The IRS recently issued proposed regulations on the 20% flow-through deduction. There is a 45-day period for people to comment, so these are not final. However, they can be relied upon until the final ones are issued, and they provide insight as to how the IRS will interpret the new laws.
Spoiler Alert: We have amazing news on how they chose to interpret the “catch all” category under “specified trades or businesses”. See below in red. This may allow you to take the 20% deduction!
Proposed Reg. 1.199A‐1 – OPERATIONAL RULES
Great examples of how to compute the 20% deduction, specifically when applying the “lesser of: (a) 20% of QBI or (b) 20% of the taxpayer’s taxable income”.
- Note that if net QBI is positive, and at least 1 entity is a loss, the loss is allocated prorata to the other QBIs
Proposed Reg. 1.199A‐2 – OPERATIONAL RULES AND DEFINITION OF W2 WAGES
Unfortunately, we haven’t seen any special carve‐out for guaranteed payments of a partnership or single member LLCs with no wages. If a taxpayer is over the taxable income limit and has LLC income and/or partnership flow through income where there are no W‐2 wages, we should consider switching them to an S corporation and paying out wages to the shareholder. As we previously discussed, there are several other factors to consider and the QBI deduction should not be the only factor in making this decision.
Bottom line:
ENTITY TYPE DOES MATTERS IF:
- the individual owner is over the taxable income threshold (on their personal return),
- there are no employees of the entity, and
- the business is not a “SSTB” and would otherwise qualify for the 20% deduction if there were wages
Proposed Reg. 1.199A‐3
Definition of QBI:
- NOT guaranteed payments
- Section 751 (hot assets)
- Section 481 (change of accounting method) adjustments – but only if the adjustment arises in taxable years ending after 12/31/2017
- Previously disallowed losses – if they are from a tax year ending 12/31/2017 or earlier, they are NOT QBI
- NOLs – NOT QBI (some exceptions
- In general, NONE of the following:
- ST or LT gains/losses
- Section 1231 gains/losses (if they end up on Schedule D). If they end up as ordinary income, they are included in QBI.
- Interest or dividend income
- Guaranteed payments or any amount received by partner for services rendered
Proposed Reg. 1.199A‐4
- Aggregation rules of multiple trades/businesses
Proposed Reg. 1.199A‐5 – SPECIFIED SERVICE TRADE OR BUSINESS (SSTB)
Everyone’s been waiting on this one! So far, I think everyone will be pleasantly surprised as to how a business where the “principal asset is the reputation or skill of its employees” is defined! SSTBs include any trade or business involving the performance of services in 1 or more of the below fields:
- Health
- Law
- Accounting
- Actuarial Science
- Performing Arts
- Consulting (providing advice and counsel)
- Athletics
- Financial Service
- Brokerage Services
- Investing & Investment Management
- Trading
- Dealing in Securities
- Any trade or business where the principal asset is the reputation or skill of 1 or more of its employees or owners, defined as any of the following:
- Receiving fees, compensation, or other income endorsing products or services
- A business in which a person licenses or receives fees, compensation, or other income for the use of an image, likeness, name, signature, voice, trademark, or any other identifying symbol
- Receiving fees, compensation, or other income for appearing at an event, radio, TB, or other media format.
Other items:
- Does not include income received for performance of services as an employee (i.e. wages). Note that there are anti‐abuse rules put in place for companies that switch employees to contractors. If the worker has been switched from employee to contractor, the 1099 income is NOT considered QBI unless the taxpayer can provide there was a reason to do so & the worker is not an employee any longer.
- A non‐STTB business that is a related party (special definition) to an SSTB will be considered an SSTB as well (think rentals to related party).
Proposed Reg. 1.199A‐6
Address 20% deduction related to trusts, PTPs, and estates. This also addresses flow through entities which may be engaged in 1 or more trades or businesses.
Other mentions:
Proposed Reg. 1.643(f)‐1
Treatment of multiple trusts
Notice 2018‐64
Specific guidance in calculating W2 wages
If you have specific questions, reach our to a ShindelRock tax professional. This is all very new information, so it will take time to interpret, but you will need to start considering whether you can structure things differently to save tax dollars. Please keep this in mind as third-quarter tax projections are coming up soon!
Lastly, the IRS has posted some FAQs:
https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-deduction-for-qualified-business-income-faqs