Recently, the IRS released final regulations providing guidance on the Qualified Business Income Deduction, also known as the Section 199A deduction. This guidance was originally released as proposed regulations back in August, and after a few tweaks and adjustments, they were made final on January 18th of this year. While the proposed regulations were helpful, taxpayers could not legally rely on them. They let taxpayers know how the IRS viewed certain aspects of the tax law, but they could not move forward with their tax plans until the regulations were finalized. To help clients, prospects and others understand the changes and how it will impact their tax planning efforts, Hanson & Co has provided a summary of key details below.
What is the Qualified Business Income Deduction?
Despite its name, the Qualified Business Income Deduction (QBI Deduction) is not for businesses. Rather, it is for business owners. Owners of pass-through entities, like S corporations and partnerships, whose taxable incomes are below certain dollar thresholds will be eligible for the full deduction, and the deduction for high earners may be limited. This deduction is calculated to be up to 20% of the taxpayer’s share of the business’s “qualified business income,” and is reported on their personal income tax return. This can make planning at an entity level even more complex. Even though the deduction does not impact the entity directly, the entity must begin collecting and reporting information that will help their owners calculate their deductions.
The final regulations adopt most of the provisions in the proposed regulations, with a few differences.
Based on comments and questions from the public, the IRS has clarified that “net capital gains” for purposes of calculating the deduction will include qualified dividend income.
In the proposed regulations, trusts and estates were considered “relevant pass-through entities” (RPE) to the extent they were able to pass through QBI and W-2 wages. The final regulations expand the definition of RPEs by including common trust funds and religious organizations if those entities file a Partnership income tax return, and if they are owned by at least one individual, estate, or trust.
The regulations adopted most of the proposed regulation’s stance on aggregating trades or businesses, with a few exceptions.
Taxpayers can choose to aggregate their businesses on future tax returns if they so wish; no longer must they make an aggregation decision in 2018 that will carry forward indefinitely. However, the decision to aggregate cannot be made on an amended return, with the exception of tax year 2018.
The rules surrounding aggregating RPEs has shifted; the new regulations permit RPEs to aggregate businesses that they operate directly or through lower-tier RPEs.
Taxpayers who were previously treated as employees may still be eligible for the deduction if in the previous three years they were treated as nonemployees. The proposed regulations did not originally allow for this three-year lookback period.
The final regulations explain in detail how property contributed to a partnership in a Section 721 transaction, or to an S corporation in a Section 351 transaction, must be valued. The basis amounts are reduced or increased based on the amount of money the transferee receives or pays.
The regulations also go into detail about how replacement property under Section 1031 or 1033 are recorded for purposes of calculating the QBI Deduction.
When issuing the final regulations, the IRS also issued proposed guidance on suspended losses, regulated investment company dividends and split interest trusts. While the new proposed guidance addresses certain areas previously untouched by the current regulations, taxpayers will need to continue to wait for final guidance. If you have questions about Section 199a, final regulations, or how you can taker advantage of this tax saving opportunity, Hanson & Co can help. For additional information please call us at 303-388-1010 or click here to contact us. We look forward to speaking with you soon.