Proposed Rules Address New 20% Deduction for Pass-Through Entities

The Treasury Department and the IRS issued proposed regulations Aug. 8 on the deduction for qualified business income under the new Code Section 199A.

Enacted as part of the Tax Cuts and Jobs Act (TCJA), the new Section 199A provides 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 engaged in domestic trades or businesses. The deduction is available for tax years beginning after Dec. 31, 2017, and will expire in 2026 unless it is extended by Congress.

The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. It’s generally equal to the lesser of 20% of their qualified business income plus 20% of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20% of taxable income minus net capital gains.

The Aug. 8 guidance addresses how specified service, trade or business (SSTB) income above those thresholds may be subject to limitation for the purposes of claiming the deduction. As anticipated, the proposed guidance does list “advising clients with respect to finances” and “developing retirement plans” and services provided by “retirement advisors” within the scope of the SSTB under services in the field of financial services.

The proposed regulations do allow a de minimis exception to mitigate compliance costs for businesses earning only a small percentage of SSTB income. Under the proposal, minimal standards are set for businesses with $25 million or less in gross receipts. As such, the proposal disregards SSTB income if it totals less than 10% of these gross receipts. For businesses in excess of $25 million in gross receipts, the rules disregard SSTB income if it comprises less than 5% of those gross receipts.

In addition, the proposed regulations:

1. contain an anti-avoidance rule under Code Section 643 to treat multiple trusts as a single trust in certain cases; and
2. seek to establish anti-abuse safeguards to prevent improper tax avoidance schemes, such as relabeling employees as independent contractors.

Taxpayers may rely on the rules in the proposed regulations until final regulations are issued. Comments on the proposed regulations and requests to testify at a public hearing scheduled for Oct. 16, 2018, must be received by 45 days after the regulations are published in the Federal Register.

Proposed Revenue Procedure

Also on Aug. 8, the IRS issued Notice 2018-64, which provides proposed language for a future revenue procedure providing guidance on methods for calculating W-2 wages for purposes of the limitations on the new Section 199A deduction:

1. for purposes of Section 199A(b)(2), which provides a limitation based on W-2 wages to the amount of the deduction for qualified business income under section 199A(a); and
2. for purposes of Section 199A(b)(7), which, for certain specified agricultural and horticultural cooperative patrons, provides a reduction to the section 199A(a) deduction based on W-2 wages.