As part of the Tax Cuts and Jobs Act (“TCJA”) enacted at the end of 2017, a new Internal Revenue Code Section 199A (“Section 199A”) was created to provide a 20-percent deduction for owners of pass-through entities (partnerships, S-Corporations and sole proprietors) for taxable years beginning after Dec. 31, 2017. Although the goal of Section 199A is to provide a tax benefit to pass-through owners, the statute itself left many questions and uncertainties as to how the deduction actually works and the types of businesses that qualify.

On August 8, 2018, long-awaited proposed regulations were published to help answer these questions and provide much needed guidance in many technical areas of Section 199A. The six major topics covered by the proposed regulations are:

  • Operational rules
  • Wage and basis limitation
  • Calculation of qualified business income (“QBI”)
  • Aggregation
  • Definitions of specified service trade or businesses (“SSTB”)
  • Rules for pass-through entities

We will provide a very high level outline of some of these topics below. It is important to note that some of the limitations on the calculation of the 20-percent business deduction do not apply if the taxpayer’s income is below $157,000 for single filers and $315,000 for married couples filing jointly.

Qualified Business Income

In order for a business activity to generate qualified business income or QBI, the activity must rise to the level of a “trade or business” under Section 162. The determination of whether an activity carried on by the taxpayer is considered a trade or business should be evaluated based on all relevant facts. Activities that do not constitute a trade or business (i.e., hobby activities) do not generate QBI and thus the income of these activities are not eligible for the 20-percent deduction.

Certain types of income are specifically excluded from the definition of QBI, such as:

  • Wage income earned as an employee
  • Guaranteed payments paid to a partner of a partnership
  • Investment income from portfolio activities such as interest, dividend and/or capital gains
  • Income from a SSTB (discussed later)

Wage and Basis Limitations

Limitations based on W-2 wages paid and basis in qualified property could reduce or completely eliminate the deduction. The wage limitation limits the deduction to 50 percent of the total wages paid by the trade or business generating the QBI. One initial concern for practitioners was whether the deduction would be eliminated for certain entities within a group under common control, whereby one entity pays all of the W-2 wages for the employees who provide services to all of the entities. The proposed regulations allow businesses under common control to aggregate W-2 wages if the wage expense is allocated to each of the trade or business.

For businesses that do not pay sufficient W-2 wages to support the 20-percent deduction, the alternative test is a computation based on the unadjusted basis of qualified property. The limitation is based on 2.5-percent of the unadjusted basis of qualified property immediately after acquisition plus 25 percent of total W-2 wages paid. It is important to note that only property subject to depreciation is considered qualified property. Therefore, land or inventory that is not depreciable would not be considered qualified property. Additionally, intangible property such as goodwill or patents would not be qualified property.

Taxpayers with taxable income below the aforementioned income thresholds are not subject to these limitations.

Specified Service Trade or Businesses (“SSTB”)

The intention of the Section 199A deduction was to provide a benefit to as many businesses as possible that are operating in a pass-through form (i.e. partnerships, LLCs and S-corporations). However, the statute and proposed regulations specifically exclude income from SSTB from QBI, meaning such income would not be eligible for the 20-percent deduction. However, this exclusion does not apply to taxpayer with taxable income below the threshold amounts listed above. Taxpayers conducting a SSTB with taxable income below threshold can continue to claim the 20-percent business deduction. This benefit begins to phase out once single filers have taxable income of $207,500 and married filing joint filers have taxable income of $415,000.

Section 199A provides a list of business types that do not qualify for the 20-percent deduction. These include trade or businesses performing services in the fields of health, accounting, law, financial services, consulting and a “catch-all” category discussed below. Certain investing, investment management and trading businesses are also treated as SSTB. Notable exclusions from the definition of SSTB include banking, real estate brokers, engineers, architects, property management and insurance agent brokers. The catch-all category of disqualified businesses includes all businesses where the principal asset of the business is the reputation or skill of one or more of its employees or owners. Prior to clarification in the Proposed Regulations, practitioners were unsure how this catch-all category would be applied, as it seems to encompass a potentially large group of businesses. The regulations actually define the catch-all very narrowly, so that only the following three categories of business activities would be treated as a SSTB:

  • Receiving income for endorsing products or services
  • Licensing or receiving income for the use of an individual’s image, likeness or trademark
  • Receiving appearance fees

Other Provisions

  • The regulations also provide de minimis rules for otherwise qualified trades or businesses that produce a small amount of income from a SSTB. Under the de minimis rules, the fact that an otherwise qualified business has some income from unqualified activities will not cause the entire business to become disqualified.
  • The regulations also address the provision of services or rentals from one related company to another related company that is also an SSTB. Prior to the regulations, some taxpayers were considering spinning off portions of otherwise unqualified businesses in an attempt to receive some benefit of 199A. The regulations attempt to prevent this by reclassifying otherwise qualified income as SSTB income if it relates to property or services provided to a commonly owned SSTB.
  • The regulations attempt to cut down on employees being reclassified as independent contractors or partners to take advantage of the 199A deduction. Since employees cannot take the 199A deduction on wages, there is some incentive to be treated as an independent contractor and receive Schedule C or pass-through income instead. The regulations mitigate this strategy by creating a rebuttable presumption that a former employee who continues to perform the same services for that employer as an independent contractor is still an employee for purposes of 199A.
  • Taxpayers are permitted to aggregate certain qualified businesses in order to optimize the potential 199A deduction. There are specific requirements that must be met in order to aggregate businesses, and taxpayers must make an annual disclosure of their groupings.


We have only highlighted some of the main points above. These proposed regulations and rules are extremely complex and their application is highly dependent on the facts and circumstances of each business and its owners. Even with these proposed regulations, there remain areas of uncertainty and further guidance or interpretation is needed. However, there are many planning opportunities associated with the Section 199A deduction such as looking at aggregation of businesses or conducting cost segregation studies to increase the depreciable basis of qualified property to maximize the 20-percent business deduction. Please contact your GHJ tax advisor (310-873-1600) if you have any questions or wish to discuss the rules in more detail.