The ownership requirements in passthrough entities for purposes of combining them to increase the 20 percent deduction are clearly laid out in the actual regulation language, an IRS official says.
Some taxpayers had wondered whether the language in the preamble to the final section 199A passthrough deduction rules (T.D. 9847) could mean there were ways to use broad definitions of phrases to make it easier to aggregate trades or businesses. But according to Danielle Grimm, special counsel to the IRS associate chief counsel (passthroughs and special industries), it’s the language in the actual regulations — not the preamble — that should be relied on.
“We did receive comments on the issue, and I would encourage taxpayers and tax professionals to look at the regulatory language,” Grimm said November 14 at the American Institute of CPAs National Tax Conference in Washington.
The 20 percent passthrough deduction in section 199A was added in the Tax Cuts and Jobs Act to provide parity for the corporate income tax rate cut from 35 percent to 21 percent. The deduction is available for passthrough owners and sole proprietors and applies to qualified business income below specific income thresholds, above which wage and basis restrictions apply. Above those thresholds, income from some businesses, such as law and accounting, doesn’t qualify for the deduction.
Taxpayers can aggregate their trades or businesses to combine wages and basis in property to increase the overall deduction. However, several criteria must be met. Those criteria include a requirement that the same person or group of persons (directly or by attribution) own 50 percent or more of each trade or business to be aggregated, that the ownership must exist for the majority of the tax year, including the last day of the tax year, and that none of the businesses can be specified service trades or businesses.
Whose Tax Year Matters?
Kate Abdoo of PwC said the preamble to the final regulations says the ownership requirements are met as long as one person or group of persons holds a 50 percent or more ownership interest in the trade or business, so it wouldn’t require an overlap of ownership.
In other words, the preamble language suggests that not every member in the group of persons has to have an ownership interest in each trade or business, Abdoo said. Based solely on that language, a group of persons could presumably be defined very broadly.
For example, Partnership 1 is owned equally by A, B, and C, but Partnership 2 is owned equally by C, D, and E. Some taxpayers thought that based on the preamble language, the group to be tested for ownership under aggregation could encompass all the partners in Partnership 1 and Partnership 2.
Grouping partners A through E together wouldn’t work in this case, Grimm said, pointing out that the regulation language says the same person or group of persons must own 50 percent or more of each entity.
“It literally must be the same group of persons, but their ownership interests may differ in each entity,” Grimm said. “We do think that the regulatory language is clear.”
Abdoo pointed to the requirement that the ownership has to exist for a majority of the tax year, including the last day of the tax year, and asked Grimm whose last day matters.
“Are we talking about the individual’s tax year for this requirement, or is it the partnership’s tax year?” Abdoo asked. Grimm responded that it’s the trade or business’s tax year that matters.