With the extended filing season upon us, questions abound on the various nuances of 199A. The Service on January 18, 2019, issued the final regulation and three related pieces of guidance, implementing the new qualified business income deduction under Section 199A. The final regulations provide further guidance on which taxpayers may qualify for this 20% deduction and clarify the process of calculating the deduction. This blog will highlight some of the most significant changes the Service implemented in the final regulations as compared to the proposed regulations.
In the proposed Regulations, the IRS had taken a rigid position on how a Specified Service Trade or Business (“SSTB”) may taint the income of a non-SSTB services entity, and how the de minimis rule affected the entity qualifying for the deduction.
Final 199A Regulations
The IRS in final regulations limited the impact of the income received from an SSTB through the application of the de minimis rule. Specifically, the IRS eliminated the 80% requirement related to a non-SSTB providing services to an SSTB that has common ownership of 50% or more. In addition, the Service has allowed a company with a mix of service and non-service income to ignore SSTB income if it is below a certain percentage amount of the gross receipts. The de minimis rule allows a business with gross receipts of less than $25 million to qualify for the deduction if 10% or less of its gross receipts were from the performance of services in a disqualified field.
In other changes, there was ample concern regarding the basis of property contributed to a partnership. The Service, in the proposed regulations, had set the property basis to equal the depreciation basis of the property at the time of contribution. In the final regulations, the Service has changed its position and allowed for carryover basis. Additionally, the Service and Treasury reversed course in the final regulations and allowed section 743(b) basis adjustments to be used by an incoming partner within specified limits. A move welcomed by tax practitioners.
Aggregation and Netting Income
Another highly-regarded change in the final regulations, which may eliminate a lot of issues in calculating the deduction, relates to aggregation and the process of netting income. According to the final regulation, aggregation is allowed at a relevant pass-through entity level, rather than just at the taxpayer level. However, if the entity were to aggregate the partners or shareholders it was required to aggregate the income as well. Deciding whether to aggregate or not to aggregate is a decision that must be assessed separately to evaluate its effect on an entity.
In calculating the deduction, a relevant pass-through entity that aggregates its income must also aggregate the W-2 wages and the unadjusted basis immediately after acquisition (“UBIA”) of qualified property. If the relevant pass-through entity does not elect to aggregate, it must still offset the losses against the income of other commonly controlled entities. However, it will not be able to use W-2 wages or the UBIA of qualified property limitations applicable to calculating the deduction. They evaporate in the year they are earned. Thus, the partners and shareholders of relevant pass-through entities that meet the requirements for aggregation should consider this option. The final regulations allow, for tax year 2018 ONLY, a taxpayer to elect to aggregate on an amended return.
The final regulations now allow the exclusion of DNI distributions from the calculation of qualified business income as they relate to trusts. Attribution rules were broadened to include those within Sections 267(b) and 707(b).
What is Unchanged?
While some of the changes in the final regulations were hailed as victories, the final regulations are still wanting in other areas. For instance, the Service refused to change its position on excluding dividends from the capital gains and the QBI calculation. Also, the Service declined to provide a trade or business safe harbor for purposes of the Section 199A deduction, stating that this is a factual test that will require an assessment of the facts and circumstances.
Taxpayers who operate their business through a pass-through and are impacted by this Section 199A deduction should consider consulting with a tax specialist to determine whether and how they qualify for this 20% deduction. If you have questions regarding 199A or other complex tax issues, please contact Steven Miller, National Director of Tax.