De Minimis Thresholds Recommended for Proposed Section 199A Regs

October 1, 2018

CC:PA:LPD:PR (REG-107892-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC, 20044

Re: Proposed Regulations Under Section 199A (REG-107892-18)

Ladies and Gentlemen:

We very much appreciate the careful thought and effort reflected in the proposed regulations under Section 199A of the Internal Revenue Code of 1986, as amended, published in the Federal Register on August 16, 2018 (the “Proposed Regulations”). This letter submits two comments on Section 1.199A-5 of the Proposed Regulations, regarding (i) the percentage thresholds established for purposes of the de minimis rule, and (ii) the effect of exceeding the percentage threshold.

Percentages for the De Minimis Threshold

Section 1.199A-5(c)(1) of the Proposed Regulations provides that a trade or business (determined before the application of the aggregation rules in proposed § 1.199A-4) is not a specified service trade or business for purposes of Section 199A (“SSTB”) if the trade or business: (i) has gross receipts of $25 million or less (in a taxable year) and less than 10 percent of the gross receipts of the trade or business is attributable to the performance of services in an SSTB or (ii) has gross receipts greater than $25 million (in a taxable year) and less than 5 percent of the gross receipts of the trade or business are attributable to the performance of services in an SSTB.

We believe the same percentage amount should apply for purposes of the de minimis threshold regardless of the amount of gross receipts of the trade or business. Otherwise, a business that grows from receipts of $24.9 million to $25.1 million would cease to be eligible for the deduction afforded by Section 199A if six percent (6%) of the gross receipts of the business are from the performance of services in an SSTB.

We also believe that the 10% threshold in Section 199A-5(c)(1) of the Proposed Regulations is the more appropriate measurement of what is de minimis, since the relative percentage of gross receipts that are, or are not, from the performance of services in an SSTB are likely to fluctuate significantly from year-to-year and a 5% threshold provides very little flexibility. More importantly, a higher de minimis amount will permit many qualified businesses to avoid having to track and allocate expenses. If this amount is set too low, more businesses will be required to perform detailed expense allocations which should not be necessary in circumstances where the vast majority of the income qualified for the deduction.

Effect of Exceeding the De Minimis Threshold

The preamble to the Proposed Regulations explains the adoption of the de minimis threshold as follows:

The de minimis rule set forth in Section 1.199A-5(c)(1) of the Proposed Regulations may not avoid under and over inclusive determinations of what activities give rise to a trade or business for Section 199A purposes. If gross receipts from the performance of services in an SSTB exceeds the applicable de minimis threshold, it is unclear if the remaining receipts from qualified business activities would qualify for the Section 199A deduction, potentially resulting in over inclusion and under inclusion. If the effect of exceeding the de minimis threshold is to taint and disqualify as much as almost 90% or 95% of the gross receipts from an otherwise qualified trade or business, that result would truly be a trap for the unwary. Well-advised taxpayers will simply rearrange their activities into separate relevant pass-through entities (“RPEs”) to avoid such a result. However, taxpayers should not be required to perform meaningless restructuring solely to qualify for a deduction Congress intended for them to receive.

We believe that the regulations do not intend such treatment, and a clarification is necessary and within the Treasury's authority. The deduction afforded by Section 199A is allowed only with respect to qualified business income as defined in Section 199A(c). Section 199A(f)(4) directs Treasury to prescribe regulations for (among other things) “requiring or restricting the allocation of items and wages” under Section 199A. We recommend that final regulations under Section 199A clarify that, in cases where a taxpayer exceeds the de minimis threshold, the gross receipts from the performance of services in an SSTB and related items of deduction and loss are not taken into account as part of qualified business income within the meaning of Section 199A(c). The requested clarification will place taxpayers on the same footing whether they conduct business within the same RPE or in different RPEs.

Thank you for considering these comments. Please do not hesitate to call the undersigned if you have any further questions.

Sincerely,

Rick Grafmeyer
Capitol Tax Partners, LLP
Washington, DC