The IRS recently released highly anticipated regulations addressing the deduction for up to 20% of qualified business income (QBI) from pass-through entities (including the aggregation of business for QBI purposes.) The deduction was a major component of the Tax Cuts and Jobs Act, which became law late last year. It has also been referred to as the pass-through deduction, the QBI deduction or the Section 199A deduction.
Who: The QBI deduction is available only to individuals, estates and trusts. The newly proposed regulations refer to all three as “individuals.”
What: The QBI deduction can be up to 20 percent of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income.
- For QBI deduction purposes, pass-through entities are defined as:
- sole proprietorships
- single-member (one owner) LLCs that are treated as sole proprietorships for tax purposes
- S corporations
- partnerships
- LLCs that are treated as partnerships for tax purposes
When: Tax years beginning in 2018 and ending in 2025 (unless extended by Congress).
Operational rules and definitions
Definitions of new terms used to apply the QBI deduction rules are included in the proposed regulations, including the definition of QBI and of specified service trades or businesses (SSTBs).
In defining what constitutes an eligible business for QBI deduction purposes, the IRS decided to go with the Internal Revenue Code Section 162 definition of a trade or business, because that definition is derived from longstanding case law and IRS guidance dealing with a broad range of industries. By using this definition, the IRS created uncertainty of whether real estate operations meet this definition and qualify for the deduction but hopefully this issue will be clarified once the IRS responds to comments on these proposed regulations.
Specified service trades or businesses
The proposed regulations define SSTBs. The status as an SSTB is important, because QBI deductions based on SSTB income begin to be phased out after an individual’s taxable income (calculated before any QBI deduction) exceeds $157,500 ($315,000 for a married joint filer).
The proposed regulations also include an anti-abuse rule intended to prevent service business owners from separating out parts of what otherwise would be an integrated SSTB, such as an optometrist practice’s sales of vision care items, in an attempt to qualify the separated part for the QBI deduction.
Defining SSTBs
In general, an SSTB is a trade or business that performs services in one or more of the following fields:
- Health
- Law
- Accounting
- Actuarial science
- Consulting
- Financial, brokerage, investing or investment management
- Trading
- Performing arts
- Athletics
In addition, an SSTB can be any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.
You may ask: What’s a trade or business where the principal asset is the reputation or skill of an owner or employee? Good question. Before the proposed regulations were released, there was concern that this SSTB definition could snare unsuspecting businesses, such as a restaurant with a well-regarded chef.
Thankfully, the proposed regulations limit this definition to trades or businesses that meet one or more of the following descriptions:
- One in which a person receives fees, compensation or other income for endorsing products or services,
- One that licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark or any other symbol associated with that individual’s identity, or
- One that receives fees, compensation or other income for appearing at an event or on radio, television or another media format.
Other QBI deduction issues
The proposed regulations supply guidance on when QBI deductions can be claimed based on qualified income from publicly traded partnerships (PTPs) and qualified dividends from real estate investment trusts (REITs).
Finally, the proposed regulations include special computational and reporting rules that pass-through entities, PTPs, trusts and estates may need to follow to provide their owners and beneficiaries with the information necessary to calculate allowable QBI deductions at the owner or beneficiary level.