Association Seeks Guidance on Wages for Business Income Purposes

April 25, 2018

The Honorable David J. Kautter
Assistant Secretary of the Treasury for Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

RE: Definition of W-2 Wages for Purposes of § 199A of the Internal Revenue Code

Dear Assistant Secretary Kautter:

On behalf of the National Association of Professional Employer Organizations (NAPEO), I am writing to request timely clarification regarding the meaning of “W-2 wages” for purposes of section 199A of the Internal Revenue Code (“Code”) as added to the Code by H.R. 1, Pub. Law 115-97 (Dec. 22, 2017) (the “Act”). This action is necessary due to the confusion this provision is causing the clients of professional employer organizations (PEOs), and the resulting harm being caused to PEOs.

NAPEO is the voice of the PEO industry. PEOs provide payroll, human resources, employee benefits, and compliance assistance services to between 156,000 and 180,000 small and mid-sized businesses, employing between 2.7 and 3.4 million people. The estimated 2.7 to 3.4 million employees who benefit from PEO services is a number larger than the size of the entire agriculture/forestry industry in the United States (and close to the size of the federal government, the education sector, and the information sector). Thanks to PEOs, the IRS has a higher rate of tax compliance amongst small businesses.

When the Act was signed into law, it added a new section (199A) to the Code. This new section generally allows taxpayers to deduct, for federal income tax purposes, a taxpayer's “combined qualified business income amount” from pass-through entities up to 20 percent of the taxpayer's taxable income. The qualified business income amount of any qualified trade or business is generally 20 percent of the taxpayer's income attributable to the qualified trade or business, but it generally cannot exceed the greater of: (1) 50 percent of the W-2 wages paid with respect to the qualified trade or business; or (2) the sum of 25 percent of such W-2 wages and 2.5 percent of the unadjusted basis at acquisition of the entity's tangible depreciable property. For purposes of Code section 199A, “W-2 wages” means “with respect to any person for any taxable year of such person, the [total wages, elective deferrals, and section 457 deferred compensation] paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year.”

New Code section 199A was largely modeled after Code section 199, the domestic manufacturing deduction, which was repealed by the Act. Like the new deduction for taxpayers with certain income from pass-through entities, the domestic manufacturing deduction was calculated based, in part, on W-2 wages paid to workers. Importantly, Code section 199 and Code section 199A use substantively identical definitions of the term “W-2 wages.” Regulations promulgated under Code section 199 were clear that, for purposes of calculating the domestic manufacturing deduction, taxpayers may “take into account any wages paid by another entity and reported by the other entity on Forms W-2 with the other entity as the employer listed in Box c of the Forms W-2, provided that the wages were paid to employees of the taxpayer for employment by the taxpayer.”

After passage of the Act, some business owners of pass-through entities who are clients of PEOs have been advised by accountants and/or other third party consultants that, without guidance similar to that which was promulgated under Code section 199, they will not be eligible to take the 20 percent deduction offered by Code section 199A. The lack of guidance on Section 199A has generated a great deal of confusion among the clients and potential clients of PEOs and is causing harm to PEOs themselves. Because of the significant financial impact that the Code section 199A deduction has on pass-through entity owners, without clarification from the IRS, many of these business owners believe they are being forced to choose between engaging with a PEO to help them manage their human resources, employee benefits, and payroll functions or being able to utilize the Code section 199A deduction.

Here are some examples NAPEO members have shared with us:

This is just a small sample of the correspondence NAPEO has received from its members on this tax provision.

In order to mitigate harm to pass-through entities and their workers, NAPEO is asking that Treasury and IRS immediately clarify that wages reported by a PEO or other third party payors with respect to work site employees of a pass-through entity will be permitted to be taken into account when calculating the qualified business income amount of a pass-through entity. Such a result is in keeping with the language of the statute, Congressional intent, previous Treasury and IRS guidance under Code section 199, and sound tax policy.

NAPEO understands that Treasury and IRS bear a significant burden in implementing the Act. We believe, however, that guidance here can be quickly promulgated. Unlike other, more complex, tax reform implementation questions under Code section 199A, the answer to this question is straightforward and consistent with precedent, and guidance can be issued in the form of instructions to IRS forms, a Question and Answer on the IRS webpage, or other similar sub-regulatory guidance.

We hope you will move with all due speed to clarify this issue. We would be happy to meet with you to discuss this issue in more depth. If you have any questions, feel free to contact me or Thom Stohler, NAPEO's Vice President of Federal Government Affairs (703-739-8167), tstohler@napeo.org.

All the best,

Patrick J. Cleary
President and CEO
NAPEO
Alexandria, VA