive QBI. The W-2 wages and UBIA of qualified property from the trades or businesses with negative QBI are disallowed and will not benefit the trades or businesses with positive QBI. The resulting net gain or income with respect to each trade or business is the taxpayer’s QBI with respect to that trade or business.
If the taxpayer’s QBI from all trades or businesses combined is negative for the taxable year, the loss carries forward to the subsequent tax year as negative QBI from a separate trade or business. This carryover rule does not affect the deductibility of the loss for purposes of any other provisions. The W-2 wages and UBIA of qualified property from the trades or businesses with overall net negative QBI cannot be carried forward to the subsequent tax year.
Aggregation of trades or businesses can benefit an individual taxpayer by potentially maximizing the QBI deduction. Once a taxpayer has met the requirements which establish that the businesses are in fact part of a larger, integrated trade or business, aggregation is allowed but is not required. Netting of qualified business income, however, is a requirement regardless of whether the individual taxpayer chooses to aggregate. Under the netting rules, W-2 wages and UBIA of qualified property from trades or businesses with net losses for the year are disallowed and are not carried forward to the subsequent year.