Defining a trade or business for purposes of Sec. 199A

By Kate Abdoo, J.D., LL.M.; Lee Gay, CPA; and John Kerrigan, J.D., LL.M.

New Sec. 199A provides a deduction for qualified business income (QBI) from sole proprietorships and relevant passthrough entities (RPEs). Sec. 199A allows individuals (and some trusts and estates) to deduct up to 20% of the combined QBI from qualifying trades or businesses, subject to certain limitations. QBI includes the net amount of qualified items of income, gain, deduction, and loss for any qualified trade or business of the taxpayer (Sec. 199A(c)(1)). A qualified trade or business is any trade or business that is not a specified service trade or business or the trade or business of performing services as an employee (Sec. 199A(d)(1)).

Regs. Sec. 1.199A-1(b)(14) provides that a trade or business means "a trade or business that is a trade or business under section 162 (a section 162 trade or business) other than the trade or business of performing services as an employee." Sec. 162(a) does not provide an explicit definition of what constitutes a trade or business. The preamble to the final Sec. 199A regulations states that the IRS and Treasury declined to establish a bright-line test for determining a trade or business for purposes of Sec. 199A because that specific guidance is beyond the scope of the Sec. 199A regulations. However, the preamble discusses two relevant considerations for taxpayers, derived from case law addressing trades or businesses under Sec. 162. First, a taxpayer must enter into and carry on the activity at issue with a good-faith intention to earn a profit. Second, the taxpayer must engage in the activity on a regular and continuous basis (see Groetzinger, 480 U.S. 23 (1987)).

Separate trades or businesses

Once an individual or RPE taxpayer determines that it is engaged in a trade or business within the meaning of Sec. 162, the individual or RPE should determine whether its activities constitute one or more trades or businesses. Generally, activities operated in separate taxable entities are considered separate trades or businesses (see Specialty Restaurants Corp., T.C. Memo. 1992-221). However, the IRS and Treasury acknowledge in the preamble that activities within one tax entity also may be treated as separate Sec. 162 trades or businesses (see also Chief Counsel Advice 201430013).

Whether operations are properly treated as separate trades or businesses requires consideration of various factors, derived largely from case law and IRS guidance. The preamble to the proposed regulations states that Treasury and the IRS "believe that multiple trades or business will generally not exist within an entity unless different methods of accounting could be used for each trade or business under [Regs. Sec.] 1.446-1(d)."

In determining whether a taxpayer is engaged in more than one trade or business, courts and IRS guidance have identified additional relevant factors. The courts' evaluation of these additional factors reflects that maintenance of separate books and records alone is insufficient to treat two lines of business as separate and distinct without the presence of other factors.

For a detailed discussion of the issues in this area, see "Tax Clinic: Determining What Is a Separate Trade or Business for Sec. 199A Purposes" in the July 2019 issue of The Tax Adviser.

― Kate Abdoo, J.D., LL.M.; Lee Gay, CPA; and John Kerrigan, J.D., LL.M.

The Tax Adviser is the AICPA's monthly journal of tax planning, trends, and techniques.

Also in the July issue:

  • An in-depth look at tax and accounting issues with deferred revenue.
  • An analysis of the kiddie tax and unearned scholarship income.
  • A discussion of reliance on proposed and final regulations.

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