Proposed Regs Provide Guidance on Passthrough Deduction

Proposed Regs Provide Guidance on Passthrough Deduction

Internal Revenue Service

The IRS has issued proposed regulations (REG-107892-18) providing taxpayers with computational, definitional, and antiavoidance guidance on the deduction for qualified business income (QBI) under section 199A. Comments and discussion topic outlines for the October 16 hearing are due by October 1. <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="Section 199A">Section 199A</a>, as added by the Tax Cuts and Jobs Act (<a href="/lr/resolve//1xftl">P.L. 115-97</a>), provides a deduction of up to 20 percent of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. Section 199A applies to tax years between 2017 and 2026. The proposed regs contain six substantive sections, each of which provides rules relevant to the calculation of the <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> deduction. The operational rules under proposed reg. section 1.199A-1 provide guidance on the computation of the deduction for individuals with taxable income at, below, or above the threshold amount, including individuals with taxable income within a phase-in range above the threshold amount. Proposed reg. section 1.199A-1 also defines some terms, generally defining trade or business as a <a href="/research/federal/usc26/162" resolve="/lr/resolve/section-162/cnq9" title="section 162">section 162</a> trade or business. The proposed regs incorporate special rules contained in <a href="/research/federal/usc26/199A" resolve="/lr/resolve/sections-199a/1xfpg" title="sections 199A">sections 199A</a> and <a href="/research/federal/usc26/6662A" resolve="/lr/resolve/section-6662/cp0g" title="section 6662">6662</a>. If an individual’s taxable income exceeds the threshold amount, the <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> deduction is limited based on the greater of either (1) the W-2 wages paid, or (2) the W-2 wages paid and the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to a trade or business. Proposed reg. section 1.199A-2 provides rules on determining W-2 wages and UBIA of qualified property held for use in the trade or business. A simultaneously released proposed revenue procedure (<a href="https://www.taxnotes.com/irs-notices/partnerships-and-other-passthrough-entities/irs-issues-proposed-revenue-procedure-calculating-w-2-wages/2018/08/08/28b8v">Notice 2018-64</a>) provides three methods for calculating W-2 wages. The proposed rules for determining UBIA of qualified property address partnership special basis adjustments, property transferred to increase the section 199A deduction, like-kind exchanges, involuntary conversions, other nonrecognition transactions, subsequent improvements to qualified property, and qualified property held by a relevant passthrough entity (as defined in the preamble). Proposed reg. section 1.199A-3 provides guidance on determining QBI, qualified real estate investment trust dividends, and qualified publicly traded partnership income. For QBI purposes, the regs address the treatment of <a href="/research/federal/usc26/751" resolve="/lr/resolve/section-751/cp74" title="section 751">section 751</a> gain, guaranteed payments for the use of capital, <a href="/research/federal/usc26/481" resolve="/lr/resolve/section-481/cnxq" title="section 481">section 481</a> adjustments, previously suspended losses, and net operating losses. The regs also address the QBI requirement that an item be effectively connected with a U.S. trade or business and provide some exclusions from QBI. Comments are requested on reasonable methods for the allocation of items not clearly attributable to a single trade or business and whether any safe harbors may be appropriate. While the proposed regs do not adopt the <a href="/research/federal/usc26/469" resolve="/lr/resolve/section-469/cq8z" title="section 469">section 469</a> group rules, proposed reg. section 1.199A-4 allows the aggregation of separate trades or businesses, provided some requirements are met. The regs provide reporting and disclosure requirements for individuals that choose to aggregate. The provisions under proposed reg. section 1.199A-5 on a specified service trade or business (SSTB) address the effect of classification as an SSTB (as defined in the regs), exceptions for taxpayers below the threshold amount, a de minimis exception, guidance on the meaning of the activities listed in the definition of SSTB, and the rules for determining whether a trade or business is treated as part of an SSTB. Under the de minimis rule, a trade or business is not an SSTB if less than 10 percent of the gross receipts (5 percent if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. For purposes of the SSTB definition, the regs limit the meaning of the “reputation or skill” clause to specified fact patterns. Proposed reg. section 1.199A-5 also addresses the rules regarding classification as an employee for purposes of <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a>. Proposed reg. section 1.199A-6 provides guidance that some specified entities may need to follow for purposes of computing the entities’ or their owners’ <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> deductions. The threshold amount under <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> is determined at the trust level without taking into account any distribution deductions. Thus, taxpayers could circumvent the threshold amount by dividing assets among multiple trusts, each of which would claim its own threshold amount. Thus, the proposed regs provide antiabuse rules under <a href="/research/federal/usc26/643#cnxn-0000033" resolve="/lr/resolve/section-643f/cnxn#cnxn-0000033" title="section 643(f)">section 643(f)</a> to prevent taxpayers from establishing multiple non-grantor trusts or contributing additional capital to multiple existing non-grantor trusts to avoid federal income tax. Later this year, Treasury and the IRS intend to issue separate proposed regs describing rules for applying <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> to specified agricultural and horticultural cooperatives and their patrons. Those regs will generally be based on the rules applicable to cooperatives and their patrons under former <a href="/research/federal/usc26/199" resolve="/lr/resolve/section-199/cptw" title="section 199">section 199</a>. The regs will provide that <a href="/research/federal/usc26/199A#1xfpg-0000109" resolve="/lr/resolve/section-199ag/1xfpg#1xfpg-0000109" title="section 199A(g)">section 199A(g)</a> applies only to the patronage business of a relevant cooperative and will provide more information for taxpayers that must apply the reduction under <a href="/research/federal/usc26/199A#1xfpg-0000162" resolve="/lr/resolve/section-199ab7/1xfpg#1xfpg-0000162" title="section 199A(b)(7)">section 199A(b)(7)</a>. The rules under the six substantive provisions under <a href="/research/federal/usc26/199A" resolve="/lr/resolve/section-199a/1xfpg" title="section 199A">section 199A</a> are generally proposed to apply to tax years ending after the date final regs are published. The antiabuse rules under section 199A are proposed to apply to tax years ending after December 22, 2017. The provisions under <a href="/research/federal/usc26/643" resolve="/lr/resolve/section-643/cnxn" title="section 643">section 643</a> to prevent abuse through the use of trusts are proposed to apply to tax years ending after August 16, 2018. The preamble includes details on the economic analysis of the regs.

Related IRS news release, <a href="/lr/resolve//28b8s">IR-2018-162</a>, and <a href="/lr/resolve//28b8z">FAQ</a>.

The IRS has issued proposed regulations providing taxpayers with computational, definitional, and antiavoidance guidance on the deduction for qualified business income under section 199A.

The IRS has issued proposed regulations (REG-107892-18) providing taxpayers with computational, definitional, and antiavoidance guidance on the deduction for qualified business income (QBI) under section 199A. Comments and discussion topic outlines for the October 16 hearing are due by October 1. Section 199A, as added by the Tax Cuts and Jobs Act (P.L. 115-97), provides a deduction of up to 20 percent of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. Section 199A applies to tax years between 2017 and 2026. The proposed regs contain six substantive sections, each of which provides rules relevant to the calculation of the section 199A deduction. The operational rules under proposed reg. section 1.199A-1 provide guidance on the computation of the deduction for individuals with taxable income at, below, or above the threshold amount, including individuals with taxable income within a phase-in range above the threshold amount. Proposed reg. section 1.199A-1 also defines some terms, generally defining trade or business as a section 162 trade or business. The proposed regs incorporate special rules contained in sections 199A and 6662. If an individual’s taxable income exceeds the threshold amount, the section 199A deduction is limited based on the greater of either (1) the W-2 wages paid, or (2) the W-2 wages paid and the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to a trade or business. Proposed reg. section 1.199A-2 provides rules on determining W-2 wages and UBIA of qualified property held for use in the trade or business. A simultaneously released proposed revenue procedure (Notice 2018-64) provides three methods for calculating W-2 wages. The proposed rules for determining UBIA of qualified property address partnership special basis adjustments, property transferred to increase the section 199A deduction, like-kind exchanges, involuntary conversions, other nonrecognition transactions, subsequent improvements to qualified property, and qualified property held by a relevant passthrough entity (as defined in the preamble). Proposed reg. section 1.199A-3 provides guidance on determining QBI, qualified real estate investment trust dividends, and qualified publicly traded partnership income. For QBI purposes, the regs address the treatment of section 751 gain, guaranteed payments for the use of capital, section 481 adjustments, previously suspended losses, and net operating losses. The regs also address the QBI requirement that an item be effectively connected with a U.S. trade or business and provide some exclusions from QBI. Comments are requested on reasonable methods for the allocation of items not clearly attributable to a single trade or business and whether any safe harbors may be appropriate. While the proposed regs do not adopt the section 469 group rules, proposed reg. section 1.199A-4 allows the aggregation of separate trades or businesses, provided some requirements are met. The regs provide reporting and disclosure requirements for individuals that choose to aggregate. The provisions under proposed reg. section 1.199A-5 on a specified service trade or business (SSTB) address the effect of classification as an SSTB (as defined in the regs), exceptions for taxpayers below the threshold amount, a de minimis exception, guidance on the meaning of the activities listed in the definition of SSTB, and the rules for determining whether a trade or business is treated as part of an SSTB. Under the de minimis rule, a trade or business is not an SSTB if less than 10 percent of the gross receipts (5 percent if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. For purposes of the SSTB definition, the regs limit the meaning of the “reputation or skill” clause to specified fact patterns. Proposed reg. section 1.199A-5 also addresses the rules regarding classification as an employee for purposes of section 199A. Proposed reg. section 1.199A-6 provides guidance that some specified entities may need to follow for purposes of computing the entities’ or their owners’ section 199A deductions. The threshold amount under section 199A is determined at the trust level without taking into account any distribution deductions. Thus, taxpayers could circumvent the threshold amount by dividing assets among multiple trusts, each of which would claim its own threshold amount. Thus, the proposed regs provide antiabuse rules under section 643(f) to prevent taxpayers from establishing multiple non-grantor trusts or contributing additional capital to multiple existing non-grantor trusts to avoid federal income tax. Later this year, Treasury and the IRS intend to issue separate proposed regs describing rules for applying section 199A to specified agricultural and horticultural cooperatives and their patrons. Those regs will generally be based on the rules applicable to cooperatives and their patrons under former section 199. The regs will provide that section 199A(g) applies only to the patronage business of a relevant cooperative and will provide more information for taxpayers that must apply the reduction under section 199A(b)(7). The rules under the six substantive provisions under section 199A are generally proposed to apply to tax years ending after the date final regs are published. The antiabuse rules under section 199A are proposed to apply to tax years ending after December 22, 2017. The provisions under section 643 to prevent abuse through the use of trusts are proposed to apply to tax years ending after August 16, 2018. The preamble includes details on the economic analysis of the regs.

Sec. 199A Qualified business income

Sec. 643 Definitions applicable to subparts A, B, C, and D

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Proposed Regs Provide Guidance on Passthrough Deduction