Section 199A (199A), one of the key provisions of the Tax Cuts and Jobs Act signed into law in December 2017, provided a 20% deduction for qualified business income (QBI) for owners of pass-through businesses such as partnerships, S corporations, and sole proprietorships. Taxpayers soon began asking for guidance on how to implement this tax break. Proposed regulations for 199A were issued in August 2018. The IRS and Treasury Department received many suggestions and comments to consider before releasing the final regulations, which were unveiled in mid-January. Following are some of the important components of the final regulations and how they differ from and improve upon the proposed regulations.
Certain rental income derived from a trade or business can be treated as qualified business income and is, therefore, now eligible in the final regulations for the Section 199A deduction through the use of a “safe harbor.” Two of the main requirements of a safe harbor are separate books and records and 250 hours of qualifying rental services per taxable year. Separable books and records are needed from taxpayers to establish a separate trade or business for 199A purposes. Triple net leases, which include a lease agreement requiring to pay the taxes, insurance, and fees, do not qualify.
Aggregation of businesses is now allowed at either the entity or individual level. The proposed regulations permitted businesses to be aggregated together at the individual taxpayer level only. This can allow taxpayers to maximize their Section 199A deduction. Requirements for aggregation include a certain relatedness and common control between the aggregated businesses. The final regulations allowed aggregation to be used at both the entity and the individual level.
Qualifying property must be held at the end of the taxable year by taxpayers to be able to use its basis as part of the Section 199A limitations test. One of two limitation tests can be used to compute the 199A deduction:
- The Section 199A deduction cannot exceed 50% of the wages paid as part of the business.
- The deduction cannot exceed 25% of the wages paid, plus 2.5% of the unadjusted basis in qualified property immediately before acquisition (UBIA). The proposed regulations require UBIA to be held at the end of the taxable year to meet the limitations test. Taxpayers requested a pro-ration rule be allowed by the IRS, but this was rejected in the final regulations.
The proposed regulations stated that a relevant pass-through entity must state whether a business or trade is a specified service trade or business (SSTB) and “separately report an item of QBI, W-2 wages, or UBIA of qualified property.” Any omitted information would cause all the items to be presumed as being zero, not just the missing item, and possibly result in disallowed deductions. The final regulations eased off on this rule, stating that only the missing item would be presumed to be zero.
Taxpayers can choose to follow either the proposed regulations issued in August 2018 or the final regulations released in January 2019. However, selecting from both is not allowed. You must use either one set of regulations or the other in its entirety. While the final regulations shed some needed light on Section 199A, they raise many new questions that taxpayers must answer before claiming the deduction.
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