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 December 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 January 18, 2019, Treasury and the Internal Revenue Service (“IRS”) released final regulations on the 20 percent deduction for pass-through businesses. In conjunction with the release of the final regulations, the IRS also published a new set of proposed regulations, as well as Notice 2019-07, and Revenue Procedure 2019-11. This alert provides an overview of some of the key provisions contained in this recent guidance.
The final regulations adopt a majority of the key provisions contained in the proposed regulations that were released on August 8, 2018 with certain changes based on comments provided by taxpayers, practitioners, and professional organizations.
Final 199A Regulations
Some of the highlights of the changes or clarifications incorporated into the final regulations are as follows:
- Define “net capital gain” to included qualified dividend income
- Expand of the definition of “relevant pass-through entities” (“RPEs”) to include common trust funds and certain religious organizations
- Adopt the definition of a trade or business as defined under Internal Revenue Code (“IRC”) Section 162
- Clarify that a rental to a commonly controlled trade or business is automatically presumed to be a trade or business itself, but only if the commonly controlled business is an individual or an RPE (not a C corporation)
- Clarify that an entity with a single owner that is treated as a disregarded entity is also disregarded for 199A purposes
- Provide that if an RPE conducts both SSTB and non-SSTB activities, exceeding the 5percent/10 percent SSTB de minimis rule does not cause all of the income to be considered SSTB income, provided the taxpayer can establish two separate and distinct businesses.
- Remove the “80 percent cliff” from the proposed regulations, so that now if a non-SSTB RPE provides property or services to a commonly controlled SSTB, only its portion of income related to the SSTB rental will be recharacterized as SSTB income.
- Provide that what constitutes a SSTB/non-SSTB activities should be determined on the facts and circumstances of each business.
- Provide that an aggregation election can be made by an RPE, which binds its owners to the election. The aggregation should be reported by the RPE as well as its individual owners. The owners cannot separate the RPE’s aggregation, but can aggregate additional trades/businesses with it if they qualify.
- If an aggregation is not made on a tax return, it may be made for future years on a future return. For tax year 2018 only, a taxpayer may amend their return to report an aggregation that was not made on the originally filed return.
- Qualified Business Income (“QBI”) must be reduced by a taxpayer’s deduction for self-employment tax, self-employed health insurance, and retirement plan contributions that relate to the business generating the QBI.
- When property is transferred to a partnership or S Corp, the starting point for the UBIA calculation is based on the transferor’s original cost, rather than their adjusted basis at the time of contribution.
- When property is acquired via 1031 exchange, its starting point for the UBIA calculation is based on the taxpayer’s original cost of the relinquished property, rather than the adjusted basis of the replacement property.
- Allow an “excess Section 743(b) basis adjustment” to be treated as qualified property
- If a taxpayer treats a rental activity as a Section 162 trade/business for purposes of Section 199A, then the taxpayer should also comply with the 1099 filing requirements for the rental activity.
- Modify the anti-abuse presumption regarding people previously treated as employees to include a 3-year lookback rule
- Clarify common ownership rules for purposes of the aggregation rule to include the attribution rules of Sections 267 and 707
- Revise the presumption related to the failure of an RPE to separately identify or report an item related to Section 199A
The above list is not intended to be all inclusive. Please contact us to discuss how the final regulations may affect your specific tax situation.
Proposed 1.199A-3 Regulations
The new set of proposed regulations provide guidance on issues not addressed previously. Notably, the proposed regulations provide that previously disallowed, suspended, limited, or carried over losses under IRC Section 469, 465, 704, and 1366 are taken into account for 199A purposes on a first-in, first-out basis and are treated as from a separate trade or business. The above rules would apply for losses incurred after January 1, 2018. There is also guidance provided for regulated investment companies and publicly traded partnerships.
Revenue Procedure 2019-11 – Calculating W-2 Wages
This revenue procedure outlines three qualified methods for taxpayers to determine their W-2 wages for purposes of the Section 199A 20 percent business deduction. It also addresses the application of the methods in the case of a short taxable year.
Notice 2019-07 – Safe Harbor for Real Estate Trade or Business
This notice provides a safe harbor for taxpayers to treat rental real estate as a trade or business (solely for purposes of 199A) if they meet certain requirements. Both individuals and RPEs holding real estate activities can apply this safe harbor. In applying the safe harbor, taxpayers with multiple properties must treat each property as a separate enterprise or treat all similar properties as a single enterprise. However, commercial and residential real estate may not be part of the same enterprise. The general safe harbor requirements are as follows:
- -Separate books and records are maintained for each enterprise
- -At least 250 hours of rental services are performed each tax year with respect to the rental real estate enterprise. This would include services such as maintenance, repairs, rent collection, and efforts to rent the property. It does not include hours spent arranging for financing or reviewing the book and records of the trade or business. Note that the services may be performed by the owners themselves or by their employees, agents, or independent contractors.
- -The taxpayer maintains contemporaneous records regarding the specific services performed
Notably, property leased under a triple net lease or used by the taxpayer as a residence for any part of the year under Section 280A would not be eligible under the proposed safe harbor. A taxpayer applying this safe harbor must attach a statement to their return indicating that they have met the requirements of the safe harbor.
If you have any questions regarding the information presented above, please contact your GHJ advisors at 310.873.1600.