IRS Releases Proposed Regulations to Clarify Qualified Business Income Deduction
When tax reform passed in December last year, corporations received a lower tax rate of 21%, while rates were slightly reduced for individuals. To give a similar benefit to businesses organized as pass-through entities tax reform enacted a 20% Qualified Business Income (QBI) deduction. See our Tax Advisor from Jan. 13th for a more in-depth overview.
Unfortunately, the statute was particularly unclear on several important details. The Internal Revenue Service (IRS) recently issued long-awaited proposed regulations that help with these problems. The regulations, while not final, go a long way in clarifying ambiguity in the Section 199A statute.
Below we’ve highlighted some of the key items from the 184 pages of proposed regulations.
How are W-2 wages calculated?
One of the limitations on the QBI deduction is the entities W-2 wages. The IRS sets out several methods for calculating W-2 wages, but the easiest are:
- The lesser of W-2 box 1 wages or box 5 wages
- W-2 box 1 wages plus retirement contributions
The regulations make clear that wages do include wages paid by 3rd parties on behalf of the business (ie. PEOs).
The regulations also make clear that guaranteed payments of any kind are not QBI even if they are paid to another entity.
What is a specified service trade or business (SSTB)?
A Specified Service Trade or Business (SSTB) is defined much more precisely in the proposed regulations. The regs make clear that the definitions of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage services are defined narrowly. The phrase “service business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners” is now more narrowly defined. Instead of an all-encompassing definition, only those persons who do endorsements, licensing and appearance fees are included in the regulations.
Can separate entities be aggregated together?
An individual make elect to aggregate several entities together, but there are several rules that need to be followed for this to occur:
- The businesses need to share over 50% common ownership for the majority of the year
- None of the businesses can be an SSTB
- The businesses must pass 2 of 3 relationship tests relating to product, facility or interdependency
The regulations also indicate that the QBI is only available for true trades or businesses. They do allow self-rentals to count as trade or businesses and to be aggregated with the parent company.
What are the operational & calculation steps with multiple entities?
There are several operational steps involved in the calculation of QBI for each entity and then the amount you get to deduct on your tax return. Aggregated businesses are treated as one entity for the calculation purposes. Here is an overview of the various steps:
- Determine QBI for each entity
- Net any entities with a negative QBI with entities having a positive QBI – while QBI income is netted with losses from qualified businesses, the wage and property factors stay with each trade or business
- Calculate the wage or asset limitations for each separate entity
These new proposed regulations issued by Treasury go a long way in clearing up the lingering questions related to the implementation of the QBI deduction, however, the rules are still very complex. It is important to contact your tax professional for specific advice for your particular tax situation.
Cindy H. Mitchell?>
Michael A. Hydell?>
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