September 6, 2018

IRS Releases Proposed Regulations for the 20% QBI Deduction

The Qualified Business Income Deduction (QBI Deduction) was one of the many changes included in the tax reform package signed by President Trump in December of 2017. This 20% deduction, which is available to pass-through entity business owners beginning this year, was simple at first glance but appeared to be complex in execution. Once experts began to consider how taxpayers’ returns would look utilizing this deduction, the complexities of the law began to emerge and it became apparent that further guidance would be needed. Luckily, the IRS released proposed regulations surrounding this 20% deduction on August 8^th. While these regulations are not yet finalized, they can give us a good idea of how the IRS will be interpreting the law, which can help us make better planning decisions for the remainder of the 2018 tax year and beyond. To help clients, prospects and others understand the guidance and how it will impact their business, Wilson Lewis has provided a summary of key information below.

Section 199a Basics

The 20% QBI Deduction, also known as the Section 199a deduction, is available to owners of flow-through entities – partnerships, S corporations, and sole proprietorships. This is not a business deduction; rather, it is a deduction for the individual owners and will be reported on their personal tax return. It’s available whether the taxpayer itemizes or not, so it has the potential to impact quite a few returns. It will be limited by the taxpayer’s overall income, will be unavailable to owners of specified service trades or businesses (SSTB), and may be limited based on the W-2 wages of the business’s employees.

Proposed Regulations

The IRS has answered quite a few of the more burning questions about Section 199a in these proposed regulations, and two of the most common ones are the following:

What is Qualified Business Income?

The deduction is calculated to be 20% of a taxpayer’s “Qualified Business Income” (QBI). The proposed regulations define QBI as all of a taxpayer’s income except for:

• W-2 wages earned directly from the flow-through business entity;
• Guaranteed payments;
• Independent contractor revenue from de-facto employees looking to circumvent the 199a rules by transforming QBI-ineligible wage income into QBI-eligible independent contractor income;
• Income from a SSTB; and,
• Certain investment income.

It’s still unclear whether the IRS intends for rental real estate income to be included in QBI, and we expect there to be more discussion about this in future hearings.

How do I calculate the deduction when I have multiple businesses?

The answer is: it depends on the businesses. A taxpayer who has multiple flow-through entities that are unrelated will aggregate their businesses differently than a taxpayer who has multiple flow-through entities that are interrelated with each other. Taxpayers can fully combine their business data (like when determining the W-2 wage limitations) only when their businesses are so similar or intertwined that they are thought of as the same entity. Specifically, this aggregation will be allowed as long as two out of the following three things are true:

1. The businesses provide a service or product that are generally the same (e.g. a candy store and a chocolate store), or that are generally provided together (e.g. lawn care services and fertilizer sales).
2. The businesses share facilities or equipment (e.g. an accounting department).
3. The businesses are operated in coordination with each other (e.g. a manufacturer of carpet and a retailer of carpet).

Additionally, none of the businesses can be SSTBs, and the taxpayer must own the majority interest in each of the business (including via family attribution) for most of the year. In practice, aggregating businesses for the purposes of the 199a deduction may cause the loss in one business to offset the income in another, zeroing out the potential deduction, which is why tax planning is key before a decision is made. The decision to aggregate businesses in this manner is binding for future years.

Conversely, aggregating the data from multiple unique businesses will be done at an individual level. These taxpayers must calculate the business limitations separately before combining the results and taking one single deduction on their tax return.

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At 184 pages long, the proposed regulations are extremely detailed and contain much more than just what we have discussed today. The document also details how the business limitations should be calculated, what businesses are considered SSTBs, and how investors in publicly traded partnerships should calculate their deduction. We will continue unpacking this document and will relay the information to you as time goes on. In the meantime, if you would like to discuss how these regulations will impact your current planning strategy, Wilson Lewis can help! For additional information please contact us directly. We look forward to speaking with you soon.