Clarity On 199A: A Discussion on The Newly Proposed Regulations
On August 8, 2018, the U.S. Treasury issued proposed regulations intended to clarify the newly enacted Section 199A, a complex tax code section that allows a tax deduction of up to 20% of the income from many types of domestic businesses. This new deduction is expected to impact millions of taxpayers. The proposed regulations address many questions raised by the new law, and although the regulations are only in proposed form, taxpayers are permitted to rely on them until final regulations are issued.
Below are a few of the questions asked by attendees of our recent webinar, with answers provided by our CohnReznick subject matter experts: Director David Patch, and Senior Manager Daniel King.
Q) If I have a business partnership interest, is it better to pay myself W-2 wages or to take guaranteed payments?
A) Unfortunately, the IRS takes the position that partners cannot be employees of their own partnership, so having the partnership attempt to pay W-2 wages to a partner would not be an option.
In addition, any guaranteed payments received for services provided to the partnership are not eligible for the Section 199A deduction. Consider possibly taking a larger allocable share of the partnership’s income in lieu of a guaranteed payment since an allocation of partnership income may qualify for the deduction.
Q) Is the aggregation election made on a year-by-year basis or is it permanent?
A) The proposed regulations provide that once a taxpayer chooses to aggregate two or more trades or businesses, they cannot be disaggregated unless and until the facts change, such that aggregation is no longer allowable. However, newly created or acquired business may be added to the aggregated business if the requirements are met.
Q) What happens if there is no W-2 salary income? What if all income is from LLCs owning commercial rental properties?
A) If a trade or business generates qualified business income (QBI), but pays no W-2 wages, the limitation based on 50% of W-2 wages will be zero. However, there is an alternative limitation based on 25% of W-2 wages and 2.5% of the Unadjusted Basis Immediately After Acquisition (UBIA) of qualified property. A business holding commercial real estate will typically have a large amount of qualified property, and that may produce a sufficient alternative limitation to support the Section 199A deduction. If the deduction is still limited, there may be other options.
Note that if your taxable income is below, or within, the phase-in range, the limitation may not apply, or, may apply only in part. Aggregating businesses where allowable may also increase the Section 199A deduction because the W-2 wages and UBIA of the aggregated businesses are combined. Also, you may consider changing the way the properties are serviced to allow the businesses to claim their own W-2-based wage deductions.
Q) If there are multiple ownership interests in various operating companies, are the income and wages aggregated to determine the 20% deduction?
A) In general, the Section 199A deduction with respect to each qualifying trade or business is computed separately. However, if certain requirements are met, taxpayers may choose to aggregate two or more otherwise separate trades or businesses, in which case the income and wages of those businesses would be aggregated for purposes of computing the deduction.
Q) How does the use of a PEO affect the wages of an operating entity?
A) The proposed regulations provide that wages paid by a third party such as a PEO may be treated as W-2 wages of the taxpayer, e.g., the operating entity, only if paid to “common law” employees of the taxpayer for employment by the taxpayer. In effect, this means that the employees of the PEO would have to be considered employees of the LLC for federal income tax purposes under judicially developed principles. Since this provision was intended to apply to PEOs it is likely that many, if not most PEO arrangements, will qualify.
Q) Is a real estate management company a SSB?
A) Specified service trades or businesses (SSTBs) include the provision of services in investing and investment management. However, the proposed regulations specifically provide that this category does not include directly managing real property.
Q) Are Architects and Engineers a SSB?
A) Architects and engineers were expressly excluded from the list of business that are automatically considered SSTBs. Thus, such businesses would be SSTBs only if they fall within another specified category, such as consulting. So, the answer in any case depends on the specific facts.
Q) You mentioned a carve-out for schedule E rental property owners. Can you explain how this is included or excluded in this new calculation?
A) For income to be included in calculating the Section 199A deduction, it must be derived from a “trade or business.” A rental activity may not be considered a trade or business if the level of activity associated with the rental is insufficient. However, the proposed regulations provide that if the rental activity does not rise to the level of a trade or business, it is nevertheless treated as a trade or business for purposes of Section 199A, if the property is rented or licensed to a trade or business which is “commonly controlled” as defined by the regulations.
Q) Are IT government contracting services qualified?
A) Government contracting services are not listed as an SSTB. However, depending on the nature of the services being provided, many government contracting businesses may fall within one of the other categories. For example, such a business may constitute a “consulting” business within the meaning of the statute and proposed regulations. If the business is determined to be an SSTB, its owner may still be eligible for a Section 199A deduction with respect to the income it generates if the taxpayer’s taxable income is less than a certain threshold amount.
Q) Is there any guidance as to whether a real estate development firm would be an SSTB under the "reputation or skill of employee or owner” specification?
A) A “trade or business where the principle asset of such trade or business is the reputation or skill of one or more employees or owners,” is one category of specified service trade or business (SSTB) generally excluded from the Section 199A deduction. The proposed regulations define this category very narrowly to effectively include only income from product endorsements, the use of the person’s name or likeness, event appearances, and similar types of activities. A real estate development firm would not generally fall within that definition.
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Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Clarity on 199A: A Discussion on The Newly Proposed Regulations