The IRS has issued proposed reliance regulations on the Internal Revenue Code (IRC) Section 199A pass-through, or “qualified business income” (QBI), deduction. The regulations explain the following elements of the Section 199A combined qualified business income amount: qualified business income (QBI), qualified REIT dividends and qualified publicly traded partnership (PTP) income. The regulations also provide rules that certain specified entities (e.g., trusts and estates) need to follow for purposes of computing their owners’/beneficiaries’ deductions.
For tax years beginning after 2017 and before 2026, Section 199A, which was enacted in the Tax Cuts and Jobs Act, and amended by the Consolidated Appropriations Act, 2018, allows individuals and some estates and trusts (but not corporations) 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.
A taxpayer is allowed to deduct:
- the lesser of: (a) the “combined qualified business income amount” of the taxpayer, or (b) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the sum of net capital gain and the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year; plus
- the lesser of: (i) 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer for the tax year, or (ii) taxable income (reduced by the net capital gain) of the taxpayer for the tax year.
The “combined qualified business income amount” means, for any tax year, an amount equal to: (i) the deductible amount for each qualified trade or business of the taxpayer (defined as 20% of the taxpayer’s QBI subject to the W-2 wage limit; see below); plus (ii) 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified PTP income of the taxpayer for the tax year.
QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer. For this purpose, qualified items of income, gain, deduction, and loss are items of income, gain, deduction, and loss to the extent these items are effectively connected with the conduct of a trade or business within the U.S. under IRC Section 864(c) and included or allowed in determining taxable income for the year. If the net amount of qualified income, gain, deduction, and loss relating to qualified trade or businesses of the taxpayer for any tax year is less than zero, the amount is treated as a loss from a qualified trade or business in the succeeding tax year.
QBI does not include: certain investment items; reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered with respect to the trade or business; any guaranteed payment to a partner for services to the business under IRC Section 707(c) ; or a payment under IRC Section 707(a) to a partner for services rendered with respect to the trade or business.
The proposed regulations would generally apply to tax years ending after the date the Treasury decision adopting them as final regulations is published in the Federal Register, but taxpayers may rely on the above proposed regulations pending their finalization.
Exceptions to this general rule include:
- To prevent abuse of Section 199A and the regulations thereunder, the anti-abuse rules of Proposed Regulation Section 1.199A-3(c)(2)(B) and Section 1.199A-6(d)(3)(v) are proposed to apply to tax years ending after December 22, 2017, the date of enactment of the TCJA.
- For purposes of determining QBI, W-2 wages, and UBIA of qualified property, if an individual receives any of these items from a relevant pass-through entity (“RPE”) with a tax year that begins before January 1, 2018 and ends after December 31, 2017, such items are treated as having been incurred by the individual during the individual’s tax year in which or with which such RPE tax year ends.
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