The IRS issued proposed regulations regarding the qualified trade or business income deduction under Sec. 199A, which was enacted by P.L. 115-97, the law known as the Tax Cuts and Jobs Act (TCJA). At the same time, it issued Notice 2018-64, which provides guidance on how to compute W-2 wages for purposes of the deduction, along with frequently asked questions on its website (available at irs.gov). The proposed rules include a way that taxpayers can group or aggregate separate trades or businesses and an anti-abuse rule designed to prevent taxpayers from separating out parts of an otherwise disqualified business in an attempt to qualify those separated parts for the Sec. 199A deduction.
Sec. 199A provides a deduction of up to 20% of income from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. It may be taken by individuals and by some estates and trusts. The deduction is generally equal to the lesser of 20% of the taxpayer's qualified business income (QBI) plus 20% of the taxpayer's qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or 20% of taxable income minus net capital gains.
For taxpayers whose taxable income exceeds a threshold amount ($315,000 for taxpayers filing joint returns and $157,500 for other taxpayers in 2018), the deduction may be limited based on the type of trade or business engaged in by the taxpayer, the wages paid with respect to the trade or business, and/or the unadjusted basis immediately after acquisition of qualified property held for use in the trade or business. These limitations are subject to phase-in rules based upon taxable income above the threshold amount. The application of those limits is described in the proposed regulations.
The Service noted that, although the rules will not be effective until published as final in the Federal Register, taxpayers may rely on them until then.
Prop. Regs. Sec. 1.199A-1 contains the operational rules, including how to determine the deduction for taxpayers with incomes at or below the threshold amounts and for those with incomes above the thresholds. It also defines the following terms: aggregated trade or business, applicable percentage, phase-in range, qualified business income, QBI component, qualified PTP income, qualified REIT dividends, reduction amount, relevant passthrough entity (RPE), specified service trade or business (SSTB), threshold amount, total QBI amount, unadjusted basis immediately after acquisition (UBIA) of qualified property, and W-2 wages.
The definition of a trade or business is also in this section; the IRS decided to apply the definition of "trade or business" under Sec. 162(a) because it is derived from a large amount of case law and administrative guidance in the context of a broad range of industries.
Prop. Regs. Sec. 1.199A-2 contains rules for determining W-2 wages and the UBIA of qualified property, both of which are components in calculating limitations on the deduction. The rules for determining W-2 wages are based on the rules under the repealed Sec. 199 deduction for qualified domestic production activities, except, unlike Sec. 199, the Sec. 199A W-2 wages are determined separately for each trade or business.
Prop. Regs. Sec. 1.199A-3 restates the definitions in Sec. 199A(c) and provides additional guidance on the determination of QBI, qualified REIT dividends, and qualified PTP income.
Prop. Regs. Sec. 1.199A-4 contains aggregation rules allowing separate trades or businesses to be grouped when applying the Sec. 199A rules. The IRS rejected comments suggesting the application of the grouping rules under Sec. 469, the passive loss provision, and instead proposed a flexible method that looks into common ownership, shared services, and other commonality, but specifically excludes SSTBs from being aggregated under the rules. The regulations impose a duty of consistency that requires that once multiple trades or businesses are aggregated into a single aggregated trade or business under Sec. 199A, taxpayers must consistently report the aggregated group in subsequent tax years. Aggregation allows for ease of administration and was one of the AICPA's recommendations (available at aicpa.org) in a letter it sent to the IRS in February.
Prop. Regs. Sec. 1.199A-5 defines trades or businesses that are not qualified trades or businesses for purposes of the deduction: SSTBs and the trade or business of performing services as an employee. The regulations include an anti-abuse rule designed to prevent taxpayers from separating out parts of what otherwise would be an integrated SSTB, such as the administrative functions, in an attempt to qualify those separated parts for the Sec. 199A deduction.
Prop. Regs. Sec. 1.199A-6 contains special rules for RPEs, PTPs, trusts, and estates for purposes of computing the entities' or their owners' Sec. 199A deductions.
Prop. Regs. Sec. 1.643(f)-1 addresses concerns regarding the abusive use of multiple trusts by confirming the applicability of Sec. 643(f). Sec. 643(f) permits the IRS to issue regulations to prevent taxpayers from establishing multiple nongrantor trusts or contributing additional capital to multiple existing nongrantor trusts to avoid federal income tax.
Notice 2018-64, issued simultaneously with the proposed regulations, proposes a revenue procedure with three methods for calculating W-2 wages for purposes of: (1) the limitation based on W-2 wages to the amount of the deduction for qualified business income under Sec. 199A; and (2) the reduction to the Sec. 199A deduction based on W-2 wages for certain specified agricultural and horticultural cooperative patrons.
- Notice 2018-64
— By Sally P. Schreiber, J.D., a JofA senior editor.