Sec. 199A: Regulations shed light on QBI deduction

Here’s what practitioners need to know about this important deduction.
By Judith Folse Witteman, CPA

Sec. 199A: Prop. regs. shed light on QBI deduction
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Editor’s note: The IRS issued final regulations under Sec. 199A on Jan. 18. For coverage, see “Qualified Business Income Deduction Regs. and Other Guidance Issued.” The article below has been updated to reflect the final regulations.

Sec. 199A was enacted on Dec. 22, 2017, as part of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. It provides a deduction of up to 20% of income from a domestic trade or business operated as a sole proprietorship or through a partnership or S corporation, trust, or estate, for tax years beginning after Dec. 31, 2017, and ending before Jan. 1, 2026. The Sec. 199A deduction replaces the now-repealed Sec. 199 domestic production activities deduction.

The new deduction was enacted to provide tax relief to small businesses that do not operate as C corporations, because C corporation tax rates were significantly reduced under the TCJA, from graduated rates with a top rate of 35% to a flat rate of 21%. Unlike the qualified business income (QBI) deduction, the corporate rate change is permanent, and the TCJA also eliminated the alternative minimum tax (AMT) for corporations (TCJA §§13001 and 12001; see also Notice 2018-38).

Since the law was enacted, the IRS issued proposed regulations on Aug. 8, 2018 (REG-107892-18), while also soliciting comments for a public hearing that was held on Oct. 16, 2018. In addition, the IRS published "Basic Questions and Answers on New 20-Percent Deduction for Pass-Through Businesses" and Notice 2018-64, which provides methods for calculating W-2 wages for Sec. 199A purposes. In January, the IRS issued final regulations (RIN 1545-BO71) and more guidance on calculating W-2 wages (Rev. Proc. 2019-11).


Under the statute, the deduction is available in full to taxpayers with taxable incomes below $315,000 for joint returns and $157,500 for other taxpayers. It is generally equal to the lesser of 20% of combined QBI plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or 20% of taxable income less net capital gain. The final regulations include qualified dividends in net capital gain. The deduction may be limited for taxpayers above these thresholds. The proposed regulations provide guidance for calculating these modifications. QBI is, for any tax year, the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer; however, it does not include any qualified REIT dividends or qualified PTP income. Combined QBI is the aggregate of the deductible amount for each of a taxpayer's qualified trades or businesses plus 20% of the taxpayer's aggregate REIT dividends and income from PTPs.

The deductible amount for each qualified trade or business is the lesser of 20% of its QBI, or the greater of either 50% of its wages, or 25% of its wages plus 2.5% of its unadjusted basis immediately after the acquisition of all qualified property. Qualified property is defined in the statute as tangible property subject to depreciation under Sec. 167 that is held by, and available for use in, the qualified trade or business at the close of the tax year and used at any point during the tax year in the production of QBI, for which the depreciable period has not ended before the close of the tax year. The depreciable period starts on the date the property is first placed in service and ends on the later of (1) 10 years after that date, or (2) the last day of the last full year of the applicable recovery period under Sec. 168 (ignoring Sec. 168(g)). Thus, qualified property includes property that has exhausted its depreciation period if it is still in its first 10 years of service.

The statute directs the IRS to issue guidance in cases of short tax years or where a major portion of a trade or business is acquired or disposed of during the tax year. Regs. Sec. 1.199A-2 contains those rules.


There is an exception from the definition of a qualified trade or business for specified service trades or businesses (SSTBs) as defined in Sec. 199A(d)(2). SSTBs include trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial services, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business that relies on the reputation or skill of one or more of its employees. SSTBs also include trades or businesses involving the performance of investing and investment management services, trading, or dealing in securities, partnership interests, or commodities.

Taxpayers with taxable incomes below a threshold amount (in 2019, $321,400 for taxpayers filing joint returns, $160,725 for married taxpayers filing separately, and $160,700 for single and head-of-household returns) with trades or businesses that are SSTBs are not subject to this exception. In 2019, the exception is phased in for taxpayers filing joint returns with taxable incomes from $321,400 to $421,400, for married taxpayers filing separately with taxable incomes from $160,725 to $210,725, and for single and head-of-household taxpayers with taxable incomes from $160,700 to $210,700. Taxpayers with taxable incomes above the upper threshold amount are subject to the exception in full.

Tax planning note: Generally, an SSTB should have little or no taxable income if there is an employee who generates most of its income due to the deductibility of reasonable compensation from salaries paid to this employee. However, due to the availability of the Sec. 199A deduction up to the threshold amount of income, a planning opportunity exists to retain capital in the business in lieu of paying salary to use for capital expenditures, business expansion, or paying down debt. Since the Sec. 199A deduction uses wages as part of the computation, planning for each client should be considered on a case-by-case basis.

QBI from a passthrough partnership or S corporation is determined at the partner/shareholder level. The statute also provides for an anti-abuse rule for qualified property to prevent the manipulation of the depreciable period of qualified property using transactions between related parties, and the carryforward of losses of QBI from one year to the succeeding tax year. Another significant provision of the statute is that it allows an entity-level deduction to specified agricultural or horticultural cooperatives that is substantially similar to the domestic production activities deduction under former Sec. 199.

It is also important to note that Sec. 199A(f)(4) expressly gives Treasury authority to promulgate regulations under Sec. 199A. This provision will give the regulations themselves more weight than regulations promulgated without this express authority.

Practitioners also need to be aware of the TCJA's impact on the Sec. 6662(b)(2) substantial-understatement penalty. For any taxpayer that takes a Sec. 199A deduction, a special rule decreases the threshold that triggers the penalty from an understatement that is 10% of the tax required to be shown on the original return or $5,000, to an understatement that is 5% of the tax required to be shown on the original return or $5,000 (Sec. 6662(d)(1)(C)).


The proposed regulations contain six sections that address the operational rules on how to compute the deduction; how to determine W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property; QBI, REIT dividends, and PTP income; aggregation rules; which trades or businesses are SSTBs; and rules for relevant passthrough entities, PTPs, trusts, and estates. They also provide for an anti-abuse rule under Sec. 643(f) to prevent taxpayers from establishing multiple trusts or contributing additional capital to multiple existing trusts to increase their Sec. 199A deduction.


The regulations clarify many questions that the IRS received from commenters, shedding light on a number of areas of concern. A summary of the highlights follows. Readers are encouraged to refer to the regulations for additional details.

First, the operational rules coin the term "relevant passthrough entities" (RPEs) to use in discussing the computational aspects of determining QBI for the Sec. 199A deduction. The term is used to describe passthrough entities that directly operate the trade or business or pass through the trade or business's items of income, gain, loss, or deduction from lower-tier RPEs to the individual. The QBI of an RPE is determined at the shareholder/partner level, and the deduction has no effect on the adjusted basis of a partner's interest in the partnership or a shareholder's basis in S corporation stock. Under the regulations an RPE includes a common trust fund as described in Temp. Regs. Sec. 1.6032-T and a Sec. 501(d) apostolic organization.

The regulations also clarify that the definition of a trade or business for purposes of Sec. 199A generally is the same as for Sec. 162(a), because of the large body of existing case law and administrative guidance interpreting the meaning of "trade or business" in the context of a broad range of industries. However, in an exception to this rule, for purposes of Sec. 199A, the regulations extend the definition of a trade or business beyond the Sec. 162 definition to the rental or licensing of tangible or intangible property to a related trade or business if the rental or licensing and the other trade or business are commonly controlled under Prop. Regs. Sec. 1.199A-4(b)(1)(i).

As for carryovers of unused deductions, the regulations clarify that QBI cannot be less than zero, and the carryforward of QBI does not affect the current-year deduction for purposes of other sections of the Code. They also clarify that if an individual has an overall loss after adding qualified REIT dividends and PTP income, then the portion of the Sec. 199A deduction related to the REIT and PTP income is zero for the tax year, and it does not affect QBI for the year. Instead, the loss from the REIT or PTP is carried forward and used to offset REIT/PTP income in the succeeding year or years for Sec. 199A purposes.

For taxpayers who have multiple trades or businesses, the regulations provide that losses are netted with income before the application of limitations for individuals over the threshold amount, based on W-2 wages and UBIA of qualified property and determining QBI. But the IRS also asked for comments on this proposed computation (Regs. Sec. 1.199A-1(d)).

The regulations also clarify that the Sec. 199A deduction does not reduce net earnings from self-employment under Sec. 1402 or net investment income under Sec. 1411, and it does not result in individuals' being subject to the AMT.

If an individual's taxable income exceeds the threshold amount, Sec. 199A imposes a limit on the deduction based on the greater of either W-2 wages paid or the wages paid and UBIA. The regulations generally apply the rules under former Sec. 199, which also contained a W-2 wage limitation, with the exception that the wages are prorated across each separate qualified trade or business to determine QBI.

Simultaneously with its release of the regulations, the IRS also issued Rev. Proc. 2019-11, which provides three methods of calculating W-2 wages. The three methods for determining W-2 wages are substantially similar to the methods provided in Rev. Proc. 2006-47 under former Sec. 199.

To calculate UBIA, the regulations state that the existing rules used to determine "unadjusted basis" in Regs. Secs. 1.263(a)—(h)(5) provide a reasonable basis to determine UBIA under Sec. 199A. Similarly, the rules for determining UBIA for qualified property subject to a Sec. 1031 like-kind exchange or a Sec. 1033 involuntary conversion are described in Regs. Sec. 1.199A-2.

They also state that the term "immediately after acquisition" means the date the property was placed in service. For qualified property contributed to a partnership or an S corporation in a Sec. 721 or 351 transaction, respectively, and immediately placed in service, the basis will be the same basis determined under Secs. 723 and 362, respectively. However, to avoid abuse of these property basis rules, property acquired within 60 days of the end of the tax year and disposed of within 120 days without having been used for at least 45 days before disposition will generally not be qualified property included in the UBIA computation.

The proposed regulations clarify that Sec. 199A applies to income that is effectively connected with a U.S. trade or business under Sec. 864(c), whether the taxpayer is domestic or foreign, including both U.S. citizens and resident aliens, as well as nonresident aliens that have QBI, as long as the item is also incurred "with respect to" a trade or business under Sec. 162.

Any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss, including any item treated as one of these items, that are treated as capital gains or losses, is not taken into account as a qualified item of income, gain, deduction, or loss.  If they are not capital gains or losses, they are included in QBI.

Interest income on accounts or notes receivable for services or goods of the trade or business is included in QBI, while interest income on working capital and reserves is not QBI, since it is held for investment.

Sec. 199A(c)(4)(A) excludes reasonable compensation from the computation of QBI. Similarly, guaranteed payments for services under Sec. 707(c) are excluded. The regulations clarify that the term "reasonable compensation" is limited to the compensation paid by an S corporation but does not extend this rule to partnerships for purposes of this section. Rather, the regulations state that this rule is intended to clarify that even if an S corporation fails to pay a reasonable salary to its shareholder-employees, it is nonetheless precluded from including an amount equal to reasonable compensation in QBI.

In the case of expenditures that are allocable to more than one of the taxpayer's trades or businesses, the regulations do not specify any allocation methods, but they allow the use of any reasonable method as long as it is consistently applied. The IRS requested further comments from the public on reasonable allocation methods.

With respect to whether the IRS will allow aggregation of trades or businesses for purposes of determining QBI for each business, the regulations clarify that the aggregation rules under the Sec. 469 passive activity loss rules are inappropriate to apply to Sec. 199A. A degree of aggregation is allowed, with the exception of SSTBs, but according to a set of criteria applicable to Sec. 199A specified in the regulations. Once multiple trades or businesses are aggregated, they must be reported consistently in subsequent years unless there is a material change in circumstance. New trades or businesses or newly acquired trades or businesses may be added. Taxpayers must choose to aggregate their businesses on an original tax return except for 2018, when it can be done an an amended return.

A bright-line de minimis rule is provided for businesses that have partial SSTB income. A business is not classified as an SSTB if gross receipts of the business are $25 million or less in a tax year, and less than 10% of the business's gross receipts are from SSTB services. For businesses with over $25 million in gross receipts, the business is not an SSTB if less than 5% of gross receipts are from SSTB services.

As for the "reputation or skill" clause pertinent to the definition of an SSTB, the proposed regulations limit this clause to businesses that receive income for endorsing products or services; license or receive income for the use of an individual's image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual's identity; or receive appearance fees or income.

For trusts, the regulations contain an anti-abuse rule against the use of multiple trusts that have substantially the same grantor and beneficiaries and have a principal purpose of tax avoidance.

Finally, the IRS intends to issue regulations concerning specified agricultural or horticultural cooperatives after it has had time to study the issue more, but it anticipates they will conform to existing regulations for these entities under former Sec. 199.


It is the author's view that these regulations provide significant useful guidance to clarify many aspects of Sec. 199A. In light of exposure to the lessened understatement amount to trigger Sec. 6662 penalties, practitioners should become familiar with them.

About the author

Judith Folse Witteman, CPA, is a practicing CPA in Katy, Texas.

To comment on this article or to suggest an idea for another article, contact Sally P. Schreiber, a JofA senior editor, at or 919-402-4828.

AICPA resources



  • "Tax Reform: A Case Study Approach to Section 199A" (#WC1820573)
  • "Tax Reform: Overview of Section 199A" (#WC1819562)

For more information or to make a purchase, go to or call the Institute at 888-777-7077.

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