[Federal Register Volume 83, Number 159 (Thursday, August 16, 2018)]
[Proposed Rules]
[Pages 40884-40930]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-17276]
[[Page 40883]]
Vol. 83
Thursday,
No. 159
August 16, 2018
Part III
Department of the Treasury
-----------------------------------------------------------------------
Internal Revenue Service
-----------------------------------------------------------------------
26 CFR Part 1
Qualified Business Income Deduction; Proposed Rule
Federal Register / Vol. 83 , No. 159 / Thursday, August 16, 2018 /
Proposed Rules
[[Page 40884]]
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-107892-18]
RIN 1545-BO71
Qualified Business Income Deduction
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
-----------------------------------------------------------------------
SUMMARY: This document contains proposed regulations concerning the
deduction for qualified business income under section 199A of the
Internal Revenue Code (Code). The regulations will affect individuals,
partnerships, S corporations, trusts, and estates engaged in domestic
trades or businesses. The proposed regulations also contain an anti-
avoidance rule under section 643 of the Code to treat multiple trusts
as a single trust in certain cases. This document also provides notice
of a public hearing on these proposed regulations.
DATES: Written or electronic comments must be received by October 1,
2018. Outlines of topics to be discussed at the public hearing
scheduled for October 16, 2018, at 10 a.m. must be received by October
1, 2018. If no outlines of topics are received by October 1, 2018 the
public hearing will be cancelled.
ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-107892-18), Room 5203,
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
107892-18), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW, Washington, DC 20224, or via the Federal eRulemaking Portal
at www.regulations.gov (indicate IRS and REG-107892-18). The public
hearing will be held in the Auditorium, Internal Revenue Service, 1111
Constitution Avenue NW, Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Vishal R. Amin, Frank J. Fisher, or Wendy L. Kribell at (202) 317-6850
or Adrienne M. Mikolashek at 202-317-5279; concerning submissions of
comments and outlines of topics for the public hearing, Regina Johnson
at (202) 317-6901 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995 (44
U.S.C. 3507(d)). The Department of the Treasury (Treasury Department)
and the IRS request comment on the assumptions, methodology, and burden
estimates related to this information collection. Comments on the
collection of information should be sent to the Office of Management
and Budget, Attn: Desk Officer for the Department of the Treasury,
Office of Information and Regulatory Affairs, Washington, DC 20503,
with copies to the Internal Revenue Service, Attn: IRS Reports
Clearance Officer, SE-:CAR:MP:T:T:SP, Washington, DC 20224. Comments on
the collection of information should be received by October 15, 2018.
Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the IRS, including whether the information will
have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information;
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of service to provide information.
Details of the estimated collection burden can be found in Section
I.J. of the Special Analyses section later in this document.
The collection of information required by this proposed regulation
is in proposed Sec. 1.199A-4 and proposed Sec. 1.199A-6. The
collection of information in proposed Sec. 1.199A-4 is required for
taxpayers that choose to aggregate two or more trades or businesses.
The collection of information in proposed Sec. 1.199A-6 is required
for passthrough entities that report section 199A information to their
owners or beneficiaries. It is necessary to report the information to
the IRS in order to ensure that taxpayers properly report in accordance
with the rules of the proposed regulations the correct amount of
deduction under section 199A. The collection of information is
necessary to ensure tax compliance.
The likely respondents are individuals with qualified business
income from more than one trade or business as well as most
partnerships, S corporations, trusts, and estates that have qualified
business income.
Estimated total annual reporting burden: 25 million hours.
Estimated average annual burden hours per respondent will vary from
30 minutes to 20 hours, depending on individual circumstances, with an
estimated average of 2.5 hours.
Estimated number of respondents: 10 million.
Estimated annual frequency of responses: annually.
Estimated monetized burden: Using the IRS's taxpayer compliance
cost estimates, taxpayers who are self-employed with multiple
businesses are estimated to have a monetization rate of $39 per hour.
Pass-throughs that issue K-1s have a monetization rate of $53 per hour.
(See ``Taxpayer compliance Costs for Corporations and Partnerships: A
New Look,'' Contos, et al. IRS Research Bulletin (2012) p. 5 for a
description of the model.)
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by section 6103.
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under sections 199A and 643 of the Code.
I. Section 199A
Section 199A was enacted on December 22, 2017, by Sec. 11011 of
``An Act to provide for reconciliation pursuant to titles II and V of
the concurrent resolution on the budget for fiscal year 2018,'' Public
Law 115-97 (TCJA), and was amended on March 23, 2018, retroactively to
January 1, 2018, by Sec. 101 of Division T of the Consolidated
Appropriations Act, 2018, Public Law 115-141, (2018 Act). Section 199A
applies to taxable years beginning after 2017 and before 2026.
Section 199A provides a deduction of up to 20 percent of income
from a domestic business operated as a sole
[[Page 40885]]
proprietorship or through a partnership, S corporation, trust, or
estate (section 199A deduction). The section 199A deduction may be
taken by individuals and by some estates and trusts. A section 199A
deduction is not available for wage income or for business income
earned through a C corporation. For taxpayers whose taxable income
exceeds a statutorily-defined amount (threshold amount), section 199A
may limit the taxpayer's section 199A deduction based on (i) the type
of trade or business engaged in by the taxpayer, (ii) the amount of W-2
wages paid with respect to the trade or business (W-2 wages), and/or
(iii) the unadjusted basis immediately after acquisition (UBIA) of
qualified property held for use in the trade or business (UBIA of
qualified property). These statutory limitations are subject to phase-
in rules based upon taxable income above the threshold amount.
Section 199A also allows individuals and some trusts and estates
(but not corporations) a deduction of up to 20 percent of their
combined qualified real estate investment trust (REIT) dividends and
qualified publicly traded partnership (PTP) income, including qualified
REIT dividends and qualified PTP income earned through passthrough
entities. This component of the section 199A deduction is not limited
by W-2 wages or UBIA of qualified property.
The section 199A deduction is the lesser of (1) the sum of the
combined amounts described in the prior two paragraphs or (2) an amount
equal to 20 percent of the excess (if any) of taxable income of the
taxpayer for the taxable year over the net capital gain of the taxpayer
for the taxable year.
Additionally, section 199A(g) provides that specified agricultural
or horticultural cooperatives may claim a special entity-level
deduction that is substantially similar to the domestic production
activities deduction under former section 199.
Finally, the statute expressly grants the Secretary authority to
prescribe such regulations as are necessary to carry out the purposes
of section 199A (section 199A(f)(4)), and provides specific grants of
authority with respect to: The treatment of acquisitions, dispositions,
and short-tax years (section 199A(b)(5)); certain payments to partners
for services rendered in a non-partner capacity (section
199A(c)(4)(C)); the allocation of W-2 wages and UBIA of qualified
property (section 199A(f)(1)(A)(iii)); restricting the allocation of
items and wages under section 199A and such reporting requirements as
the Secretary determines appropriate (section 199A(f)(4)(A)); the
application of section 199A in the case of tiered entities (section
199A(f)(4)(B)); preventing the manipulation of the depreciable period
of qualified property using transactions between related parties
(section 199A(h)(1)); and determining the UBIA of qualified property
acquired in like-kind exchanges or involuntary conversions (section
199A(h)(2)).
II. Section 643
Part I of subchapter J of chapter 1 of the Code provides rules
related to the taxation of estates, trusts, and beneficiaries. For
various subparts of part I of subchapter J, sections 643(a), 643(b),
and 643(c) define the terms distributable net income (DNI), income, and
beneficiary, respectively. Sections 643(d) through 643(i) (other than
section 643(f)) provide additional rules. Section 643(f) grants the
Secretary authority to treat two or more trusts as a single trust for
purposes of subchapter J if (1) the trusts have substantially the same
grantors and substantially the same primary beneficiaries and (2) a
principal purpose of such trusts is the avoidance of the tax imposed by
chapter 1 of the Code. Section 643(f) further provides that, for these
purposes, spouses are treated as a single person.
Explanation of Provisions
The purpose of these proposed regulations is to provide taxpayers
with computational, definitional, and anti-avoidance guidance regarding
the application of section 199A. These proposed regulations contain six
substantive sections, Sec. Sec. 1.199A-1 through 1.199A-6, each of
which provides rules relevant to the calculation of the section 199A
deduction. Additionally, the proposed regulations would establish anti-
abuse rules under section 643(f) to prevent taxpayers from establishing
multiple non-grantor trusts or contributing additional capital to
multiple existing non-grantor trusts in order to avoid Federal income
tax, including abuse of section 199A. This Explanation of Provisions
describes each of the proposed regulation sections in turn.
I. Proposed Sec. 1.199A-1: Operational Rules
Section 1.199A-1 of the proposed regulations (proposed Sec.
1.199A-1) provides guidance on the determination of the section 199A
deduction. For simplicity, the proposed regulations use the term
individual when referring to an individual, trust, estate, or other
person eligible to claim the section 199A deduction. The term relevant
passthrough entity (RPE) is used to describe passthrough entities that
directly operate the trade or business or pass through the trade or
business' items of income, gain, loss, or deduction from lower-tier
RPEs to the individual.
Proposed Sec. 1.199A-1(b) contains definitions applicable for
section 199A and Sec. Sec. 1.199A-1 through 1.199A-6. Proposed Sec.
1.199A-1(c) provides guidance on the computation of the section 199A
deduction for individuals with taxable income at or below the threshold
amount. Proposed Sec. 1.199A-1(d) provides guidance on the computation
of the section 199A deduction for individuals with taxable income above
the threshold amount, including individuals with taxable income within
a phase-in range above the threshold amount. Proposed Sec. 1.199A-1(e)
provides special rules related to the section 199A deduction.
A. Defined Terms
Defined terms in proposed Sec. 1.199A-1(b) include aggregated
trade or business, applicable percentage, phase-in range, qualified
business income (QBI), QBI component, qualified PTP income, qualified
REIT dividends, reduction amount, RPE, specified service trade or
business (SSTB), threshold amount, total QBI amount, UBIA of qualified
property, and W-2 wages.
Proposed Sec. 1.199A-1(b) also defines trade or business for
purposes of section 199A and proposed Sec. Sec. 1.199A-1 through
1.199A-6. Neither the statutory text of section 199A nor the
legislative history provides a definition of trade or business for
purposes of section 199A. Multiple commenters stated that section 162
is the most appropriate definition for purposes of section 199A.
Although the term trade or business is defined in more than one
provision of the Code, the Department of the Treasury (Treasury
Department) and the IRS agree with commenters that for purposes of
section 199A, section 162(a) provides the most appropriate definition
of a trade or business. This is based on the fact that the definition
of trade or business under section 162 is derived from a large body of
existing case law and administrative guidance interpreting the meaning
of trade or business in the context of a broad range of industries.
Thus, the definition of a trade or business under section 162 provides
for administrable rules that are appropriate for the purposes of
section 199A and which taxpayers have experience applying and therefore
defining trade or business as a section 162 trade or business will
reduce compliance costs, burden, and administrative complexity.
[[Page 40886]]
The proposed regulations extend the definition of trade or business
for purposes of section 199A beyond section 162 in one circumstance.
Solely for purposes of section 199A, the rental or licensing of
tangible or intangible property to a related trade or business is
treated as a trade or business if the rental or licensing and the other
trade or business are commonly controlled under proposed Sec. 1.199A-
4(b)(1)(i). It is not uncommon that for legal or other non-tax reasons
taxpayers may segregate rental property from operating businesses. This
rule allows taxpayers to aggregate their trades or businesses with the
associated rental or intangible property under proposed Sec. 1.199A-4
if all of the requirements of proposed Sec. 1.199A-4 are met. In
addition, this rule may prevent taxpayers from improperly allocating
losses or deductions away from trades or businesses that generate
income that is eligible for a section 199A deduction.
B. Computation of the Section 199A Deduction for Individuals With
Taxable Income Below the Threshold Amount
1. Basic Computational Rules
An individual with income attributable to one or more domestic
trades or businesses, other than as a result of owning stock of a C
corporation or engaging in the trade or business of being an employee,
and with taxable income (before computing the section 199A deduction)
at or below the threshold amount, is entitled to a section 199A
deduction equal to the lesser of (i) 20 percent of the QBI (generally
defined as the net amount of qualified items of income, gain,
deduction, and loss with respect to a qualified trade or business of
the taxpayer) from the individual's trades or businesses plus 20
percent of the individual's combined qualified REIT dividends and
qualified PTP income or (ii) 20 percent of the excess (if any) of the
individual's taxable income over the individual's net capital gain.
Proposed Sec. 1.199A-1(c) contains guidance on calculating the amount
of the deduction in these circumstances. If an individual's combined
QBI is negative or combined qualified REIT dividends and PTP income is
less than zero, proposed Sec. 1.199A-1(c)(2) provides rules for the
carryover of the losses.
2. Carryover Loss Rules for Negative Total QBI Amounts
If an individual has multiple trades or businesses, the individual
must calculate the QBI from each trade or business and then net the
amounts. Section 199A(c)(2) provides that, for purposes of section
199A, if the net QBI with respect to qualified trades or businesses of
the taxpayer for any taxable year is less than zero, such amount shall
be treated as a loss from a qualified trade or business in the
succeeding taxable year. Proposed Sec. 1.199A-1(c)(2)(i) repeats this
rule and provides that the section 199A carryover rules do not affect
the deductibility of the losses for purposes of other provisions of the
Code.
3. Carryover Loss Rules if Combined Qualified REIT Dividends and
Qualified PTP Income is Less Than Zero
One commenter stated it was not clear whether, if a taxpayer has an
overall loss from combined qualified REIT dividends and qualified PTP
income (because a loss from a PTP exceeds REIT dividends and PTP
income), the negative amount should be netted against any net positive
QBI (regardless of source), or whether the negative amount should be
segregated and subject to its own loss carryforward rule distinct from
but analogous to the QBI loss carryforward rule. Section 199A
contemplates that qualified REIT dividends and qualified PTP income are
computed and taken into account separately from QBI and should not
affect QBI. If overall losses attributable to qualified REIT dividends
and qualified PTP income were netted against QBI, these losses would
affect QBI. Therefore, a separate loss carryforward rule is needed to
segregate an overall loss attributable to qualified REIT dividends and
qualified PTP income from QBI. Additionally, commenters have expressed
concern that losses in excess of income could create a negative section
199A deduction, a result incompatible with the statute. Accordingly,
proposed Sec. 1.199A-1(c)(2)(ii) provides that if an individual has an
overall loss after qualified REIT dividends and qualified PTP income
are combined, the portion of the individual's section 199A deduction
related to qualified REIT dividends and qualified PTP income is zero
for the taxable year. In addition, the overall loss does not affect the
amount of the taxpayer's QBI. Instead, such overall loss is carried
forward and must be used to offset combined qualified REIT dividends
and qualified PTP income in the succeeding taxable year or years for
purposes of section 199A.
C. Computation of the Section 199A Deduction for Individuals With
Taxable Income Above the Threshold Amount
Proposed Sec. 1.199A-1(d) addresses the calculation of the section
199A deduction for individuals with taxable income above the threshold
amount. All of the rules relating to the REIT/PTP component of the
section 199A deduction applicable to individuals with taxable income at
or below the threshold amount also apply to individuals with taxable
income above the threshold amount. The QBI component of the section
199A deduction, however, is subject to limitations for individuals with
taxable income exceeding the threshold amount. These limitations
include the exclusion or reduction of items from an SSTB and
limitations based on the W-2 wages of the trade or business or a
combination of the W-2 wages and the UBIA of qualified property.
Proposed Sec. 1.199A-1(d) provides guidance on the application of
these limitations.
Proposed Sec. 1.199A-1(d)(2)(i) addresses the limitation or
exclusion from QBI for SSTBs. SSTBs are specified service trades or
businesses as defined in section 199A(d)(2) and proposed Sec. 1.199A-5
(see part V. of the Explanation of Provisions). If an individual's
taxable income is above the threshold amount but within the phase-in
range then the individual must calculate an applicable percentage that
limits the QBI, W-2 wages, and UBIA of qualified property from an SSTB
that are used to calculate the individual's section 199A deduction. If
the individual's taxable income is above the phase-in range, then no
amount of QBI, W-2 wages, or UBIA of qualified property from an SSTB
can be used by the individual in calculating the individual's section
199A deduction.
Proposed Sec. 1.199A-1(d)(iv) addresses the limitations on QBI
based on W-2 wages and UBIA of qualified property. An individual must
determine the W-2 wages and the UBIA of qualified property attributable
to each trade or business contributing to the individual's combined QBI
under the rules of proposed Sec. 1.199A-2. The W-2 wages and UBIA of
qualified property amounts are compared to QBI in order to determine an
individual's QBI component for each trade or business.
After determining the QBI for each trade or business, the
individual must compare 20 percent of that trade or business' QBI to
the alternative limitations for that trade or business. The limitation
to which the 20 percent of QBI is compared is the greater of 50 percent
of the W-2 wages attributable to the trade or business or 25 percent of
those W-2 wages plus 2.5 percent of the UBIA of qualified property for
that trade or business. If 20 percent of the QBI of the trade or
business is greater than the relevant alternative limitation, the QBI
component is limited in the calculations
[[Page 40887]]
under the proposed regulations to the amount of the alternative
limitation. If an individual's taxable income is within the phase-in
range and 20 percent of QBI is greater than either of the limitation
amounts, the individual's QBI component for the trade or business is
instead equal to 20 percent of QBI reduced by the reduction amount as
described in proposed Sec. 1.199A-1(d)(iv)(B).
One commenter noted that, if combined QBI from all of an
individual's trades or businesses is greater than zero, but the
individual's QBI from one or more trades or businesses is less than
zero, the mechanics of how the loss should be offset against the QBI
income for purposes of calculating the section 199A deduction are
unclear. How such a loss is allocated matters in situations in which an
individual has taxable income above the threshold amount and more than
one trade or business with positive QBI. The commenter suggested that a
``netting'' approach best reflects Congress's intent, and that the
absence of a netting approach would lead to inconsistent and
counterintuitive results that Congress did not intend. The Treasury
Department and the IRS agree that a netting approach is contemplated by
the carryforward rule of section 199A(c)(2) and is necessary to ensure
results consistent with the intent of section 199A. Accordingly,
proposed Sec. 1.199A-1(d)(iii) provides that, if an individual has QBI
of less than zero from one trade or business, but has overall QBI
greater than zero when all of the individual's trades or businesses are
taken together, then the individual must offset the net income in each
trade or business that produced net income with the net loss from each
trade or business that produced net loss before the individual applies
the limitations based on W-2 wages and UBIA of qualified property. The
individual must apportion the net loss among the trades or businesses
with positive QBI in proportion to the relative amounts of QBI in such
trades or businesses. Then, for purposes of applying the limitation
based on W-2 wages and UBIA of qualified property, the net gain or
income with respect to each trade or business (as offset by the
apportioned losses) is the taxpayer's QBI with respect to that trade or
business. The W-2 wages and UBIA of qualified property from the trades
or businesses which produced negative QBI are not taken into account
for purposes of proposed Sec. 1.199A-1(d) and are not carried over
into the subsequent year. The Treasury Department and the IRS request
comments on the approach described above.
D. Special Rules
Proposed Sec. 1.199A-1(e) incorporates special rules contained in
sections 199A and 6662. Section 199A(f)(1) provides that in the case of
a partnership or S corporation, section 199A is applied at the partner
or shareholder level. The proposed regulations provide that the section
199A deduction has no effect on the adjusted basis of the partner's
interest in the partnership. With respect to S corporations, the
section 199A deduction has no effect on the adjusted basis of a
shareholder's stock in an S corporation or the S corporation's
accumulated adjustments account.
The proposed regulations provide that the deduction under section
199A does not reduce net earnings from self-employment under section
1402 or net investment income under section 1411. Therefore, both
sections 1402 and 1411 are calculated as though there is no section
199A deduction.
Section 199A(f)(1)(C) provides that if in the case of a taxpayer
with QBI from within the Commonwealth of Puerto Rico, if such income is
taxable under section 1 for a taxable year, then for purposes of
determining QBI of such individual for such taxable year, the term
``United States'' shall include the Commonwealth of Puerto Rico.
Proposed Sec. 1.199A-1(e)(3) repeats this statutory language.
Section 199A(f)(2) provides that for purposes of determining
alternative minimum taxable income under section 55, QBI shall be
determined without regard to any adjustments under sections 56 through
59. To clarify that the section 199A deduction does not result in
individuals being subject to the alternative minimum tax, proposed
Sec. 1.199A-1(e)(4) provides that, for purposes of determining
alternative minimum taxable income under section 55, the deduction
allowed under section 199A(a) for a taxable year shall be equal in
amount to the deduction allowed under section 199(A)(a) in determining
taxable income for that taxable year.
Section 6662(a) provides a penalty for an underpayment of tax
required to be shown on a return. Under section 6662(b)(2), the penalty
applies to the portion of any underpayment that is attributable to a
substantial understatement of income tax. Section 6662(d)(1) defines
substantial understatement of income tax, which is generally an
understatement that exceeds the greater of 10 percent of the tax
required to be shown on the return or $5,000. Section 6662(d)(1)(C)
provides a special rule in the case of any taxpayer who claims the
deduction allowed under section 199A for the taxable year, which
requires that section 6662(d)(1)(A) is applied by substituting ``5
percent'' for ``10 percent.'' Proposed Sec. 1.199A-1(e)(5) cross-
references this rule.
Section 199A(b)(7) provides that in the case of any qualified trade
or business of a patron of a specified agricultural or horticultural
cooperative, the amount determined under section 199A(b)(2) with
respect to such trade or business shall be reduced by the lesser of (A)
9 percent of so much of the qualified business income with respect to
such trade or business as is properly allocable to qualified payments
received from such cooperative, or (B) 50 percent of so much of the W-2
wages with respect to such trade or business as are so allocable.
Proposed Sec. 1.199A-1(e)(6) repeats this statutory language.
II. Proposed Sec. 1.199A-2: Determination of W-2 Wages and the UBIA of
Qualified Property
As described in part I.C. of this Explanation of Provisions, if an
individual's taxable income exceeds the threshold amount, section
199A(b)(2)(B) imposes a limit on the section 199A deduction based on
the greater of either (i) the W-2 wages paid, or (ii) the W-2 wages
paid and UBIA of qualified property attributable to a trade or
business. This part of this Explanation of Provisions describes the
rules in proposed Sec. 1.199A-2 regarding the determination of W-2
wages and UBIA of qualified property.
A. W-2 Wages Attributable to a Trade or Business
The W-2 wage rules of proposed Sec. 1.199A-2 generally follow the
rules under former section 199. Section 199, which was repealed by the
TCJA, provided for a deduction with respect to certain domestic
production activities and contained a W-2 wage limitation similar to
the one in section 199A. The legislative text of the W-2 wage
limitation in section 199A is modeled on the text of former section
199, and both taxpayers and the IRS have developed experience in
applying those W-2 wage rules for over a decade. The regulations under
former section 199 provided rules to determine W-2 wages, which provide
a useful starting point in developing the W-2 wage rules under section
199A, including rules on the definition of W-2 wages, wages paid by
persons other than the common-law employer, and methods for calculating
W-2 wages.
The Treasury Department and the IRS have received comments
concerning
[[Page 40888]]
whether amounts paid to workers who receive Forms W-2 from third party
payors (such as professional employer organizations, certified
professional employer organizations, or agents under section 3504) that
pay these wages to workers on behalf of their clients and report wages
on Forms W-2, with the third party payor as the employer listed in Box
c of the Forms W-2, may be included in the W-2 wages of the clients of
third party payors. In order for wages reported on a Form W-2 to be
included in the determination of W-2 wages of a taxpayer, the Form W-2
must be for employment by the taxpayer. The regulations under former
section 199, specifically Sec. 1.199-2(a)(2), addressed this issue,
providing that, since employees of the taxpayer are defined in the
regulations as including only common law employees of the taxpayer and
officers of a corporate taxpayer, taxpayers may take into account wages
reported on Forms W-2 issued by other parties provided that the wages
reported on the Forms W-2 were paid to employees of the taxpayer for
employment by the taxpayer.
Proposed Sec. 1.199A-2(b)(2)(ii) provides a rule for wages paid by
a person other than the common law employer that is substantially
similar to the rule in Sec. 1.199-2(a)(2). Specifically, the proposed
regulations provide that, in determining W-2 wages, a person may take
into account any W-2 wages paid by another person and reported by the
other person on Forms W-2 with the other person as the employer listed
in Box c of the Forms W-2, provided that the W-2 wages were paid to
common law employees or officers of the person for employment by the
person. In such cases, the person paying the W-2 wages and reporting
the W-2 wages on Forms W-2 is precluded from taking into account such
wages for purposes of determining W-2 wages with respect to that
person. Persons that pay and report W-2 wages on behalf of or with
respect to others can include certified professional employer
organizations under section 7705, statutory employers under section
3401(d)(1), and agents under section 3504. Under this rule, persons who
otherwise qualify for the deduction under section 199A are not limited
in applying the deduction merely because they use a third party payor
to pay and report wages to their employees. However, with respect to
individuals who taxpayers assert are their common law employees for
purposes of section 199A, taxpayers are reminded of their duty to file
returns and apply the tax law on a consistent basis.
Unlike former section 199, the W-2 wage limitation in section 199A
applies separately for each trade or business. Accordingly, proposed
Sec. 1.199A-2 provides that, in the case of W-2 wages that are
allocable to more than one trade or business, the portion of the W-2
wages allocable to each trade or business is determined to be in the
same proportion to total W-2 wages as the deductions associated with
those wages are allocated among the particular trades or businesses.
Section 199A(b)(4) also requires that to be taken into account, W-2
wages must be properly allocable to QBI. W-2 wages are properly
allocable to QBI if the associated wage expense is taken into account
in computing QBI.
Additionally, proposed Sec. 1.199A-2(b)(4) restates the rule of
section 199A(f)(1)(A)(iii), which provides that, in the case of a trade
or business conducted by an RPE, a partner's or shareholder's allocable
share of wages must be determined in the same manner as the partner's
allocable share or a shareholder's pro rata share of wage expenses.
Consistent with section 199A(b)(5) and the legislative history of
the TCJA, which direct the Secretary to provide rules for applying the
W-2 wage limitation in cases in which the taxpayer acquires, or
disposes of, a trade or business, the major portion of a trade or
business, or the major portion of a separate unit of a trade or
business during the year, proposed Sec. 1.199A-2(b)(2)(iv)(B) provides
rules that apply in the case of an acquisition or disposition of a
trade or business. See Joint Explanatory Statement of the Committee of
Conference, 38. Specifically, proposed Sec. 1.199A-2(b)(2)(iv)(B)(1)
provides that, in the case of an acquisition or disposition of a trade
or business, the major portion of a trade or business, or the major
portion of a separate unit of a trade or business that causes more than
one individual or entity to be an employer of the employees of the
acquired or disposed of trade or business during the calendar year, the
W-2 wages of the individual or entity for the calendar year of the
acquisition or disposition are allocated between each individual or
entity based on the period during which the employees of the acquired
or disposed of trade or business were employed by the individual or
entity, regardless of which permissible method is used for reporting
predecessor and successor wages on Form W-2. For this purpose, the
period of employment is determined consistently with the principles for
determining whether an individual is an employee described in proposed
Sec. 1.199A-2(b).
A notice of proposed revenue procedure, Notice 2018-64, 2018-35 IRB
____, which provides three methods for calculating W-2 wages is being
issued concurrently with this notice of proposed rulemaking. The three
methods in the notice are substantially similar to the methods provided
in Rev. Proc. 2006-47, 2006-2 C.B. 869, for purposes of calculating
``paragraph (e)(1) wages'' (that is, wages described in Sec. 1.199-
2(e)(1) issued under former section 199). The first method (the
unmodified Box method) allows for a simplified calculation while the
second and third methods (the modified Box 1 method and the tracking
wages method) provide for greater accuracy.
B. The UBIA of Qualified Property
Section 199A(b)(2)(B)(ii) provides an alternative deduction
limitation based on 25 percent of W-2 Wages with respect to the
qualified trade or business and 2.5 percent of the UBIA of qualified
property. Proposed Sec. 1.199A-2 restates the statutory definitions
under the qualified property rules, and provides additional guidance.
1. General Definition of UBIA of Qualified Property
Proposed Sec. 1.199A-2(c)(1) restates the definition of qualified
property in section 199A(b)(6)(A), which provides that ``qualified
property'' means tangible property of a character subject to
depreciation that is held by, and available for use in, a trade or
business at the close of the taxable year, and which is used in the
production of QBI, and for which the depreciable period has not ended
before the close of the taxable year. Proposed Sec. 1.199A-2(c)(2)
also restates the definition of depreciable period in section
199A(b)(6)(B), which provides that ``depreciable'' period means the
period beginning on the date the property is first placed in service by
the taxpayer and ending on the later of (a) the date 10 years after
that date, or (b) the last day of the last full year in the applicable
recovery period that would apply to the property under section 168(c),
regardless of the application of section 168(g).
Because the applicable recovery period under section 168(c) of the
property is not changed by any additional first-year depreciation
deduction allowable under section 168, proposed Sec. 1.199A-
2(c)(2)(ii) also clarifies that the additional first-year depreciation
deduction allowable under section 168 (for example, under section
168(k) or section 168(m)) does not affect
[[Page 40889]]
the applicable recovery period under section 168(c).
Proposed Sec. 1.199A-2(c)(3) provides a definition of UBIA. The
Treasury Department and the IRS believe that existing general
principles used to define ``unadjusted basis'' in Sec. 1.263(a)-
3(h)(5) provide a reasonable basis for an administrable rule that is
appropriate for the purposes of section 199A and that their use will
reduce compliance costs, burden, and administrative complexity because
taxpayers have experience applying them. In addition, the Treasury
Department and the IRS believe that ``immediately after acquisition''
means as of the date the property is placed in service because section
199A provides that ``qualified property'' must be used in the
production of QBI. In order to be used in the production of QBI, the
qualified property necessarily must be placed in service. Determining
UBIA as of the date the property is placed in service ensures
consistency between purchased and produced qualified property, and
reduces compliance costs, burden, and administrative complexity because
taxpayers are already required to determine that amount. Accordingly,
proposed Sec. 1.199A-2 provides that the term ``UBIA'' means the basis
as determined under section 1012 or other applicable sections of
chapter 1, including subchapter O (relating to gain or loss on
dispositions of property), subchapter C (relating to corporate
distributions and adjustments), subchapter K (relating to partners and
partnerships), and subchapter P (relating to capital gains and losses).
UBIA is determined without regard to any adjustments described in
section 1016(a)(2) or (3), any adjustments for tax credits claimed by
the taxpayer (for example, under section 50(c)), or any adjustments for
any portion of the basis for which the taxpayer has elected to treat as
an expense (for example, under sections 179, 179B, or 179C). Therefore,
for purchased or produced qualified property, UBIA generally will be
its cost under section 1012 as of the date the property is placed in
service. For qualified property contributed to a partnership in a
section 721 transaction and immediately placed in service, UBIA
generally will be its basis under section 723. For qualified property
contributed to an S corporation in a section 351 transaction and
immediately placed in service, UBIA generally will be its basis under
section 362. Further, for property inherited from a decedent and
immediately placed in service by the heir, the UBIA generally will be
its fair market value at the time of the decedent's death under section
1014. However, proposed Sec. 1.199A-2(c)(3) provides that UBIA does
reflect the reduction in basis for the percentage of the taxpayer's use
of property for the taxable year other than in the taxpayer's trade or
business.
2. Partnership Special Basis Adjustments
After the enactment of the TCJA, the Treasury Department and the
IRS received comments requesting guidance as to whether partnership
special basis adjustments under sections 734(b) or 743(b) constitute
qualified property for purposes of section 199A. Treating partnership
special basis adjustments as qualified property could result in
inappropriate duplication of UBIA of qualified property (if, for
example, the fair market value of the property has not increased and
its depreciable period has not ended). Accordingly, proposed Sec.
1.199A-2(c)(1)(iii) provides that partnership special basis adjustments
are not treated as separate qualified property.
3. Property Transferred With a Principal Purpose of Increasing Section
199A Deduction
Qualified property includes depreciable property used during the
taxable year in the production of QBI and held by, and available for
use in, the trade or business at the close of the taxable year.
However, it would be inconsistent with the purposes of section 199A to
permit trades or businesses to transfer or acquire property at the end
of the year merely to manipulate the UBIA of qualified property
attributable to the trade or business. Therefore, pursuant to the
authority granted to the Secretary under section 199A(f)(4), proposed
Sec. 1.199A-2(c)(1)(iv) provides that property is not qualified
property if the property is acquired within 60 days of the end of the
taxable year and disposed of within 120 days without having been used
in a trade or business for at least 45 days prior to disposition,
unless the taxpayer demonstrates that the principal purpose of the
acquisition and disposition was a purpose other than increasing the
section 199A deduction.
4. Like-Kind Exchanges and Involuntary Conversions
Section 199A does not provide rules to determine UBIA for qualified
property in the case of an exchange of property under section 1031
(like-kind exchange) or involuntary conversion under section 1033.
However, section 199A(h)(2) specifically instructs the Secretary to do
so. The Treasury Department and the IRS believe that existing general
principles used for like-kind exchanges and involuntary conversions
under Sec. 1.168(i)-(6) provide a useful analogy for administrable
rules that are appropriate for the purposes of section 199A and that
their use will reduce compliance costs, burden, and administrative
complexity because taxpayers have experience applying them.
Accordingly, proposed Sec. 1.199A-2(c)(2)(iii) generally follows the
rules of Sec. 1.168(i)-6 to provide that qualified property that is
acquired in a like-kind exchange, as defined in Sec. 1.168(i)-
6(b)(11), or in an involuntary conversion, as defined in Sec.
1.168(i)-6(b)(12), is treated as replacement Modified Accelerated Cost
Recovery System (MACRS) property as defined in Sec. 1.168(i)-6(b)(1)
whose depreciable period generally is determined as of the date the
relinquished property was first placed in service. Accordingly, subject
to one exception, proposed Sec. 1.199A-2(c)(2)(iii) provides that, for
purposes of determining the depreciable period, the date the exchanged
basis in the replacement qualified property is first placed in service
by the trade or business is the date on which the relinquished property
was first placed in service by the individual or RPE and the date the
excess basis in the replacement qualified property is first placed in
service by the individual or RPE is the date on which the replacement
qualified property was first placed in service by the individual or
RPE. As a result, the depreciable period under section 199A for the
exchanged basis of the replacement qualified property will end before
the depreciable period for the excess basis of the replacement
qualified property ends.
The exception is that proposed Sec. 1.199A-2(c)(2)(iii)(C)
provides that, for purposes of determining the depreciable period, if
the individual or RPE makes an election under Sec. 1.168(i)-6(i)(1)
(the election not to apply Sec. 1.168(i)-6)), the date the exchanged
basis and excess basis in the replacement qualified property are first
placed in service by the trade or business is the date on which the
replacement qualified property is first placed in service by the
individual or RPE, with UBIA determined as of that date. In this case,
the depreciable periods under section 199A for the exchanged basis and
the excess basis of the replacement qualified property will end on the
same date.
Thus, unless the exception applies, qualified property acquired in
a like-kind exchange or involuntary conversion will have two separate
placed in service dates under the
[[Page 40890]]
proposed regulations: For purposes of determining the UBIA of the
property, the relevant placed in service date will be the date the
acquired property is actually placed in service; for purposes of
determining the depreciable period of the property, the relevant placed
in service date generally will be the date the relinquished property
was first placed in service. The proposed regulations contain an
example illustrating these rules.
5. Other Nonrecognition Transactions
The Treasury Department and the IRS have received comments
requesting guidance on the application of the qualified property rules
to nonrecognition transfers involving transferred basis property within
the meaning of section 7701(a)(43) (transferred basis transactions).
For example, taxpayers and practitioners requested guidance on how to
determine the depreciable period of the property if a partnership
conducts a trade or business and qualified property is contributed to
that trade or business in a nonrecognition transfer under section
721(a). Also of relevance in the context of non-recognition transfers,
section 199A(h)(1) grants the Secretary anti-abuse authority to apply
rules similar to the rules under section 179(d)(2) (which can restrict
the expensing of certain assets in transferred basis transactions) to
prevent the manipulation of the depreciable period of qualified
property using transactions between related parties.
The Treasury Department and the IRS believe that existing general
principles used for transferred basis transactions under Sec.
168(i)(7) provide a useful analogy for administrable rules that are
appropriate for the purposes of section 199A and that their use will
reduce compliance costs, burden, and administrative complexity because
taxpayers have experience applying them. Accordingly, proposed Sec.
1.199A-2(c)(2)(iv) provides that, for purposes of determining the
depreciable period, if an individual or RPE (the transferee) acquires
qualified property in a transaction described in section 168(i)(7)(B),
the transferee determines the date on which the qualified property was
first placed in service using a two-step approach. First, for the
portion of the transferee's UBIA of the qualified property that does
not exceed the transferor's UBIA of such property, the date such
portion was first placed in service by the transferee is the date on
which the transferor first placed the qualified property in service.
Second, for the portion of the transferee's UBIA of the qualified
property that exceeds the transferor's UBIA of such property, if any,
such portion is treated as separate qualified property that the
transferee first placed in service on the date of the transfer. Thus,
qualified property acquired in these non-recognition transactions will
have two separate placed in service dates under the proposed
regulations: For purposes of determining the UBIA of the property, the
relevant placed in service date will be the date the acquired property
is placed in service by the transferee (for instance, the date the
partnership places in service property received in a section 721
transaction); for purposes of determining the depreciable period of the
property, the relevant placed in service date generally will be the
date the transferor first placed the property in service (for instance,
the date the partner placed the property in service in his or her sole
proprietorship). The proposed regulations contain an example
illustrating these rules.
The Treasury Department and the IRS request comments concerning
appropriate methods for accounting for non-recognition transactions,
including rules to prevent the manipulation of the depreciable period
of qualified property using transactions between related parties.
6. Redetermination of UBIA and Subsequent Improvements to Qualified
Property
The Treasury Department and the IRS have received comments
requesting guidance on the treatment of subsequent improvements to
qualified property. Subsequent improvements to qualified property are
generally treated as a separate item of property under section
168(i)(6). The Treasury Department and the IRS do not believe a
different approach is necessary for purposes of section 199A.
Accordingly, proposed Sec. 1.199A-2(c)(1)(ii) provides that, in the
case of any addition to, or improvement of, qualified property that is
already placed in service by the taxpayer, such addition or improvement
is treated as separate qualified property that the taxpayer first
placed in service on the date such addition or improvement is placed in
service by the taxpayer for purposes of determining the depreciable
period of the qualified property. For example, if a taxpayer acquired
and placed in service a machine on March 26, 2018, and then incurs
additional capital expenditures to improve the machine in May 2020, and
places such improvements in service on May 27, 2020, the taxpayer has
two qualified properties: The machine acquired and placed in service on
March 26, 2018, and the improvements to the machine incurred in May
2020 and placed in service on May 27, 2020.
7. Allocation of UBIA of Qualified Property by RPEs
In the case of a trade or business conducted by an RPE, section
199A(f) provides that a partner's or shareholder's allocable share of
the UBIA of qualified property is determined in the same manner as the
partner's allocable share or shareholder's pro rata share of
depreciation. Proposed Sec. 1.199A-2(a)(3) provides that, in the case
of qualified property held by an RPE, each partner's or shareholder's
share of the UBIA of qualified property is an amount that bears the
same proportion to the total UBIA of qualified property as the
partner's or shareholder's share of tax depreciation bears to the
entity's total tax depreciation attributable to the property for the
year. In the case of qualified property of a partnership that does not
produce tax depreciation during the year (for example, property that
has been held for less than 10 years but whose recovery period has
ended), each partner's share of the UBIA of qualified property is based
on how gain would be allocated to the partners pursuant to sections
704(b) and 704(c) if the qualified property were sold in a hypothetical
transaction for cash equal to the fair market value of the qualified
property. In the case of qualified property of an S corporation that
does not produce tax depreciation during the year, each shareholder's
share of the UBIA of the qualified property is a share of the UBIA
proportionate to the ratio of shares in the S corporation held by the
shareholder over the total shares of the S corporation.
III. Proposed Sec. 1.199A-3: QBI, Qualified REIT Dividends, Qualified
PTP Income
Proposed Sec. 1.199A-3 restates the definitions in section 199A(c)
and provides additional guidance on the determination of QBI, qualified
REIT dividends, and qualified PTP income.
A. QBI
Section 199A(c)(1) provides that the term ``QBI'' means, for any
taxable year, the net amount of qualified items of income, gain,
deduction, and loss attributable to any qualified trade or business of
the taxpayer. QBI does not include any qualified REIT dividends or
qualified PTP income. Section 199A(c)(3)(A) provides that the term
``qualified items of income, gain, deduction, and loss'' means items of
income, gain, deduction, and loss to the
[[Page 40891]]
extent such items are (i) effectively connected with the conduct of a
trade or business within the United States (within the meaning of
section 864(c), determined by substituting ``qualified trade or
business (within the meaning of section 199A)'' for ``nonresident alien
individual or a foreign corporation'' or for ``a foreign corporation''
each place it appears), and (ii) included or allowed in determining
taxable income for the taxable year. Section 199A(c)(3)(B) provides a
list of items that are not taken into account as qualified items of
income, gain, deduction, and loss, including capital gain or loss,
dividends, interest income other than interest income properly
allocable to a trade or business, amounts received from an annuity
other than in connection with a trade or business, certain items
described in section 954, and items of deduction or loss properly
allocable to these items. Section 199A(c)(4) provides that QBI does not
include reasonable compensation paid to the taxpayer by any qualified
trade or business of the taxpayer for services rendered with respect to
the trade or business, any guaranteed payment described in section
707(c) paid to a partner for services rendered with respect to the
trade or business, and to the extent provided in regulations, any
payment described in section 707(a) to a partner for services rendered
with respect to the trade or business.
i. Treatment of Section 751 Gain
The Treasury Department and the IRS have received comments stating
that it is unclear whether gain or loss that is treated as ordinary
income under section 751 should be QBI if the section 751 income meets
all of the other requirements to be QBI. This uncertainty is caused
because section 199A(e)(5) lists: (i) The taxpayer's allocable share of
the QBI from a publicly traded partnership and (ii) income described in
section 751(a) as separate categories of qualified publicly traded
partnership income, which could be read to imply that income described
in section 751 is not QBI. Section 1.199-5(f), issued under former
section 199, specifically included section 751(a) or (b) gains as
domestic production gross receipts.
The Treasury Department and the IRS do not view the statutory
reference to section 751(a) gain as qualified PTP income to exclude
section 751 gain from being QBI, but rather view such reference as
clarifying the rules for PTPs. Accordingly, proposed Sec. 1.199A-
3(b)(1)(i) clarifies that any gain attributable to assets of a
partnership giving rise to ordinary income under section 751(a) or (b)
is considered attributable to the trades or businesses conducted by the
partnership, and therefore, may constitute QBI if the other
requirements of section 199A and proposed Sec. 1.199A-3 are satisfied.
ii. Guaranteed Payments for the Use of Capital
Because guaranteed payments for the use of capital under section
707(c) are determined without regard to the income of the partnership,
proposed Sec. 1.199A-3(b)(1)(ii) provides that such payments are not
considered attributable to a trade or business, and thus do not
constitute QBI. However, the partnership's related expense for making
the guaranteed payments may constitute QBI if the other requirements
are satisfied.
iii. Section 481 Adjustments
Section 1.199-8(g), issued under former section 199, provides rules
on how section 481(a) adjustments are taken into account for purposes
of former section 199. Similarly, proposed Sec. 1.199A-3(b)(1)(iii)
provides that section 481 adjustments attributable to a trade or
business, whether positive or negative, and arising in a taxable year
ending after December 31, 2017, are treated as attributable to that
trade or business. Accordingly, such section 481 adjustments will
constitute QBI to the extent the requirements of section 199A,
including proposed Sec. 1.199A-3, are satisfied. Section 481
adjustments arising in a taxable year ending before January 1, 2018, do
not constitute QBI.
iv. Previously Suspended Losses
Several sections of the Code, including sections 465, 469, 704(d),
and 1366(d), provide for disallowance of losses and deductions in
certain cases. Generally, the disallowed amounts are suspended and
carried forward to the following year, at which point they are re-
tested and may become allowable. Proposed Sec. 1.199A-3(b)(1)(iv)
provides that, to the extent that any previously disallowed losses or
deductions are allowed in the taxable year, they are treated as items
attributable to the trade or business. However, losses or deductions
that were disallowed for taxable years beginning before January 1,
2018, are not taken into account for purposes of computing QBI in a
later taxable year.
v. Net Operating Losses
Generally, items giving rise to a net operating loss are allowed in
computing taxable income in the year incurred. Because those items
would have been taken into account in computing QBI in the year
incurred, the net operating loss should not be treated as QBI in
subsequent years. Otherwise, the same loss could be taken into account
in multiple tax years. However, losses disallowed by section 461(l)
give rise to a net operating loss without ever having been allowable in
computing taxable income. Thus, if deductions are disallowed by reason
of 461(l), those disallowed deductions will not be included in the QBI
computation in the year incurred (because they are not includable in
taxable income), and, if the resulting net operating loss also is not
included in the QBI computation, the deduction would permanently escape
the QBI rules. This result would be inappropriate. Accordingly,
proposed Sec. 1.199A-3(b)(1)(v) provides that generally, a deduction
under section 172 for a net operating loss is not considered
attributable to a trade or business and therefore, is not taken into
account in computing QBI. However, to the extent the net operating loss
is comprised of amounts attributable to a trade or business that were
disallowed under section 461(l), the net operating loss is considered
attributable to that trade or business, and will constitute QBI to the
extent the requirements of section 199A, including proposed Sec.
1.199A-3, are satisfied.
The Treasury Department and the IRS request comments regarding the
interaction of section 199A and 461(l) generally.
vi. Requirement That an Item Be Effectively Connected With a U.S. Trade
or Business
Section 199A applies to all noncorporate taxpayers, whether such
taxpayers are domestic or foreign. Accordingly, section 199A applies to
both U.S. citizens and resident aliens as well as nonresident aliens
that have QBI. As noted previously in this Explanation of Provisions,
QBI includes items of income, gain, deduction, and loss to the extent
such items are (i) included or allowed in determining taxable income
for the taxable year and (ii) effectively connected with the conduct of
a trade or business within the United States (within the meaning of
section 864(c), determined by substituting ``qualified trade or
business (within the meaning of section 199A)'' for ``nonresident alien
individual or a foreign corporation'' or for ``a foreign corporation''
each place it appears).
[[Page 40892]]
a. Summary of Rules for Generally Determining Whether Income Is
Effectively Connected With a United States Trade or Business
Section 864(c) provides rules that nonresident alien individuals
and foreign corporations use to determine which items of income, gain,
or loss are effectively connected with a United States trade or
business. Section 873(a) permits nonresident aliens to deduct expenses
only if and to the extent that they are connected with, or properly
allocable and apportioned to, income effectively connected with a
United States trade or business.
Thus, for example, a U.S. partner of a partnership that operates a
trade or business in both the United States and in a foreign country
would only include the items of income, gain, deductions, and loss that
would be effectively connected with a United States trade or business.
Similarly, a shareholder of an S corporation that is engaged in a trade
or business in both the United States and in a foreign country would
only take into account the items of income, gain, deduction, and loss
that would be effectively connected to the portion of the business
conducted by the S corporation in the United States, determined by
applying the principles of section 864(c).
In general, whether a nonresident alien is engaged in a trade or
business within the United States, as opposed to a trade or business
conducted solely outside the United States, is based upon the all the
facts and circumstances, as developed through case law and other
published guidance. Pursuant to section 875(1), a nonresident alien is
considered engaged in a trade or business within the United States if
the partnership of which such individual is a member is so engaged.
Section 864(b) provides that the term ``trade or business within
the United States'' includes (but is not limited to) the performance of
personal services within the United States at any time during the
taxable year, but excludes the performance of services described in
section 864(b)(1) and (2). Section 864(b)(1) covers a limited set of
nonresident aliens who perform services in the United States on behalf
of foreign persons not otherwise engaged in a U.S. trade or business,
or on behalf of U.S. persons through a foreign office, if the
nonresident aliens are present in the United States less than 90 days
during the taxable year and their compensation does not exceed $3,000.
Section 864(b)(2) generally treats foreign persons, including
partnerships, who are trading in stocks, securities, and in commodities
for their own account or through a broker or other independent agent as
not engaged in a United States trade or business.
b. Application to Section 199A
Although the cross reference in section 199A(c)(3)(A)(i) to section
864 is limited to paragraph (c) of that section, no income derived from
excluded services under section 864(b)(1) or (2) could ever be
effectively connected income in the hands of a nonresident alien.
Accordingly, section 199A incorporates the specific rules regarding the
scope of the term ``trade or business in the United States'' in
determining QBI. As such, if a trade or business is not engaged in a
U.S. trade or business by reason of section 864(b), items of income,
gain, deduction, or loss from that trade or business will not be
included in QBI because such items would not be effectively connected
with the conduct of a U.S. trade or business.
If a trade or business is determined to be conducted in the United
States, section 864(c)(3) generally treats all income of a nonresident
alien from sources within the United States as effectively connected
with the conduct of a U.S. trade or business. However, any income from
sources within the United States described in section 871(a)(1) or (h)
and any gain or loss from the sale of capital assets are only
effectively connected if the income meets requirements of section
864(c)(2) and the regulations thereunder. Under section 864(c)(4),
income from sources without the United States is generally not treated
as effectively connected with the conduct of a U.S. trade or business
unless an exception under section 864(c)(4)(B) applies. Thus, a trade
or business's foreign source income, gain, or loss, (and any deductions
effectively connected with such foreign source income, gain, or loss)
would generally not be included in QBI, unless the income meets an
exception in section 864(c)(4)(B). Whether income is U.S. or foreign
sourced is determined under sections 861, 862, 863, and 865, and the
regulations thereunder.
This rule does not mean that any item that is effectively connected
with the conduct of a trade or business with the United States is
therefore QBI. As discussed previously, the item must also be ``with
respect to'' a trade or business. Certain provisions of the Code allow
items to be treated as effectively connected, even though they are not
with respect to a trade or business. For example, section 871(d) allows
a nonresident alien individual to elect to treat income from real
property in the United States that would not otherwise be treated as
effectively connected with the conduct of a trade or business within
the United Sates as effectively connected. However, for purposes of
section 199A, if items are not attributable to a trade or business
under 162, such items do not constitute QBI.
Similarly, the fact that a deduction is allowed for purposes of
computing effectively connected taxable income does not necessarily
mean that it is taken into account for purposes of section 199A. For
example, for purposes of computing effectively connected taxable
income, section 873(b) allows certain deductions, including for theft
losses of property located within the United States and charitable
contributions allowed under section 170, to be taken into account
regardless of whether they are connected with income that is
effectively connected with the conduct of a trade or business within
the United States. However, for purposes of section 199A, these items
would not be taken into account because section 199A only permits a
deduction for income that is both attributable to a trade or business
and that is also effectively connected income.
vii. Exclusion From QBI for Certain Items
a. Treatment of Section 1231 Gains and Losses
Section 199A(c)(3)(B)(i) provides that QBI does not include any
item of short-term capital gain, short-term capital loss, long-term
capital gain, or long-term capital loss. The Treasury Department and
the IRS have received comments requesting guidance on the extent to
which gains and losses subject to section 1231 may be taken into
account in calculating QBI. Section 1231 provides rules under which
gains and losses from certain involuntary conversions and the sale of
certain property used in a trade or business are either treated as
long-term capital gains or long-term capital losses, or not treated as
gains and losses from sales or exchanges of capital assets.
Section 199A(c)(3)(B)(i) excludes capital gains or losses,
regardless of whether those items arise from the sale or exchange of a
capital asset. The legislative history of section 199A provides that
QBI does not include any item taken into account in determining net
long-term capital gain or net long-term capital loss. Conference Report
page 30. Accordingly, proposed Sec. 1.199A-3(b)(2)(ii)(A) clarifies
that, to the extent gain or loss is treated as capital gain or loss, it
is not included in QBI. Specifically, if gain or loss is
[[Page 40893]]
treated as capital gain or loss under section 1231, it is not QBI.
Conversely, if section 1231 provides that gains or losses are not
treated as gains and losses from sales or exchanges of capital assets,
section 199A(c)(3)(B)(i) does not apply and thus, the gains or losses
must be included in QBI (provided all other requirements are met).
b. Interest Income
Section 199A(c)(4)(C) provides that QBI does not include any
interest income other than interest income that is properly allocable
to a trade or business. The Treasury Department and the IRS believe
that interest income received on working capital, reserves, and similar
accounts is not properly allocable to a trade or business, and
therefore should not be included in QBI, because such interest income,
although held by a trade or business, is simply income from assets held
for investment. Accordingly, proposed Sec. 1.199A-3(b)(2)(ii)(C)
provides that interest income received on working capital, reserves,
and similar accounts is not properly allocable to a trade or business.
In contrast, interest income received on accounts or notes receivable
for services or goods provided by the trade or business is not income
from assets held for investment, but income received on assets acquired
in the ordinary course of trade or business.
c. Reasonable Compensation
Section 199A(c)(4)(A) provides that QBI does not include
``reasonable compensation paid to the taxpayer by any qualified trade
or business of the taxpayer for services rendered with respect to the
trade or business.'' Similarly, guaranteed payments for services under
section 707(c) are excluded from QBI. The phrase ``reasonable
compensation'' is a well-known standard in the context of S
corporations. Under Rev. Rul. 74-44, 1974-1 C.B. 287, S corporations
must pay shareholder-employees ``reasonable compensation for services
performed'' prior to making ``dividend'' distributions with respect to
shareholder-employees' stock in the S corporation under section 1368.
See also David E. Watson, P.C. v. United States, 668 F.3d 1008, 1017
(8th Cir. 2012). The legislative history of section 199A confirms that
the reasonable compensation rule was intended to apply to S
corporations.
The Treasury Department and the IRS have received requests for
guidance on whether the phrase ``reasonable compensation'' within the
meaning of section 199A extends beyond the context of S corporations
for purposes of section 199A. The Treasury Department and the IRS
believe ``reasonable compensation'' is best read as limited to the
context from which it derives: Compensation of S corporation
shareholders-employees. If reasonable compensation were to apply
outside of the context of S corporations, a partnership could be
required to apply the concept of reasonable compensation to its
partners, regardless of whether amounts paid to partners were
guaranteed. Such a result would violate the principle set forth in Rev.
Rul. 69-184, 1969-1 CB 256, that a partner of a partnership cannot be
an employee of that partnership. There is no indication that Congress
intended to change this long-standing Federal income tax principle.
Accordingly, proposed Sec. 1.199A-3(b)(2)(ii)(H) provides that QBI
does not include reasonable compensation paid by an S corporation but
does not extend this rule to partnerships. Because the trade or
business of performing services as an employee is not a qualified trade
or business under section 199A(d)(1)(B), wage income received by an
employee is never QBI. The rule for reasonable compensation is merely a
clarification that, even if an S corporation fails to pay a reasonable
wage to its shareholder-employees, the shareholder-employees are
nonetheless prevented from including an amount equal to reasonable
compensation in QBI.
d. Guaranteed Payments
Section 199A(c)(4)(B) provides that QBI does not include any
guaranteed payment described in section 707(c) paid by a partnership to
a partner for services rendered with respect to the trade or business.
Proposed Sec. 1.199A-3(b)(2)(ii)(I) restates this statutory rule and
clarifies that the partnership's deduction for such guaranteed payment
is an item of QBI if it is properly allocable to the partnership's
trade or business and is otherwise deductible for Federal income tax
purposes. It may be unclear whether a guaranteed payment to an upper-
tier partnership for services performed for a lower-tier partnership is
QBI for the individual partners of the upper-tier partnership if the
upper-tier partnership does not itself make a guaranteed payment to its
partners. Section 199A(c)(4)(B) does not limit the term ``partner'' to
an individual. Consequently, for purposes of the guaranteed payment
rule, a partner may be an RPE. Accordingly, proposed Sec. 1.199A-
3(b)(2)(ii)(I) clarifies that QBI does not include any guaranteed
payment described in section 707(c) paid to a partner for services
rendered with respect to the trade or business, regardless of whether
the partner is an individual or an RPE. Therefore, for the purposes of
this rule, a guaranteed payment paid by a lower-tier partnership to an
upper-tier partnership retains its character as a guaranteed payment
and is not included in QBI of a partner of the upper-tier partnership
regardless of whether it is guaranteed to the ultimate recipient.
e. Section 707(a) Payments
Section 199A(c)(4)(C) provides that QBI does not include, to the
extent provided in regulations, any payment described in section 707(a)
to a partner for services rendered with respect to the trade or
business. Section 707(a) addresses arrangements in which a partner
engages with the partnership other than in its capacity as a partner.
Within the context of section 199A, payments under section 707(a) for
services are similar to, and therefore, should be treated similarly as,
guaranteed payments, reasonable compensation, and wages, none of which
is includable in QBI. In addition, consistent with the tiered
partnership rule for guaranteed payments described previously, to the
extent an upper-tier RPE receives a section 707(a) payment, that income
should not constitute QBI to the partners of the upper-tier entity.
Accordingly, proposed Sec. 1.199A-3(b)(2)(ii)(J) provides that QBI
does not include any payment described in section 707(a) to a partner
for services rendered with respect to the trade or business, regardless
of whether the partner is an individual or an RPE. The Treasury
Department and the IRS request comments on whether there are situations
in which it is appropriate to include section 707(a) payments in QBI.
viii. Allocation of Items Not Clearly Attributable to a Single Trade or
Business
Proposed Sec. 1.199A-3(b)(5) provides that, if an individual or an
RPE directly conducts multiple trades or businesses, and has items of
QBI that are properly attributable to more than one trade or business,
the taxpayer or entity must allocate those items among the several
trades or businesses to which they are attributable using a reasonable
method that is consistent with the purposes of section 199A. The chosen
reasonable method for each item must be consistently applied from one
taxable year to another and must clearly reflect the income of each
trade or business. There are several different ways to allocate
expenses, such as direct tracing or allocating based on gross income,
but whether these are reasonable depends on the facts and circumstances
of each
[[Page 40894]]
trade or business. The Treasury Department and the IRS are considering
whether ``reasonable method'' should be defined to include the direct
tracing method, allocations based on gross income, or other methods,
within appropriate parameters. The Treasury Department and the IRS
request comments on reasonable methods for the allocation of items not
clearly attributable to a single trade or business and whether any safe
harbors may be appropriate.
B. Qualified REIT Dividends and Qualified PTP Income
Proposed Sec. 1.199A-3(c)(1) restates the statutory provisions
regarding qualified REIT dividends and provides additional guidance
relating to such dividends. Pursuant to the regulatory authority
conferred under section 199A(f)(4), proposed Sec. 1.199A-3(c) provides
an anti-abuse rule to prevent dividend stripping and similar
transactions aimed at capturing qualified REIT dividends without having
economic exposure to the REIT stock for a meaningful period of time.
The proposed anti-abuse rule incorporates the principles of section
246(c).
Proposed Sec. 1.199A-3(c)(2) restates the statutory provisions
regarding qualified PTP income and provides additional guidance
regarding such income. One commenter questioned whether section 751
income recognized upon the sale of an interest in a PTP must meet the
standards for QBI (such as the requirement that the income be
effectively connected with a U.S. trade or business) to qualify as
qualified PTP income. Section 199A includes special rules exempting
qualified PTP income from the W-2 wage and UBIA of qualified property
limitations. However, these statutory rules do not exempt qualified PTP
income from the other QBI requirements. Accordingly, proposed Sec.
1.199A-3(c)(3)(ii) clarifies that the other rules applicable to the
determination of QBI apply to the determination of qualified PTP
income.
IV. Proposed Sec. 1.199A-4: Aggregation Rules
A. Overview
The proposed regulations incorporate the rules under section 162
for determining whether a trade or business exists for purposes of
section 199A. A taxpayer can have more than one trade or business for
purposes of section 162. See Sec. 1.446-1(d)(1). However, in most
cases, a trade or business cannot be conducted through more than one
entity.
The Treasury Department and the IRS have received comments
requesting that the regulations provide that taxpayers be permitted to
group or ``aggregate'' trades or businesses under section 199A using
the grouping rules described in Sec. 1.469-4 (grouping rules). Section
1.469-4 sets forth the rules for grouping a taxpayer's trade or
business activities and rental activities for purposes of applying the
passive activity loss and credit limitation rules of section 469.
Section 469 uses the term ``activities'' in determining the application
of the limitation rules under section 469. In contrast, section 199A
applies to trades or businesses. By focusing on activity, the grouping
rules may be both under and over inclusive in determining what
activities give rise to a trade or business for section 199A purposes.
Additionally, section 469 is a loss limitation rule used to prevent
taxpayers from sheltering passive losses with nonpassive income. The
section 199A deduction is not based on the level of a taxpayer's
involvement in the trade or business (that is, both active and passive
owners of a trade or business may be entitled to a section 199A
deduction if they otherwise satisfy the requirements of section 199A
and these proposed regulations). Complicating matters further, a
taxpayer's section 469 groupings may include specified service trades
or businesses, requiring separate rules to segregate the two categories
of trades or businesses to calculate the section 199A deduction.
Therefore, the grouping rules under section 469 are not appropriate
for determining a trade or business for section 199A purposes.
Accordingly, the Treasury Department and the IRS are not adopting the
section 469 grouping rules as the means by which taxpayers can
aggregate trades or businesses for purposes of applying section 199A.
Although it is not appropriate to apply the grouping rules under
section 469 to section 199A, the Treasury Department and the IRS agree
with practitioners that some amount of aggregation should be permitted.
It is not uncommon for what are commonly thought of as single trades or
businesses to be operated across multiple entities. Trades or
businesses may be structured this way for various legal, economic, or
other non-tax reasons. The fact that businesses are operated across
entities raises the question of whether, in defining trade or business
for purposes of section 199A, section 162 trades or businesses should
be permitted or required to be aggregated or disaggregated, and if so,
whether such aggregation or disaggregation should occur at the entity
level or the individual level. Allowing taxpayers to aggregate trades
or businesses offers taxpayers a means of combining their trades or
businesses for purposes of applying the W-2 wage and UBIA of qualified
property limitations and potentially maximizing the deduction under
section 199A. If such aggregation is not permitted, taxpayers could be
forced to incur costs to restructure solely for tax purposes. In
addition, business and non-tax law requirements may not permit many
taxpayers to restructure their operations. Therefore, proposed Sec.
1.199A-4 permits the aggregation of separate trades or businesses,
provided certain requirements are satisfied.
The Treasury Department and the IRS are aware that many commenters
were concerned with having multiple regimes for grouping (that is,
under sections 199A, 1411, and 469). Accordingly, comments are
requested on the aggregation method described in proposed Sec. 1.199A-
4, including whether this would be an appropriate grouping method for
purposes of sections 469 and 1411, in addition to section 199A.
B. Aggregation Rules
Under proposed Sec. 1.199A-4, aggregation is permitted but is not
required. However, an individual may aggregate trades or businesses
only if the individual can demonstrate that the requirements in
proposed Sec. 1.199A-4(b)(1) are satisfied. First, consistent with
other provisions in the proposed regulations, each trade or business
must itself be a trade or business as defined in Sec. 1.199A-1(b)(13).
Second, the same person, or group of persons, must directly or
indirectly, own a majority interest in each of the businesses to be
aggregated for the majority of the taxable year in which the items
attributable to each trade or business are included in income. All of
the items attributable to the trades or businesses must be reported on
returns with the same taxable year (not including short years).
Proposed Sec. 1.199A-4(b)(3) provides rules allowing for family
attribution. Because the proposed rules look to a group of persons,
non-majority owners may benefit from the common ownership and are
permitted to aggregate. The Treasury Department and the IRS considered
certain reporting requirements in which the majority owner or group of
owners would be required to provide information about all of the other
pass-through entities in which they held a majority interest. Due to
the complexity and potential burden
[[Page 40895]]
on taxpayers of such an approach, proposed Sec. 1.199A-4 does not
provide such a reporting requirement. The Treasury Department and the
IRS request comments on whether a reporting or other information
sharing requirement should be required.
Third, none of the aggregated trades or businesses can be an SSTB.
Proposed Sec. 1.199A-5 addresses SSTBs and trades or businesses with
SSTB income.
Fourth, individuals and trusts must establish that the trades or
businesses meet at least two of three factors, which demonstrate that
the businesses are in fact part of a larger, integrated trade or
business. These factors include: (1) The businesses provide products
and services that are the same (for example, a restaurant and a food
truck) or they provide products and services that are customarily
provided together (for example, a gas station and a car wash); (2) the
businesses share facilities or share significant centralized business
elements (for example, common personnel, accounting, legal,
manufacturing, purchasing, human resources, or information technology
resources); or (3) the businesses are operated in coordination with, or
reliance on, other businesses in the aggregated group (for example,
supply chain interdependencies).
C. Individuals
An individual is permitted to aggregate trades or businesses
operated directly and trades or businesses operated through RPEs.
Individual owners of the same RPEs are not required to aggregate in the
same manner.
An individual directly engaged in a trade or business must compute
QBI, W-2 wages, and UBIA of qualified property for each trade or
business before applying the aggregation rules. If an individual has
aggregated two or more trades or businesses, then the combined QBI, W-2
wages, and UBIA of qualified property for all aggregated trades or
businesses is used for purposes of applying the W-2 wage and UBIA of
qualified property limitations described in proposed Sec. 1.199A-
1(d)(2)(iv).
D. RPEs
RPEs must compute QBI, W-2 wages, and UBIA of qualified property
for each trade or business. An RPE must provide its owners with
information regarding QBI, W-2 wages, and UBIA of qualified property
attributable to its trades or businesses.
The Treasury Department and the IRS considered permitting
aggregation by an RPE in a tiered structure. The Treasury Department
and the IRS considered several approaches to tiered structures,
including permitting only the operating entity to aggregate the trades
or businesses or permitting each tier to add to the aggregated trade or
business from a lower-tier, provided that the combined aggregated trade
or business otherwise satisfied the requirements of proposed Sec.
1.199A-4(b)(1) had the businesses all been owned by the lower-tier
entity. The Treasury Department and the IRS are concerned that the
reporting requirements needed for either of these rules would be overly
complex for both taxpayers and the IRS to administer. In addition,
because the section 199A deduction is in all cases taken at the
individual level, it should not be detrimental, and in fact may provide
flexibility to taxpayers, to provide for aggregation at only one level.
The Treasury Department and the IRS request comments on the proposed
approach to tiered structures and the reporting necessary to allow an
individual to demonstrate to which trades or businesses his or her QBI,
W-2 wages, and UBIA of qualified property are attributable for purposes
of calculating his or her section 199A deduction.
E. Reporting and Consistency
Proposed Sec. 1.199A-4(c)(1) requires that once multiple trades or
businesses are aggregated into a single aggregated trade or business,
individuals must consistently report the aggregated group in subsequent
tax years. Proposed Sec. 1.199A-4(c)(1) provides rules for situations
in which the aggregation rules are no longer met as well as rules for
when a newly created or acquired trade or business can be added to an
existing aggregated group.
Proposed Sec. 1.199A-4(c)(2)(i) provides reporting and disclosure
requirements for individuals that choose to aggregate, including
identifying information about each trade or business that constitutes a
part of the aggregated trade or business. Proposed Sec. 1.199A-
4(c)(2)(ii) allows the Commissioner to disaggregate trades or
businesses if an individual fails to make the required aggregation
disclosure. The Treasury Department and the IRS request comments as to
whether it is administrable to create a standard under which trades or
businesses will be disaggregated by the Commissioner and what that
standard might be.
V. Proposed Sec. 1.199A-5: Specified Service Trade or Business and the
Trade or Business of Performing Services as an Employee
Section 199A(c)(1) provides that only items attributable to a
qualified trade or business are taken into account in determining the
section 199A deduction for QBI. Section 199A(d)(1) provides that a
``qualified trade or business'' means any trade or business other than
(A) an SSTB, or (B) the trade or business of performing services as an
employee.
A. SSTB
This part V.A. explains the provisions under proposed Sec. 1.199A-
5 relating to SSTBs. First, the effect of classification as an SSTB is
discussed. Second, the exceptions for taxpayers below the threshold
amount and a de minimis exception are described. Third, guidance is
provided on the meaning of the activities listed in the definition of
SSTB. Fourth, the rules for determining whether a trade or business is
treated as part of an SSTB are described. Finally, rules regarding
classification as an employee for purposes of section 199A are
discussed.
1. Effect of being an SSTB
a. General Rule
Consistent with section 199A, proposed Sec. 1.199A-5(a)(2)
provides that, unless an exception applies, if a trade or business is
an SSTB, none of its items are to be taken into account for purposes of
determining a taxpayer's QBI. In the case of an SSTB conducted by an
entity, such as a partnership or an S corporation, if it is determined
that the trade or business is an SSTB, none of the income from that
trade or business flowing to an owner of the entity is QBI, regardless
of whether the owner participates in the specified service activity.
Therefore, a direct or indirect owner of a trade or business engaged in
an SSTB is treated as engaged in the SSTB for purposes of section 199A
regardless of whether the owner is passive or participated in the SSTB.
Similarly, none of the W-2 wages or UBIA of qualified property will be
taken into account for purposes of section 199A. For example, because
the field of athletics is an SSTB, if a partnership owns a professional
sports team, the partners' distributive shares of income from the
partnership's athletics trade or business is not QBI, regardless of
whether the partners participate in the partnership's trade or
business. Proposed Sec. 1.199A-5 contains further examples
illustrating the operation of this rule.
b. Exceptions to the General Rule
Under section 199A(d)(3), individuals with taxable income below the
threshold amount are not subject to a restriction with respect to
SSTBs. Therefore, if an individual or trust has taxable income below
the threshold amount, the individual or trust is
[[Page 40896]]
eligible to receive the deduction under section 199A notwithstanding
that a trade or business is an SSTB. As described in part I.C of this
Explanation of Provisions, the exclusion of QBI, W-2 wages, and UBIA of
qualified property from the computation of the section 199A deduction
is subject to a phase-in for individuals with taxable income within the
phase-in range. The application of this phase-in is determined at the
individual, trust, or estate level, which may not be where the trade or
business is operated. Therefore, if a partnership or an S corporation
operates an SSTB, the application of the threshold does not depend on
the partnership or S corporation's taxable income but rather, the
taxable income of the individual partner or shareholder claiming the
section 199A deduction. For example, if the partnership's taxable
income is less than the threshold amount, but each of the partnership's
individual partners have income that exceeds the threshold amount plus
$50,000 ($100,000 in the case of a joint return) then none of the
partners may claim a section 199A deduction with respect to any income
from the partnership's SSTB.
An RPE conducting an SSTB may not know whether the taxable income
of any of its equity owners is below the threshold amount. However, the
RPE is best positioned to make the determination as to whether its
trade or business is an SSTB. Therefore, reporting rules under proposed
Sec. 1.199A-6(b)(3)(B) requires each RPE to determine whether it
conducts an SSTB and disclose that information to its partners,
shareholders, or owners. With respect to each trade or business, once
it is determined that a trade or business is an SSTB, it remains an
SSTB and cannot be aggregated with other trades or business. In the
case of a trade or business conducted by an individual, such as a sole
proprietorship, disregarded entity, or grantor trust, the determination
of whether the business is an SSTB is made by the individual.
Section 199A defines an SSTB to include any trade or business that
``involves the performance of services in'' a specified service
activity. Although the statute, read literally, does not suggest that a
certain quantum of specified service activity is necessary to find an
SSTB, the Treasury Department and the IRS believe that requiring all
taxpayers to evaluate and quantify any amount of specified service
activity would create administrative complexity and undue burdens for
both taxpayers and the IRS. Therefore, analogous to the regulations
under section 448, it is appropriate to provide a de minimis rule,
under which a trade or business will not be considered to be an SSTB
merely because it provides a small amount of services in a specified
service activity.
Accordingly, proposed Sec. 1.199A-5(c)(1) provides that a trade or
business (determined before the application of the aggregation rules in
proposed Sec. 1.199A-4) is not an SSTB if the trade or business has
gross receipts of $25 million or less (in a taxable year) and less than
10 percent of the gross receipts of the trade or business is
attributable to the performance of services in an SSTB. For trades or
business with gross receipts greater than $25 million (in a taxable
year), a trade or business is not an SSTB if less than 5 percent of the
gross receipts of the trade or business are attributable to the
performance of services in an SSTB.
2. Definition of Specified Service Trade or Business
The definition of an SSTB set forth in section 199A incorporates,
with modifications, the text of section 1202(e)(3)(A). The text of
section 1202(e)(3)(A) substantially tracks the definition of
``qualified personal service corporation'' under section 448.
Therefore, consistent with ordinary rules of statutory construction,
the guidance in proposed Sec. 1.199A-5(b) is informed by existing
interpretations and guidance under both sections 1202 and 448 when
relevant. However, existing guidance under those sections is sparse and
the scope and purpose of those sections and section 199A are different.
The Treasury Department and the IRS also note that, unlike sections
1202(e)(3)(A) and 448, the purpose of section 199A is to provide a
deduction based on the character of the taxpayer's trade or business.
Distinct guidance for section 199A is warranted. Therefore, the
guidance in proposed Sec. 1.199A-5(b) applies only to section 199A,
not sections 1202 and 448.
a. Guidance on the Meaning of the Listed Activities
Section 199A(d)(2)(A) provides that an SSTB is any trade or
business described in section 1202(e)(3)(A) (applied without regard to
the words ``engineering [and] architecture'') or that would be so
described if the term ``employees or owners'' were substituted for
``employees'' therein. Section 199A(d)(2)(B) provides that an SSTB is
any trade or business that involves the performance of services that
consist of investing and investment management, trading, or dealing in
securities (as defined in section 475(c)(2)), partnership interests, or
commodities (as defined in section 475(e)(2)).
Section 1202 provides an exclusion from gross income for some or
all of the gain on the sale of certain qualified small business stock.
Section 1202 generally requires that, for stock to be qualified small
business stock, the corporation must be engaged in a qualified trade or
business. Section 1202(e)(3) provides that, for purposes of section
1201(e), the term ``qualified trade or business'' means any trade or
business other than any trade or business involving the performance of
services in the fields of health, law, engineering, architecture,
accounting, actuarial science, performing arts, consulting, athletics,
financial services, brokerage services, or any trade or business where
the principal asset of such trade or business is the reputation or
skill of 1 or more of its employees; any banking, insurance, financing,
leasing, investing, or similar business; any farming business
(including the business of raising or harvesting trees); any business
involving the production or extraction of products of a character with
respect to which a deduction is allowable under section 613 or 613A;
and any business of operating a hotel, motel, restaurant, or similar
business.
Thus, after application of the modifications described in section
199A(d)(2)(A), the definition of an SSTB for purposes of section 199A
is (1) any trade or business involving the performance of services in
the fields of health, law, accounting, actuarial science, performing
arts, consulting, athletics, financial services, brokerage services, or
any trade or business where the principal asset of such trade or
business is the reputation or skill of one or more of its employees or
owners, and (2) any trade or business that involves the performance of
services that consist of investing and investment management, trading,
or dealing in securities (as defined in section 475(c)(2)), partnership
interests, or commodities (as defined in section 475(e)(2)).
The Treasury Department and the IRS have received comments
requesting guidance on the meaning and scope of the various trades or
businesses described in the preceding paragraph. The Treasury
Department and the IRS agree with commenters that guidance with respect
to these trades or businesses is necessary for several reasons. Most
importantly, section 199A is a new Code provision intended to benefit a
wide range of businesses, and taxpayers need certainty in determining
whether their trade or business generates income that is eligible for
the
[[Page 40897]]
section 199A deduction. As previously discussed, given the differing
scope, objectives, and, in some respects, language of sections 199A,
448, and 1202, the guidance under sections 1202(e)(3)(A) and 448(d)(2)
is not an appropriate substitute for clear and distinct guidance
governing what constitutes an SSTB under section 199A. In particular,
some SSTBs are listed in section 1202(e)(3)(A), but not listed in
section 448(d)(2), such as athletics, financial services, brokerage
services, and any trade or business where the principal asset of such
trade or business is the reputation or skill of one or more of its
employees or owners. In addition, some activities are mentioned only in
199A, such as investment management, trading, and dealing. As described
in the remainder of this part V.A.2., proposed Sec. 1.199A-5(b)
provides guidance on the definition of an SSTB based on the plain
meaning of the statute, past interpretations of substantially similar
language in other Code provisions, and other indicia of legislative
intent.
i. SSTBs Listed in Section 199A(d)(2)(A)
The definition of an SSTB under section 199A is substantially
similar to the list of service trades or businesses provided in section
448(d)(2)(A) and Sec. 1.448-1T(e)(4)(i), as the legislative history
notes. See Joint Explanatory Statement of the Committee of Conference,
footnotes 44-46. Section 448 prohibits certain taxpayers from computing
taxable income under the cash receipts and disbursements method of
accounting. Under section 448, qualified personal service corporations
generally are not subject to the prohibition from using the cash
method. Section 448(d)(2) defines the term qualified personal service
corporation to include certain employee-owned corporations,
substantially all of the activities of which involve the performance of
services in the fields of health, law, engineering, architecture,
accounting, actuarial science, performing arts, or consulting. The
regulations under section 448(d)(2), found in Sec. 1.448-1T(e)(4)(i),
provide additional guidance on several of the terms, including health,
performing arts, and consulting. In addition, there have been several
court opinions, technical advice memoranda, and private letter rulings
interpreting the various fields listed in section 448(d)(2) and Sec.
1.448-1T(e)(4)(i).
In general, the guidance under section 448(d)(2) emphasizes the
direct provision of services by the employees of a trade or business,
rather than the application of capital. Commenters have suggested that
the regulations under section 448 serve as a reasonable starting point
for defining an SSTB for purposes of section 199A. However, commenters
also noted that the objectives and included categories of trades or
businesses within section 448 and section 199A are different.
Consistent with ordinary rules of statutory construction and the
legislative history of section 199A, proposed Sec. 1.199A-5(b) draws
upon the existing guidance under section 448(d)(2) when appropriate for
purposes of section 199A. Proposed Sec. 1.199A-5(b) generally follows
the guidance issued under section 448(d)(2) with some modifications. In
certain instances, the principles of section 448(d)(2) provide useful
analogies in defining the particular fields listed in section
1202(e)(3)(A) (as modified by section 199A(d)(2)(A)) for purposes of
section 199A.
In addition, section 1202(e)(3)(A) also includes ``any trade or
business where the principal asset of such trade or business is the
reputation of skill of 1 or more of its employees.'' Section
199A(d)(2)(A) modifies this clause by adding the words ``or owners'' to
the end, to read as follows: ``any trade or business where the
principal asset of such trade or business is the reputation or skill of
1 or more of its employees or owners.'' The meaning of this clause is
best determined by examining the language of section 1202(e)(3)(A) in
light of the purpose of section 199A.
Case law under section 448 provides that whether a service is
performed in a qualifying field under section 448(d)(2) is to be
decided by examining all relevant indicia and is not controlled by
state licensing laws. See Rainbow Tax Serv., Inc. v. Commissioner, 128
T.C. 42 (2007); Kraatz & Craig Surveying Inc., v. Commissioner, 134
T.C. 167 (2010). This approach also is appropriate for section 199A
purposes. Additionally, states can widely vary in what they require in
terms of licensure or certification. The Treasury Department and the
IRS believe that the Federal tax law should not treat similarly
situated taxpayers differently based on a particular state's decision
that for consumer protection purposes or otherwise a particular
business type requires a license or certification. Thus, proposed Sec.
1.199A-5(b) does not adopt a bright-line licensing rule for purposes of
determining whether a trade or business is within a certain field for
purposes of section 199A.
a. Health
Proposed Sec. 1.199A-5(b)(2)(ii) is informed by the definition of
``health'' under section 448 and provides that the term ``performance
of services in the field of health'' means the provision of medical
services by physicians, pharmacists, nurses, dentists, veterinarians,
physical therapists, psychologists, and other similar healthcare
professionals who provide medical services directly to a patient. The
performance of services in the field of health does not include the
provision of services not directly related to a medical field, even
though the services may purportedly relate to the health of the service
recipient. For example, the performance of services in the field of
health does not include the operation of health clubs or health spas
that provide physical exercise or conditioning to their customers,
payment processing, or research, testing, and manufacture and/or sales
of pharmaceuticals or medical devices.
b. Law
Proposed Sec. 1.199A-5(b)(2)(iii) is based on the ordinary meaning
of ``services in the field of law'' and provides that the term
``performance of services in the field of law'' means the provision of
services by lawyers, paralegals, legal arbitrators, mediators, and
similar professionals in their capacity as such. The performance of
services in the field of law does not include the provision of services
that do not require skills unique to the field of law, for example, the
provision of services in the field of law does not include the
provision of services by printers, delivery services, or stenography
services.
c. Accounting
Proposed Sec. 1.199A-5(b)(2)(iv) is based on the ordinary meaning
of ``accounting'' and provides that the term ``performance of services
in the field of accounting'' means the provision of services by
accountants, enrolled agents, return preparers, financial auditors, and
similar professionals in their capacity as such. Provision of services
in the field of accounting is not limited to services requiring state
licensure as a certified public accountant (CPA). The aim of proposed
Sec. 1.199A-5(b)(2)(iv) is to capture the common understanding of
accounting, which includes tax return and bookkeeping services, even
though the provision of such services may not require the same
education, training, or mastery of accounting principles as a CPA. The
field of accounting does not include payment processing and billing
analysis.
[[Page 40898]]
d. Actuarial Science
Proposed Sec. 1.199A-5(b)(2)(v) is based on the ordinary meaning
``actuarial science'' and provides that the term ``performance of
services in the field of actuarial science'' means the provision of
services by actuaries and similar professionals in their capacity as
such. Accordingly, the field of actuarial science does not include the
provision of services by analysts, economists, mathematicians, and
statisticians not engaged in analyzing or assessing the financial costs
of risk or uncertainty of events.
e. Performing Arts
Proposed Sec. 1.199A-5(b)(2)(vi) is informed by the definition of
``performing arts'' under section 448 and provides that the term
``performance of services in the field of the performing arts'' means
the performance of services by individuals who participate in the
creation of performing arts, such as actors, singers, musicians,
entertainers, directors, and similar professionals performing services
in their capacity as such. The performance of services in the field of
performing arts does not include the provision of services that do not
require skills unique to the creation of performing arts, such as the
maintenance and operation of equipment or facilities for use in the
performing arts. Similarly, the performance of services in the field of
the performing arts does not include the provision of services by
persons who broadcast or otherwise disseminate video or audio of
performing arts to the public.
f. Consulting
Proposed Sec. 1.199A-5(b)(2)(vii) is informed by the definition of
``consulting'' under section 448 and provides that the term
``performance of services in the field of consulting'' means the
provision of professional advice and counsel to clients to assist the
client in achieving goals and solving problems. Consulting includes
providing advice and counsel regarding advocacy with the intention of
influencing decisions made by a government or governmental agency and
all attempts to influence legislators and other government officials on
behalf of a client by lobbyists and other similar professionals
performing services in their capacity as such. The performance of
services in the field of consulting does not include the performance of
services other than advice and counsel. This determination is made
based on all the facts and circumstances of a person's business.
Additionally, the Treasury Department and the IRS are aware of the
concern noted by commenters that in certain kinds of sales transactions
it is common for businesses to provide consulting services in
connection with the purchase of goods by customers. For example, a
company that sells computers may provide customers with consulting
services relating to the setup, operation, and repair of the computers,
or a contractor who remodels homes may provide consulting prior to
remodeling a kitchen. As described previously in this Explanation of
Provisions, proposed Sec. 1.199A-5(c) provides a de minimis rule,
under which a trade or business is not an SSTB if less than 10 percent
of the gross receipts (5 percent if the gross receipts are greater than
$25 million) of the trade or business are attributable to the
performance of services in a specified service activity. However, this
de minimis rule may not provide sufficient relief for certain trades or
business that provide ancillary consulting services. The Treasury
Department and the IRS believe that if a trade or business involves the
selling or manufacturing of goods, and such trade or business provides
ancillary consulting services that are not separately purchased or
billed, then such trades or businesses are not in a trade or business
in the field of consulting. Accordingly, proposed Sec. 1.199A-
5(b)(2)(vii) provides that the field of consulting does not include
consulting that is embedded in, or ancillary to, the sale of goods if
there is no separate payment for the consulting services.
g. Athletics
The field of athletics is not listed in section 448(d)(2), and
there is little guidance on its meaning as used in section
1202(e)(3)(A). However, commenters noted, and the Treasury Department
and the IRS agree, that among the services specified in section
199A(d)(2)(A) the field of athletics is most similar to the field of
performing arts. Accordingly, proposed Sec. 1.199A-5(b)(2)(viii)
provides that the term ``performance of services in the field of
athletics'' means the performances of services by individuals who
participate in athletic competition such as athletes, coaches, and team
managers in sports such as baseball, basketball, football, soccer,
hockey, martial arts, boxing, bowling, tennis, golf, skiing,
snowboarding, track and field, billiards, and racing. The performance
of services in the field of athletics does not include the provision of
services that do not require skills unique to athletic competition,
such as the maintenance and operation of equipment or facilities for
use in athletic events. Similarly, the performance of services in the
field of athletics does not include the provision of services by
persons who broadcast or otherwise disseminate video or audio of
athletic events to the public.
h. Financial Services
Commenters requested guidance as to whether financial services
includes banking. These commenters noted that section 1202(e)(3)(A)
includes the term financial services, but that banking in separately
listed in section 1202(e)(3)(B) which suggests that banking is not
included as part of financial services in section 1202(e)(3)(A). The
Treasury Department and the IRS agree with such commenters that this
suggests that financial services should be more narrowly interpreted
here. Therefore, proposed Sec. 1.199A-5(b)(2)(ix) limits the
definition of financial services to services typically performed by
financial advisors and investment bankers and provides that the field
of financial services includes the provision of financial services to
clients including managing wealth, advising clients with respect to
finances, developing retirement plans, developing wealth transition
plans, the provision of advisory and other similar services regarding
valuations, mergers, acquisitions, dispositions, restructurings
(including in title 11 or similar cases), and raising financial capital
by underwriting, or acting as the client's agent in the issuance of
securities, and similar services. This includes services provided by
financial advisors, investment bankers, wealth planners, and retirement
advisors and other similar professionals, but does not include taking
deposits or making loans.
i. Brokerage Services
Proposed Sec. 1.199A-5(b)(2)(x) uses the ordinary meaning of
``brokerage services'' and provides that the field of brokerage
services includes services in which a person arranges transactions
between a buyer and a seller with respect to securities (as defined in
section 475(c)(2)) for a commission or fee. This includes services
provided by stock brokers and other similar professionals, but does not
include services provided by real estate agents and brokers, or
insurance agents and brokers.
j. Any Trade or Business Where the Principal Asset of Such Trade or
Business Is the Reputation or Skill of 1 or More of Its Employees or
Owners
Guidance on the meaning of the ``reputation or skill'' clause in
section
[[Page 40899]]
1202(e)(3)(A) is limited to dicta in one case. In John P. Owen v.
Commissioner, T.C. Memo 2012-21, the Tax Court examined whether Mr.
Owen, whose business was insurance, was entitled to benefits under
section 1202 with respect to the sale of his interest in a corporation
conducting such business. Under the facts described in the case, the
corporation had extensive training programs and sales structures, but
primarily relied on the services of independent contractors (including
Mr. Owen) in conducting its business. Although the Tax Court
acknowledged that the business' success was due to Mr. Owen's efforts,
it found that the principal asset of the company in question was the
training program and sales structure of the business rather than Mr.
Owen's services.
The Treasury Department and the IRS received several comments
regarding the meaning of the ``reputation or skill'' clause. Commenters
described potential methods to give maximum effect to the literal
language of the reputation or skill clause by describing ways to (1)
determine the extent to which the reputation or skill of employees or
owners constitutes an asset of the business under Federal tax
accounting principles, and (2) measure whether such an asset is in fact
the principal asset of the business.
One commenter suggested using an activity-based standard under
which no service-based businesses would qualify for the section 199A
deduction. An SSTB definition this broad would not comport with the
statute and would deny a section 199A deduction to businesses that the
statute does not appear to exclude. If the ``reputation or skill''
clause was intended to exclude all service businesses from section
199A, there would have been no reason to enumerate specific types of
businesses in section 199A(d)(2); that language would be pure
surplusage. A broad service-based test would also fail to provide a
clear classification of businesses that combine services with sales of
products, such as plumbing and HVAC services, if those businesses sell
goods or equipment in the course of providing services. Therefore, the
Treasury Department and the IRS do not believe it is consistent with
the text, structure, or purpose of section 199A to exclude all service
businesses above the threshold amount from qualifying for the section
199A deduction.
Another commenter described a balance sheet test that would compare
the value of assets other than goodwill and workforce in place to the
value of such goodwill and workforce in place. The commenter
acknowledged that such a test could also be broader than Congress
intended. In addition, the commenter noted that such a test could
easily lead to strange and unintuitive results, and may be difficult to
apply in the case of small businesses that do not maintain audited
financial statements and would both be ripe for abuse, and could
potentially result in many legal disputes between taxpayers and the
IRS.
Finally, one commenter described a standard based on whether the
trade or business involves the provision of highly-skilled services.
The commenter argued that the primary benefit of a standard like this
is that it would harmonize the meaning of the reputation or skill
phrase with the trades or businesses listed in section 1202(e)(3)(A),
each of which involve the provision of services by professionals who
either received a substantial amount of training (for example, doctors,
nurses, lawyers, and accountants), or who have otherwise achieved a
high degree of skill in a given field (for example, professional
athletes or performing artists).
Congress enacted section 199A to provide a deduction from taxable
income to trades or businesses conducted by sole proprietorships and
passthrough entities that do not benefit from the income tax rate
reduction afforded to C corporations under the TCJA. The Treasury
Department and the IRS are concerned that a broad definition of the
``reputation or skill'' phrase that relied on a balance sheet test or
numerical ratios would have several consequences inconsistent with the
intent of section 199A. Testing businesses based on metrics, some of
them subjective, that change over time could result in inappropriate
year-over-year tax consequences and lead to distorted decision-making.
As the commenters noted, such mechanical tests pose administrative
difficulties and fail to provide taxpayers with needed certainty
regarding the tax law necessary for conducting their business affairs.
Most significantly, such mechanical rules might prevent trades or
businesses that Congress intended to be eligible for the section 199A
deduction from claiming the section 199A deduction.
In sum, the Treasury Department and the IRS believe that the
``reputation or skill'' clause as used in section 199A was intended to
describe a narrow set of trades or businesses, not otherwise covered by
the enumerated specified services, in which income is received based
directly on the skill and/or reputation of employees or owners.
Additionally, the Treasury Department and the IRS believe that
``reputation or skill'' must be interpreted in a manner that is both
objective and administrable. Thus, proposed Sec. 1.199A-5(b)(2)(xiv)
limits the meaning of the ``reputation or skill'' clause to fact
patterns in which the individual or RPE is engaged in the trade or
business of: (1) Receiving income for endorsing products or services,
including an individual's distributive share of income or distributions
from an RPE for which the individual provides endorsement services; (2)
licensing or receiving income for the use of an individual's image,
likeness, name, signature, voice, trademark, or any other symbols
associated with the individual's identity, including an individual's
distributive share of income or distributions from an RPE to which an
individual contributes the rights to use the individual's image; or (3)
receiving appearance fees or income (including fees or income to
reality performers performing as themselves on television, social
media, or other forums, radio, television, and other media hosts, and
video game players). Proposed Sec. 1.199A-5(b)(4) contains two
examples illustrating the application of this definition. The Treasury
Department and the IRS request comments on this rule, the clarity of
definitions for the statutorily enumerated trades or businesses that
are SSTBs under section 199A(d)(2)(A), and the accompanying examples.
ii. SSTBs Described in 199A(d)(2)(B)
As mentioned previously, section 199A(d)(2)(B) provides that an
SSTB also includes any trade or business that involves the performance
of services that consist of investing and investment management,
trading, or dealing in securities (as defined in section 475(c)(2)),
partnership interests, or commodities (as defined in section
475(e)(2)). This rule does not appear in section 1202(e)(3)(A) or
section 448(d)(2).
Section 475(c)(2) provides a detailed list of interests treated as
securities, including stock in a corporation; ownership interests in
widely held or publicly traded partnerships or trusts; notes, bonds,
debentures, or other evidences of indebtedness; interest rate,
currency, or equity notional principal contracts; evidences of an
interest in, or derivative financial instruments in any of the
foregoing securities or any currency, including any option, forward
contract, short position, or any similar financial instruments; and
certain hedges with respect to any such securities. Section 475(e)(2)
provides a similarly detailed list of property treated as a commodity,
including any
[[Page 40900]]
commodity which is actively traded (within the meaning of section
1092(d)(1)) or any notional principal contract with respect to any such
commodity, evidences of an interest in, or derivative financial
instruments in any of the foregoing commodities, and certain hedges
with respect to any such commodities.
a. Investing and Investment Management
Proposed Sec. 1.199A-5(b)(2)(xi) uses the ordinary meaning of
``investing and investment management'' and provides that any trade or
business that involves the ``performance of services that consist of
investing and investment management'' means a trade or business that
earns fees for investment, asset management services, or investment
management services including providing advice with respect to buying
and selling investments. The performance of services that consist of
investing and investment management would include a trade or business
that receives either a commission, a flat fee, or an investment
management fee calculated as a percentage of assets under management.
The performance of services of investing and investment management does
not include directly managing real property.
b. Trading
Proposed Sec. 1.199A-5(b)(2)(xii) provides that any trade or
business involving the ``performance of services that consist of
trading'' means a trade or business of trading in securities,
commodities, or partnership interests. Whether a person is a trader is
determined taking into account the relevant facts and circumstances.
Factors that have been considered relevant to determining whether a
person is a trader include the source and type of profit generally
sought from engaging in the activity regardless of whether the activity
is being provided on behalf of customers or for a taxpayer's own
account. See Endicott v. Commissioner, T.C. Memo 2013-199; Nelson v.
Commissioner, T.C. Memo 2013-259, King v. Commissioner, 89 T.C. 445
(1987). A person that is a trader under these principles will be
treated as performing the services of trading for purposes of section
199A(d)(2)(B).
c. Dealing in Securities, Partnership Interests, and Commodities
For purposes of proposed Sec. 1.199A-5(b)(2)(xiii), the
``performance of services that consist of dealing in securities (as
defined in section 475(c)(2))'' means regularly purchasing securities
from and selling securities to customers in the ordinary course of a
trade or business or regularly offering to enter into, assume, offset,
assign, or otherwise terminate positions in securities with customers
in the ordinary course of a trade or business. For purposes of the
preceding sentence, a taxpayer that regularly originates loans in the
ordinary course of a trade or business of making loans but engages in
no more than negligible sales of the loans is not dealing in securities
for purposes of section 199A(d)(2). See Sec. 1.475(c)-1(c)(2) and (4)
for the definition of negligible sales.
For purposes of proposed Sec. 1.199A-5(b)(2)(xiii), ``the
performance of services that consist of dealing in partnership
interests'' means regularly purchasing partnership interests from and
selling partnership interests to customers in the ordinary course of a
trade or business or regularly offering to enter into, assume, offset,
assign, or otherwise terminate positions in partnership interests with
customers in the ordinary course of a trade or business.
For purposes of proposed Sec. 1.199A-5(b)(2)(xiii), ``the
performance of services that consist of dealing in commodities (as
defined in section 475(e)(2))'' means regularly purchasing commodities
from and selling commodities to customers in the ordinary course of a
trade or business or regularly offering to enter into, assume, offset,
assign, or otherwise terminate positions in commodities with customers
in the ordinary course of a trade or business.
3. Defining What Is Included in an SSTB
The Treasury Department and the IRS are aware that some taxpayers
have contemplated a strategy to separate out parts of what otherwise
would be an integrated SSTB, such as the administrative functions, in
an attempt to qualify those separated parts for the section 199A
deduction. Such a strategy is inconsistent with the purpose of section
199A. Therefore, in accordance with section 199A(f)(4), in order to
carry out the purposes of section 199A, proposed Sec. 1.199A-5(c)(2)
provides that an SSTB includes any trade or business with 50 percent or
more common ownership (directly or indirectly) that provides 80 percent
or more of its property or services to an SSTB. Additionally, if a
trade or business has 50 percent or more common ownership with an SSTB,
to the extent that the trade or business provides property or services
to the commonly-owned SSTB, the portion of the property or services
provided to the SSTB will be treated as an SSTB (meaning the income
will be treated as income from an SSTB). For example, A, a dentist,
owns a dental practice and also owns an office building. A rents half
the building to the dental practice and half the building to unrelated
persons. Under proposed Sec. 1.199A-5(c)(2), the renting of half of
the building to the dental practice will be treated as an SSTB.
Additionally, proposed Sec. 1.199A-5 provides a rule that if a
trade or business (that would not otherwise be treated as an SSTB) has
50 percent or more common ownership with an SSTB and shared expenses,
including wages or overhead expenses with the SSTB, it is treated as
incidental to an SSTB and, therefore, as an SSTB, if the trade or
business represents no more than five percent of gross receipts of the
combined business.
B. Trade or Business of Performing Services as an Employee
Under section 199(d)(1)(B), the trade or business of performing
services as an employee is not a qualified trade or business. Unlike an
SSTB, there is no threshold amount that applies to the trade or
business of performing services as an employee. Thus, wage or
compensation income earned by any employee is not eligible for the
section 199A deduction no matter the amount.
1. Definition
An individual is an employee for Federal employment tax purposes if
he or she has the status of an employee under the usual common law and
statutory rules applicable in determining the employer-employee
relationship. Guides for determining employment status are found in
Sec. Sec. 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1. As stated in
the regulations, generally, the common law relationship of employer and
employee exists when the person for whom the services are performed has
the right to direct and control the individual who performs the
services, not only as to the result to be accomplished by the work but
also as to the details and means by which that result is accomplished.
That is, an employee is subject to the direction and control of the
employer not only as to what shall be done but how it shall be done. In
this connection it is not necessary that the employer actually direct
or control the manner in which the services are performed; it is
sufficient if he or she has the right to do so.
In addition, the regulations and section 3401(c) state, generally,
that an officer of a corporation (including an S Corporation) is an
employee of the corporation. However, an officer of a
[[Page 40901]]
corporation who does not perform any services or performs only minor
services in his or her capacity as officer and who neither receives nor
is entitled to receive, directly or indirectly, any remuneration is not
considered to be an employee of the corporation. Whether an officer's
services are minor is a question of fact that depends on the nature of
the services, the frequency and duration of their performance, and the
actual and potential importance or necessity of the services in
relation to the conduct of the corporation's business. See Rev. Rul.
74-390.
To provide clarity, proposed Sec. 1.199A-5(d) provides a general
rule that income from the trade or business of performing services as
an employee refers to all wages (within the meaning of section 3401(a))
and other income earned in a capacity as an employee, including
payments described in Sec. 1.6041-2(a)(1) (other than payments to
individuals described in section 3121(d)(3)) and Sec. 1.6041-2(b)(1).
If an individual derives income in the course of a trade or business
that is not described in section 3401(a), Sec. 1.6041-2(a)(1) (other
than payments to individuals described in section 3121(d)(3)), or Sec.
1.6041-2(b)(1), that individual is not considered to be in the trade or
business of performing services as an employee with regard to such
income.
2. Presumption for Former Employees
Section 199A provides that the trade or business of providing
services as an employee is not eligible for the section 199A deduction.
Therefore, taxpayers and practitioners noted that it may be beneficial
for employees to treat themselves as independent contractors or as
having an equity interest in a partnership or S corporation in order to
benefit from the deduction under section 199A.
Section 530(b) of the Revenue Act of 1978 (Pub. L. 95-600), as
amended by section 9(d)(2) of Public Law 96-167, section 1(a) of Public
Law 96-541, and section 269(c) of Public Law 97-248, provides a
prohibition against regulations and rulings on employment status for
purposes of employment taxes. Specifically, section 530(b) provides
that no regulation or revenue ruling shall be published before the
effective date of any law clarifying the employment status of
individuals for purposes of the employment taxes by the Treasury
Department (including the IRS) with respect to the employment status of
any individual for purposes of the employment taxes. Section 530(c) of
the Revenue Act of 1978 provides that, for purposes of section 530, the
term ``employment tax'' means any tax imposed by subtitle C of the
Internal Revenue Code of 1954, and the term ``employment status'' means
the status of an individual, under the usual common law rules
applicable in determining the employer-employee relationship as an
employee or as an independent contractor (or other individual who is
not an employee). These longstanding rules of section 530 of the
Revenue Act of 1978 limit the ability of the IRS to impose employment
tax liability on employers for misclassifying employees as independent
contractors but do not preclude challenging a worker's status for
purposes of section 199A, an income tax provision under subtitle A of
the Code.
Therefore, proposed Sec. 1.199A-5(d)(3) provides that for purposes
of section 199A, if an employer improperly treats an employee as an
independent contractor or other non-employee, the improperly classified
employee is in the trade or business of performing services as an
employee notwithstanding the employer's improper classification. This
issue is particularly important in the case of individuals who cease
being treated as employees of an employer, but subsequently provide
substantially the same services to the employer (or a related entity)
but claim to do so in a capacity other than as an employee. However, it
would not be appropriate to provide that someone who formerly was an
employee of an employer is now ``less likely'' to be respected as an
independent contractor. Such a rule would not treat similarly-situated
taxpayers similarly: Two individuals who have a similar relationship
with a company and each claim to be treated as independent contractors
would be treated differently depending on any prior employment history
with the company. Therefore, proposed Sec. 1.199A-5(d)(3) does not
provide any new or different standards to be properly classified as an
independent contractor or owner of a business. Instead, proposed Sec.
1.199A-5(d)(3) contains a presumption that applies in certain
situations to ensure that individuals properly substantiate their
status.
Specifically, proposed Sec. 1.199A-5(d)(3) provides that, solely
for purposes of section 199A(d)(1)(B) and the regulations thereunder,
an individual who was treated as an employee for Federal employment tax
purposes by the person to whom he or she provided services, and who is
subsequently treated as other than an employee by such person with
regard to the provision of substantially the same services directly or
indirectly to the person (or a related person), is presumed to be in
the trade or business of performing services as an employee with regard
to such services. This presumption may be rebutted only upon a showing
by the individual that, under Federal tax rules, regulations, and
principles (including common-law employee classification rules), the
individual is performing services in a capacity other than as an
employee. This presumption applies regardless of whether the individual
provides services directly or indirectly through an entity or entities.
This presumption is solely for purposes of section 199A and does not
otherwise change the employment tax classification of the individual.
Section 199A is in subtitle A of the Code, and this rule does not apply
for purposes of any other subtitle, including subtitle C. Accordingly,
this rule does not implicate section 530(b) of the Revenue Act of 1978.
Proposed Sec. 1.199A-5(d)(3)(ii) contains three examples illustrating
this rule.
VI. Proposed Sec. 1.199A-6: Special Rules for RPEs, PTPs, Trusts, and
Estates
Proposed Sec. 1.199A-6 provides guidance that certain specified
entities (for example, RPEs, PTPs, trusts, and estates) may need to
follow for purposes of computing the entities' or their owners' section
199A deductions.
A. Computational Steps for RPEs and PTPs
Although RPEs cannot take the section 199A deduction at the RPE
level, each RPE must determine and report the information necessary for
its direct and indirect owners to determine their own section 199A
deduction. Proposed Sec. 1.199A-6(b) follows the rules applicable to
individuals with taxable income above the threshold amount set forth in
Sec. 1.199A-1(d) in directing RPEs to determine what amounts and
information to report to their owners and the IRS, including QBI, W-2
wages, the UBIA of qualified property for each trade or business
directly engaged in, and whether any of its trades or businesses are
SSTBs. RPEs must also determine and report qualified REIT dividends and
qualified PTP income received directly by the RPE. Proposed Sec.
1.199A-6(b)(3) then requires each RPE to report this information on or
with the Schedules K-1 issued to the owners. RPEs must report this
information regardless of whether a taxpayer is below the threshold.
The Treasury Department and the IRS request comments whether it is
administrable to provide a special rule that if none of the owners of
the
[[Page 40902]]
RPE have taxable income above the threshold amount, the RPE does not
need to determine and report W-2 wages, UBIA of qualified property, or
whether the trade or business is an SSTB. Although such a rule would
relieve an RPE of an unnecessary burden, the RPE would need to have
knowledge of the ultimate owner's taxable income.
The definition of an RPE does not include a PTP. However, PTPs must
still determine and report QBI under the rules of proposed Sec.
1.199A-3 for each trade or business in which the PTP is engaged and
whether those trades or businesses are SSTBs. A PTP must also determine
whether it has received any qualified REIT dividends or qualified PTP
income or loss from another PTP. These items must be reported on or
with the Schedule K-1. A PTP is not required to determine or report W-2
wages or the UBIA of qualified property.
B. Application to Trusts, Estates, and Beneficiaries
Proposed Sec. 1.199A-6(d) contains special rules for applying
section 199A to trusts and decedents' estates. To the extent that a
grantor or another person is treated as owning all or part of a trust
under sections 671 through 679 (grantor trust), including qualified
subchapter S trusts (QSSTs) with respect to which the beneficiary has
made an election under section 1361(d), the owner will compute its QBI
with respect to the owned portion of the trust as if that QBI had been
received directly by the owner.
In the case of a section 199A deduction claimed by a non-grantor
trust or estate, section 199A(f)(1)(B) applies rules similar to the
rules under former section 199(d)(1)(B)(i) for the apportionment of W-2
wages and the apportionment of UBIA of qualified property. In the case
of a non-grantor trust or estate, the QBI and expenses properly
allocable to the business, including the W-2 wages relevant to the
computation of the wage limitation, and relevant UBIA of depreciable
property must be allocated among the trust or estate and its various
beneficiaries. Specifically, proposed Sec. 1.199A-6(d)(3)(ii) provides
that each beneficiary's share of the trust's or estate's W-2 wages is
determined based on the proportion of the trust's or estate's DNI that
is deemed to be distributed to that beneficiary for that taxable year.
Similarly, the proportion of the entity's DNI that is not deemed
distributed by the trust or estate will determine the entity's share of
the QBI and W-2 wages. In addition, if the trust or estate has no DNI
in a particular taxable year, any QBI and W-2 wages are allocated to
the trust or estate, and not to any beneficiary.
In addition, proposed Sec. 1.199A-6(d)(3)(ii) provides that, to
the extent the trust's or estate's UBIA of qualified property is
relevant to a trust or estate and any beneficiary, the trust's or
estate's UBIA of qualified property will be allocated among the trust
or estate and its beneficiaries in the same proportion as DNI of the
trust or estate is allocated. This is the case regardless of how any
depreciation or depletion deductions resulting from the same property
may be allocated under section 643(c) among the trust or estate and its
beneficiaries for purposes other than section 199A.
Under section 199A, the threshold amount is determined at the trust
level without taking into account any distribution deductions.
Commenters have noted that taxpayers could circumvent the threshold
amount by dividing assets among multiple trusts, each of which would
claim its own threshold amount. This result is inappropriate and
inconsistent with the purpose of section 199A. Therefore, proposed
Sec. 1.199A-6(d)(3)(v) provides that trusts formed or funded with a
significant purpose of receiving a deduction under section 199A will
not be respected for purposes of section 199A.
The Treasury Department and the IRS request comments with respect
to whether taxable recipients of annuity and unitrust interests in
charitable remainder trusts and taxable beneficiaries of other split-
interest trusts may be eligible for the section 199A deduction to the
extent that the amounts received by such recipients include amounts
that may give rise to the deduction. Such comments should include
explanations of how amounts that may give rise to the section 199A
deduction would be identified and reported in the various classes of
income of the trusts received by such recipients and how the excise tax
rules in section 664(c) would apply to such amounts.
VII. Proposed Sec. 1.643(f)-1: Anti-Avoidance Rules for Multiple
Trusts
As described in section VI B of the Explanation of Provisions,
under section 199A, the threshold amount is determined at the trust
level without taking into account any distribution deductions.
Therefore, taxpayers could circumvent the threshold amount by dividing
assets among multiple trusts, each of which would claim its own
threshold amount. This result is inappropriate and inconsistent with
the purpose of section 199A and general trust principles.
To address this and other concerns regarding the abusive use of
multiple trusts, proposed Sec. 1.643(f)-1 confirms the applicability
of section 643(f). As noted in part II of the Background, section
643(f) permits the Secretary to prescribe regulations to prevent
taxpayers from establishing multiple non-grantor trusts or contributing
additional capital to multiple existing non-grantor trusts in order to
avoid Federal income tax. Proposed Sec. 1.643(f)-1 provides that, in
the case in which two or more trusts have substantially the same
grantor or grantors and substantially the same primary beneficiary or
beneficiaries, and a principal purpose for establishing such trusts or
contributing additional cash or other property to such trusts is the
avoidance of Federal income tax, then such trusts will be treated as a
single trust for Federal income tax purposes. For purposes of applying
this rule, spouses are treated as only one person and, accordingly,
multiple trusts established for a principal purpose of avoiding Federal
income tax may be treated as a single trust even in cases where
separate trusts are established or funded independently by each spouse.
Proposed Sec. 1.643(f)-1 further provides examples to illustrate
specific situations in which multiple trusts will or will not be
treated as a single trust under this rule, including a situation where
multiple trusts are created with a principal purpose of avoiding the
limitations of section 199A. The application of proposed Sec.
1.643(f)-1, however, is not limited to avoidance of the limitations
under section 199A and proposed Sec. Sec. 1.199A-1 through 1.199A-6.
The rule in proposed Sec. 1.643(f)-1 would apply to any
arrangement involving multiple trusts entered into or modified on or
after August 16, 2018. In the case of any arrangement involving
multiple trusts entered into or modified before August 16, 2018, the
determination of whether an arrangement involving multiple trusts is
subject to treatment under section 643(f) will be made on the basis of
the statute and the guidance provided regarding that provision in the
legislative history of section 643(f). Pending the publication of final
regulations, the position of the Treasury Department and the IRS is
that the rule in proposed Sec. 1.643(f)-1 generally reflects the
intent of Congress regarding the arrangements involving multiple trusts
that are appropriately subject to treatment under section 643(f).
[[Page 40903]]
VIII. Specified Agricultural or Horticultural Cooperatives
In the TCJA and the 2018 Act, Congress provided special rules for
applying section 199A in the case of specified agricultural and
horticultural cooperatives. The Treasury Department and the IRS
continue to study this area and intend to issue separate proposed
regulations describing rules for applying section 199A to specified
agricultural and horticultural cooperatives and their patrons later
this year. As provided in section 199A(g)(6), such regulations will
generally be based on the regulations applicable to cooperatives and
their patrons under former section 199 (as in effect before its
repeal). The Treasury Department and the IRS anticipate that the
regulations will provide that section 199A(g) applies only to the
patronage business of a relevant cooperative. The proposed regulations
will also provide more information for taxpayers that must apply the
reduction under section 199A(b)(7), which is a special rule with
respect to income received from cooperatives.
Availability of IRS Documents
IRS notices cited in this preamble are made available by the
Superintendent of Documents, U.S. Government Printing Office,
Washington, DC 20402.
Proposed Effective/Applicability Date
Section 7805(b)(1)(A) and (B) of the Code generally provide that no
temporary, proposed, or final regulation relating to the internal
revenue laws may apply to any taxable period ending before the earliest
of (A) the date on which such regulation is filed with the Federal
Register, or (B) in the case of a final regulation, the date on which a
proposed or temporary regulation to which the final regulation relates
was filed with the Federal Register. However, section 7805(b)(2)
provides that regulations filed or issued within 18 months of the date
of the enactment of the statutory provision to which they relate are
not prohibited from applying to taxable periods prior to those
described in section 7805(b)(1). Furthermore, section 7805(b)(3)
provides that the Secretary may provide that any regulation may take
effect or apply retroactively to prevent abuse.
Accordingly, proposed Sec. Sec. 1.199A-1 through 1.199A-6
generally are proposed to apply to taxable years ending after the date
of publication of a Treasury decision adopting these rules as final
regulations in the Federal Register. However, taxpayers may rely on the
rules set forth in proposed Sec. Sec. 1.199A-1 through 1.199A-6, in
their entirety, until the date a Treasury decision adopting these
regulations as final regulations is published in the Federal Register.
In addition, to prevent abuse of section 199A and the regulations
thereunder, the anti-abuse rules of proposed Sec. Sec. 1.199A-
2(c)(1)(iv), 1.199A-3(c)(2)(B), 1.199A-5(c)(2), 1.199A-5(c)(3), 1.199A-
5(d)(3), and 1.199A-6(d)(3)(v) are proposed to apply to taxable years
ending after December 22, 2017, the date of enactment of the TCJA.
Finally, the provisions of proposed Sec. 1.643-1, which prevent abuse
of the Code generally through the use of trusts, are proposed to apply
to taxable years ending after August 16, 2018.
Section 199A(f)(1) provides that section 199A applies at the
partner or S corporation shareholder level, and that each partner or
shareholder takes into account such person's allocable share of each
qualified item. Section 199A(c)(3) provides that the term ``qualified
item'' means items that are effectively connected with a U.S. trade or
business, and ``included or allowed in determining taxable income from
the taxable year.'' Section 199A applies to taxable years beginning
after December 31, 2017. However, there is no statutory requirement
under section 199A that a qualified item arise after December 31, 2017.
Section 1366(a) generally provides that, in determining the income
tax of a shareholder for the shareholder's taxable year in which the
taxable year of the S corporation ends, the shareholder's pro rata
share of the corporation's items is taken into account. Similarly,
section 706(a) generally provides that, in computing the taxable income
of a partner for a taxable year, the partner includes items of the
partnership for any taxable year of the partnership ending within or
with the partner's taxable year. Therefore, income flowing to an
individual from a partnership or S corporation is subject to the tax
rates and rules in effect in the year of the individual in which the
entity's year closes, not the year in which the item actually arose.
Accordingly, for purposes of determining QBI, W-2 wages, and UBIA
of qualified property, the effective dates provisions provide that if
an individual receives QBI, W-2 wages, or UBIA of qualified property
from an RPE with a taxable year that begins before January 1, 2018, and
ends after December 31, 2017, such items are treated as having been
incurred by the individual during the individual's tax year during
which such RPE taxable year ends.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 13563 and 12866 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including potential economic, environmental, public health and safety
effects, distributive impacts, and equity). Executive Order 13563
emphasizes the importance of quantifying both costs and benefits, of
reducing costs, of harmonizing rules, and of promoting flexibility.
These proposed regulations have been designated as subject to
review under Executive Order 12866 pursuant to the Memorandum of
Agreement (April 11, 2018) between the Treasury Department and the
Office of Management and Budget (OMB) regarding review of tax
regulations. The Treasury Department has determined that the proposed
rulemaking is subject to review as economically significant under
section 1(c) of the Memorandum of Agreement, and OMB concurs with this
designation. Accordingly, these proposed regulations have been reviewed
by the Office of Management and Budget. For more detail on the economic
analysis, please refer to the following analysis.
A. Overview
Congress enacted section 199A to provide individuals, estates, and
trusts a deduction of up to 20 percent of QBI from domestic businesses,
which includes trades or businesses operated as a sole proprietorship
or through a partnership, S corporation, trust, or estate. As stated in
the Explanation of Provisions, these proposed regulations are necessary
to provide taxpayers with computational, definitional, and anti-
avoidance guidance regarding the application of section 199A. The
proposed regulations provide guidance to taxpayers for purposes of
calculating the section 199A deduction. They provide clarity for
taxpayers in determining their eligibility for the deduction and the
amount of the allowed deduction. Among other benefits, this clarity
helps ensure that taxpayers all calculate the deduction in a similar
manner, which encourages decision-making that is economically efficient
contingent on the provisions of the overall Code.
The proposed regulations contain seven sections, six proposed under
section 199A (proposed Sec. Sec. 1.199A-1 through 1.199A-6) and one
proposed under section 643(f) (proposed
[[Page 40904]]
Sec. 1.643(f)-1). Each of proposed Sec. Sec. 1.199A-1 through 1.199A-
6 provides rules relevant to the section 199A deduction and proposed
Sec. 1.643(f)-1 would establish anti-abuse rules to prevent taxpayers
from establishing multiple non-grantor trusts or contributing
additional capital to multiple existing non-grantor trusts in order to
avoid Federal income tax, including abuse of section 199A. This
economic analysis describes the economic benefits and costs of each of
the seven sections of the proposed regulations.
B. Baseline
The analysis in this section compares the proposed regulation to a
no-action baseline reflecting anticipated Federal income tax-related
behavior in the absence of these proposed regulations.
C. Economic Analysis of Proposed Sec. 1.199A-1
1. Background
Because the section 199A deduction has not previously been
available, a large number of the relevant terms and necessary
calculations taxpayers are currently required to apply under the
statute can benefit from greater specificity. For example, the statute
uses the term trade or business to refer to the enterprise whose income
would be potentially eligible for the deduction but does not define
what constitutes a trade or business for purposes of section 199A; the
proposed regulations provide that taxpayers should generally apply the
definition of a trade or business provided by section 162(a). The
definition of trade or business in proposed Sec. 1.199A-1 is extended
beyond the section 162 definition if a taxpayer chooses to aggregate
businesses under the rules of proposed Sec. 1.199A-4. In addition,
solely for purposes of section 199A, the rental or licensing of
property to a related trade or business is treated as a trade or
business if the rental or licensing and the other trade or business are
commonly controlled under proposed Sec. 1.199A-4(b)(1)(i). The
proposed regulations also make clear that the section 199A deduction is
allowed when calculating alternative minimum taxable income of
individuals.
Because the section 199A deduction has multiple components that may
interact in determining the deduction, it is also valuable to lay out
rules for calculating the deduction since the statute does not provide
each of those particulars.
Alternative approaches the Treasury Department and the IRS could
have proposed would be to remain silent on additional definitional
specificities and to allow post-limitation netting in calculating the
section 199A deduction. The Treasury Department and the IRS concluded
these approaches would likely give rise to less economically efficient
tax-related decisions than would relying on statutory language alone
and requiring or leaving open the possibility of post-limitation
netting.
2. Anticipated Benefits of Proposed Sec. 1.199A-1
The Treasury Department and the IRS expect that the definitions and
guidance provided in Sec. 1.199A-1 will implement the 199A deduction
in an economically efficient manner. An economically efficient tax
system generally aims to treat income derived from similar economic
decisions similarly in order to reduce incentives to make choices based
on tax rather than market incentives. In this context, the principal
benefit of proposed Sec. 1.199A-1 is to reduce taxpayer uncertainty
regarding the calculation of the section 199A deduction relative to an
alternative scenario in which no such regulations were issued. In the
absence of the clarifications in proposed Sec. 1.199A-1 regarding, for
example, the definition of an eligible trade or business, similarly
situated taxpayers might interpret the statutory rules of section 199A
differently, given the statute's limited prescription of the
implementation details. In addition, without these regulations it is
likely that many taxpayers impacted by section 199A would take on more
(or less) than the optimal level of risk in allocating resources within
or across their businesses. Both of these actions would give rise to
economic inefficiencies. The proposed regulations would provide a
uniform signal to businesses and thus lead taxpayers to make decisions
that are more economically efficient contingent on the overall Code. As
an example, proposed Sec. 1.199A-1 prescribes the steps taxpayers must
take to calculate the QBI deduction in a manner that avoids perverse
incentives for shifting wages and capital assets across businesses. The
statute does not address the ordering for how the W-2 wages and UBIA of
qualified property limitations should be applied when taxpayers have
both positive and negative QBI from different businesses. The proposed
regulations clarify that in such cases the negative QBI should offset
positive QBI prior to applying the wage and capital limitations. For
taxpayers who would have assumed in the alternate that negative QBI
offsets positive QBI after applying the wage and capital limitations,
the proposed approach weakens the incentive to shift W-2 wage labor or
capital (in the form of qualified property) from one business to
another to maximize the section 199A deduction.
To illustrate this, consider a taxpayer who is above the statutory
threshold and owns two non-service sector businesses, A and B. A has
net qualified income of $10,000, while B has net qualified income of -
$5,000. Suppose that A paid $3,000 in W-2 wages, B paid $1,000 in W-2
wages, and neither business has tangible capital. If negative QBI
offsets positive QBI after applying the wage and capital limitations,
then A generates a tentative deduction of $1,500, while B generates a
tentative deduction of -$1,000, for a total deduction of $500. After
moving B's W-2 wages to A, A's tentative deduction rises to $2,000,
while B's remains -$1,000, increasing the total deduction to $1,000.
If, on the other hand, negative QBI offsets positive QBI prior to
applying the wage and capital limitations (as in the proposed
regulations), then A and B have combined income of $5,000, and the
total deduction is $1,000 because the wage and capital limitations are
non-binding. After moving B's wages to A, the total deduction remains
$1,000. Thus, an incentive to shift wages arises if negative QBI
offsets positive QBI after applying the wage and capital limitations.
By taking the opposite approach, proposed Sec. 1.199A-1 reduces
incentives for such tax-motivated, economically inefficient
reallocations of labor (or capital) relative to a scenario in which
offsets were taken after wage and capital limitations were applied.
3. Anticipated Costs of Proposed Sec. 1.199A-1
The Treasury Department and the IRS do not anticipate any
meaningful economic distortions to be induced by proposed Sec. 1.199A-
1 and request comment regarding this anticipated impact. However,
changes to the collective paperwork burden arising from this and other
sections of these regulations are discussed in section J, Anticipated
impacts on administrative and compliance costs, of this analysis.
D. Economic Analysis of Proposed Sec. 1.199A-2
1. Background
Section 199A provides a deduction of up to 20 percent of the
taxpayer's income from qualifying trades or businesses. Taxpayers with
incomes above a threshold amount cannot enjoy the full 20 percent
deduction unless
[[Page 40905]]
they determine that their businesses pay a sufficient amount of wages
and/or maintain a sufficient stock of tangible capital, among other
requirements.
Because this deduction has not previously been available, proposed
Sec. 199A-2 provides greater specificity than is available from the
statute regarding the definitions of W-2 wages and UBIA of qualified
property (that is, depreciable capital stock) relevant to this aspect
of the deduction. For example, the proposed regulations make clear that
property that is transferred or acquired within a specific timeframe
with a principal purpose of increasing the section 199A deduction is
not considered qualified property for purposes of the section 199A
deduction. In addition, proposed Sec. 1.199A-2 generally follows prior
guidance for the former section 199 deduction in determining which W-2
wages are relevant for section 199A purposes, with additional rules for
allocating wages amongst multiple trades or businesses. In these and
other cases, the proposed regulations generally aim, within the context
of the legislative language and other tax considerations, to ensure
that only genuine business income is eligible for the section 199A
deduction, and to reduce business compliance costs and government
administrative costs.
Alternative approaches would be to remain silent or to choose
different definitions of W-2 wages or qualified property for the
purposes of claiming the deduction. The Treasury Department and the IRS
rejected these alternatives as being inconsistent with other
definitions or requirements under the Code and therefore unnecessarily
costly for taxpayers to comply with and the IRS to administer.
2. Anticipated Benefits of Proposed Sec. 1.199A-2
The Treasury Department and IRS expect that proposed Sec. 1.199A-2
will implement the 199A deduction in an economically efficient manner.
For example, proposed Sec. 1.199A-2 will discourage some inefficient
transfers of capital given the statute's silence regarding the
circumstances in which certain property transfers would or would not be
considered under section 199A. Specifically, the proposed rules make
clear that property transferred or acquired within a specific timeframe
with a principal purpose of increasing the section 199A deduction is
not considered qualified for purposes of the 199A deduction.
The proposed regulations will also reduce taxpayer uncertainty
regarding the implementation of the section 199A deduction relative to
a scenario in which no regulations were issued. In the absence of such
clarification, similarly situated taxpayers would likely interpret the
section 199A deduction differently to the extent that the statute does
not adequately specify the particular implementation issues addressed
by 199A-2; and as a result, taxpayers might take on more (or less) than
the optimal level of risk in their interpretations. The proposed
regulations would lead taxpayers to make decisions that were more
economically efficient, conditional on the overall Code.
3. Anticipated Costs of Proposed Sec. 1.199A-2
The Treasury Department and the IRS do not anticipate any
meaningful economic distortions to be induced by proposed Sec. 1.199A-
2, and request comment regarding this anticipated impact. However,
changes to the collective paperwork burden arising from this and other
sections of these regulations are discussed in section J, Anticipated
impacts on administrative and compliance costs, of this analysis.
E. Economic Analysis of Proposed Sec. 1.199A-3
1. Background
Section 199A provides a deduction of up to 20 percent of the
taxpayer's income from qualifying trades or businesses. In the absence
of legislative and regulatory constraints, taxpayers would have an
incentive to count as income some income that, from an economic
standpoint, did not accrue specifically from qualifying economic
activity. The proposed regulations clarify what does and does not
constitute QBI for purposes of the 199A deduction, providing greater
implementation specificity than provided by the statute. Because
guaranteed payments for capital, for example, are not at risk in the
same way as other forms of income, they might reasonably be excluded
from QBI. Similarly, Treasury proposes that income that is a guaranteed
payment, but which is filtered through a tiered partnership in order to
avoid being labeled as such, should be treated similarly to guaranteed
payments in general and therefore excluded from QBI. This principle
applies to other forms of income that similarly represent income that
either is not at risk or does not flow from the specific economic value
provided by a qualifying trade or business, such as returns on
investments of working capital. The proposed regulations define and
clarify the types of income that might reasonably be considered QBI,
within the constraints of the legislation.
2. Anticipated Benefits of Proposed Sec. 1.199A-3
The Treasury Department and IRS expect that proposed Sec. 1.199A-3
regulations will implement the 199A deduction in an economically
efficient manner. For example, 199A-3 will discourage the creation of
tiered partnerships purely for the purposes of increasing the section
199A deduction. In the absence of regulation, some taxpayers would
likely create tiered partnerships under which a lower-tier partnership
would make a guaranteed payment to an upper-tier partnership, and the
upper-tier partnership would pay out this income to its partners
without guaranteeing it. Such an organizational structure would likely
be economically inefficient because it was, apparently, created solely
for tax minimization purposes and not for reasons related to efficient
economic decision-making.
The Treasury Department and the IRS further expect that the
proposed regulations will reduce uncertainty over whether particular
forms of income do or do not constitute QBI relative to a scenario in
which no regulations were issued. In the absence of regulations,
taxpayers would still need to determine what income is considered QBI
and similarly situated taxpayers might interpret the statutory rules
differently and pursue income-generating activities based on different
assumptions about whether that income would qualify for QBI. Proposed
Sec. 1.199A-3 provides clearer guidance for how to determine QBI,
helping to ensure that taxpayers face uniform incentives when making
economic decisions, a tenet of economic efficiency.
3. Anticipated Costs of Proposed Sec. 1.199A-3 Relative to the
Baseline
The Treasury Department and the IRS do not anticipate any
meaningful economic distortions to be induced by proposed Sec. 1.199A-
3, and request comment regarding this anticipated impact. However,
changes to the collective paperwork burden arising from this and other
sections of these regulations are discussed in section J, Anticipated
impacts on administrative and compliance costs, of this analysis.
F. Economic Analysis of Proposed Sec. 1.199A-4
1. Background
Businesses may organize either as C corporations, which are owned
by stockholders, or in a form generally
[[Page 40906]]
called a passthrough, which may take one of several legal forms
including sole proprietorships, under which there does not exist a
clear separation between the owners and the business's decision-makers.
Each organizational structure, in some circumstance, may be
economically efficient, depending on the risk profile, information
asymmetries, and decision-making challenges pertaining to the specific
business and on the risk preferences and economic situations of the
individual owners. An economically efficient tax system would keep the
choice among organizational structures neutral contingent on the
provisions of the corporate income tax.
This principle of neutral tax treatment further applies to the
various organizational structures that qualify as passthroughs. Many
passthrough business entities are connected through ownership,
management, or shared decision-making. The proposed aggregation rule
allows individuals to aggregate their trades or businesses for the
purposes of calculating the section 199A deduction. It thus helps
ensure that significant choices over ownership and management
relationships within businesses are not chosen solely to increase the
section 199A deduction.
An alternative approach would be not to allow aggregation for
purposes of claiming the deduction. The Treasury Department and the IRS
decided to allow aggregation in the specified circumstances to minimize
or avoid distortions in organizational form that could arise if
aggregation were not allowed.
2. Anticipated Benefits of Proposed Sec. 1.199A-4
The Treasury Department and the IRS expect that the aggregation
guidance provided in proposed Sec. 1.199A-4 will implement the 199A
deduction in an economically efficient manner. Economic tax principles
are called into play here because a large number of businesses that
could commonly be thought of as a single trade or business actually may
be divided across multiple entities for legal or economic reasons.
Allowing taxpayers to aggregate trades or businesses offers taxpayers a
means of putting together what they think of as their trade or business
for the purposes of claiming the deduction under section 199A without
otherwise changing ownership and management structures. If such
aggregation were not permitted, certain taxpayers would restructure
solely for tax purposes, with the resulting structures leading to less
efficient economic decision-making.
3. Anticipated Costs of Proposed Sec. 1.199A-4
The proposed regulations require common majority ownership to apply
the aggregation rule. If no aggregation were allowed, taxpayers would
have to combine businesses to calculate the deduction based on the
combined income, wages, and capital. The majority ownership threshold
may thus encourage owners to concentrate their ownership in order to
benefit from the aggregation rule. The additional costs of the proposed
regulations would be limited to those owners who would find merging
entities too costly based on other market conditions, but under these
regulations may find it beneficial to increase their ownership share in
order to aggregate their businesses and maximize their QBI deduction.
Changes to the collective paperwork burden arising from proposed
Sec. 1.199A-4 and other sections of these regulations are discussed in
section J, Anticipated impacts on administrative and compliance costs,
of this analysis. The Treasury Department and the IRS request comments
regarding these and other potential costs arising from the regulations.
G. Economic Analysis of Proposed Sec. 1.199A-5
1. Background
Section 199A provides a deduction of up to 20 percent of the
taxpayer's income from qualifying trades or businesses. In the absence
of legislative and regulatory constraints, taxpayers have an incentive
to receive labor income as income earned as a an independent contractor
or through ownership of an RPE, even though this income may not derive
from the risk-bearing or decision-making efficiencies that are unique
to being an independent contractor or to owning an equity interest in
an RPE. The Act provided several provisions that bear on this
distinction.
Proposed Sec. 1.199A-5 provides guidance on what trades or
businesses would be characterized as an SSTB under each type of
services trade or business listed in the legislative text. In addition,
proposed Sec. 1.199A-5 provides an exception to the SSTB exclusion if
the trade or business only earns a small fraction of its gross income
from specified service activities (de minimis exception). Finally, the
proposed regulations state that former employees providing services as
independent contractors to their former employer will be presumed to be
acting as employees unless they provide evidence that they are
providing services in a capacity other than an employee.
An alternative approach to the de minimis exception would be to
require businesses or their owners to trigger the SSTB exclusion
regardless of the share of gross income from specified service
activities. The Treasury Department concluded that providing a de
minimis exception is necessary to avoid very small amounts of SSTB
activity within a trade or business making the entire trade or business
ineligible for the deduction, an outcome that is inefficient in the
context of section 199A.
2. Anticipated Benefits of Proposed Sec. 1.199A-5
The Treasury Department and the IRS expect that proposed Sec.
1.199A-5 will implement the 199A deduction in an economically efficient
manner. To this end, proposed Sec. 1.199A-5 clarifies the definition
of an SSTB. In the absence of such clarification, similarly situated
taxpayers might interpret the legislative text differently, leading
some taxpayers to invest in particular businesses under the assumption
income earned from that entity was eligible for the deduction while
other taxpayers might forgo that investment due to the opposite
assumption. These disparate investment signals generate economic
inefficiencies. The proposed regulations reduce this inefficiency
relative to a scenario in which no regulation providing a de minimus
exception was issued.
Furthermore, in the absence of the proposed regulations, some
owners of businesses may find it advantageous to separate their
business activity into SSTB and non-SSTB businesses in order to receive
the section 199A deduction on their non-SSTB activity. The proposed
regulations would disallow this behavior by stating that a taxpayer
that provides property or services to an SSTB that is commonly-owned
will have the portion of property or services provided to the SSTB
treated as attributable to an SSTB. Additionally without these
regulations, some businesses may have an incentive to pay a portion of
their employees as independent contractors. Either of these actions
would entail some loss of economic efficiency due to changes in
businesses' decision-making structures based on tax incentives. They
may also inefficiently provide incentives to change employment
relationships in favor of independent contractors. The proposed
regulations help to avoid these sources of inefficiency.
[[Page 40907]]
3. Anticipated Costs of Proposed Sec. 1.199A-5 Relative to the
Baseline
In addition to the statutory threshold amount, below which SSTB
status is not relevant, proposed Sec. 1.199A-5 provides a de minimis
rule with tiered-thresholds of gross revenues arising from specified
service activity in determining whether a trade or business with a
smaller amount of specified service activity is classified as an SSTB.
This threshold may cause businesses near the cutoff to decrease their
specified service activities or increase their non-specified service
activities to avoid being classified as an SSTB. Additionally, the de
minimis rule may encourage smaller entities engaged in SSTBs to merge
with larger entities not engaged in an SSTB. The economic costs of
these mergers are difficult to quantify.
Changes to the collective paperwork burden arising from Sec.
1.199A-5 and other sections of these regulations are discussed in
section J, Anticipated impacts on administrative and compliance costs,
of this analysis. The Treasury Department and IRS request comment
regarding these and other potential costs arising from the regulations.
H. Economic Analysis of Proposed Sec. 1.199A-6
1. Background
The 199A deduction is reduced below 20 percent for some businesses
and taxpayers. The attributes that determine any such reduction must be
determined by taxpayers claiming the section 199A deduction. Proposed
Sec. 1.199A-6 provides rules for RPEs, PTPs, trusts, and estates
relevant to making these determinations. In particular, RPEs are
required to calculate and report their owners' QBI, SSTB status, W-2
wages, UBIA of qualified property, REIT dividends, and PTP income.
Similarly, PTPs must calculate and report their owners' QBI, SSTB
status, REIT dividends, and other PTP income.
2. Anticipated Benefits of Proposed Sec. 1.199A-6
The Treasury Department and IRS expect that proposed Sec. 1.199A-6
will implement the 199A deduction in an economically efficient manner.
As with other proposed regulations discussed in this Analyses, a
principal benefit of proposed Sec. 1.199A-6 is to increase the
likelihood that all taxpayers interpret the statutory rules of section
199A similarly. Additionally, we expect that requiring RPEs to
determine and report the information necessary to compute the section
199A deduction will result in a more accurate and uniform application
of the regulations and statute relative to an alternative approach
under which individual owners would most likely determine these items.
3. Anticipated Costs of Proposed Sec. 1.199A-6 Relative to the
Baseline
The Treasury Department and the IRS do not anticipate any
meaningful economic distortions to be induced by proposed Sec. 1.199A-
6, and request comment on these estimated impacts. However, changes to
the collective paperwork burden arising from this and other sections of
these regulations are discussed in section J, Anticipated impacts on
administrative and compliance costs, of this analysis.
I. Economic Analysis of Proposed Sec. 1.643(f)-1
1. Background
Proposed Sec. 1.643(f)-1 provides that taxpayers cannot set up
multiple trusts in certain cases with a principal purpose of tax
avoidance, which would include the avoidance of the statutory threshold
amounts under section 199A.
2. Anticipated Benefits of Proposed Sec. 1.643(f)-1 Relative to the
Baseline
The Treasury Department and IRS expect that the proposed Sec.
1.643(f)-1 will implement the 199A deduction in an economically
efficient manner. Because proposed Sec. 1.643(f)-1 defines the manner
in which trusts are subject to the threshold amount where the statute
is silent, the Treasury Department and the IRS anticipate that the
proposed regulations will lead to fewer resources being devoted to
setting up trusts in attempts to avoid the threshold amount rules under
section 199A. If multiple trusts have substantially the same grantors
and beneficiaries, and a principal purpose for establishing such trusts
or contributing additional cash or other property to such trusts is the
avoidance of Federal income tax, then the various trusts would be
generally considered one trust, including for section 199A purposes.
3. Anticipated Costs of Proposed Sec. 1.643(f)-1 Relative to the
Baseline
The Treasury Department and the IRS do not anticipate any
meaningful economic distortions to be induced by proposed Sec.
1.643(f)-1, and request comment on these estimated impacts. However,
changes to the collective paperwork burden arising from this and other
sections of these regulations are discussed in section J, Anticipated
impacts on administrative and compliance costs, of this analysis.
J. Anticipated Impacts on Administrative and Compliance Costs
1. Discussion
The proposed regulations have a number of effects on taxpayers'
compliance costs. Proposed Sec. 1.199A-2 provides guidance in
determining a taxpayer's share of W-2 wages and UBIA of qualified
property. The Treasury Department and the IRS expect that this guidance
reduces the tax compliance costs of making this determination and
reduces uncertainty. In the absence of the proposed regulations,
taxpayers would still need to determine how to allocate W-2 wages and
UBIA of qualified property, among other calculations. These regulations
provide clear instructions for how to do this, simplifying the process
of complying with the law.
Proposed Sec. 1.199A-4 requires that owners who decide to
aggregate their trades or businesses report the aggregation annually.
This reporting requirement adds to the tax compliance burden of these
owners. For owners who consider aggregating, these regulations increase
compliance costs because the owners must calculate their deduction for
both disaggregated and aggregated trades or businesses to make the
aggregation decision. These additional compliance costs would be
voluntary and accrue only to owners who find it beneficial to aggregate
for the purposes of calculating their section 199A deduction.
Proposed Sec. 1.199A-5 includes a requirement for former employees
working as independent contractors for their former employer to show
that their employment relationship has changed in order to be eligible
for the section 199A deduction. The burden to substantiate employment
status exists without these proposed regulations; however, the proposed
regulation may increase these individuals' compliance costs slightly.
Proposed Sec. 1.199A-6 specifies that RPEs must report relevant
section 199A information to owners. Due to these entity reporting
requirements, the proposed regulations will increase compliance costs
for RPEs. These entities will need to keep records of new information
relevant to the calculation of their owners' section 199A deduction,
such as QBI, W-2 wages, SSTB status, and UBIA of qualified property.
This recordkeeping is costly. Without these regulations, it is likely
that only some RPEs would engage in this record keeping.
Proposed Sec. 1.199A-6 reduces the compliance burden on many
individuals that own RPEs relative a
[[Page 40908]]
scenario in which no regulations were issued or regulatory alternatives
that assigned each owner of an RPE the responsibility to acquire the
required information were issued without any requirement for the RPE to
provide such information. Under the proposed regulations, owners will
receive information pertaining to the section 199A deduction from the
RPE, such as whether a given trade or business is an SSTB, whereas in
the alternate they could have been required to make such determinations
themselves.
Overall, it is likely to be more efficient for RPEs, rather than
individual owners, to keep records of section 199A deduction
information. Therefore, the Treasury Department and the IRS expect that
proposed Sec. 1.199A-6 will reduce compliance costs on net and
relative to these alternative scenarios.
2. Estimated Effect on Compliance Costs
As explained above, key provisions of proposed Sec. Sec. 1.199A-1
through 1.199A-6 will reduce compliance costs that taxpayers would
likely have incurred in the absence of the proposed rule. Most notably,
the de minimis rule of proposed Sec. 1.199A-5 provides that a trade or
business will not be considered to be an SSTB merely because it
provides a small amount of services in a specified service activity.
This provision is expected to reduce compliance costs associated with
section 199A for millions of U.S. businesses. In addition, the
aggregation rules will reduce overall costs for taxpayers because some
taxpayers would restructure their business arrangements in order to
receive the benefit of the deduction. These and other discretionary
choices by the Treasury Department and the IRS in the proposed rule
will substantially reduce taxpayers' compliance costs.
The Treasury Department and the IRS also assessed the provisions of
the proposed rule that could increase compliance burdens. Estimates of
the change in annual reporting burden associated with these proposed
regulations are presented here and in further detail in the Paperwork
Reduction Act (PRA) section. The Treasury Department and the IRS
estimate a gross (not net) increase in total reporting burden of 25
million hours annually. The estimates primarily reflect two effects of
the regulations. First, the Treasury Department and the IRS project
that approximately 1.2 million individuals with more than one directly
owned or pass-through business who voluntarily choose to aggregate will
spend 0.66 hours annually complying with proposed Sec. 1.199A-4.
Second, the Treasury Department and the IRS project that--in complying
with the proposed Sec. 1.199A-6 requirement to report relevant section
199A information to their approximately 8.8 million owners--RPEs will
spend 2.75 hours annually per owner. These estimates do not include the
decrease in compliance costs to individuals who would no longer find it
necessary to compute the quantities detailed in proposed Sec. 1.199A-6
because they would receive this information from each RPE. Nor do these
estimates reflect the decrease in compliance costs outlined above.
Valuations of the burden hours of $39/hour in the case of
individuals making aggregation decisions and $53/hour in the case of
RPEs reporting section 199A information lead to a PRA-based estimate of
the gross reporting annualized costs to taxpayers of approximately $1.3
billion over ten years; this estimate does not account for the
provisions of the proposed regulations that will substantially reduce
compliance costs. Because these estimates assume that the costs are the
same each year, the annualized costs do not vary with the discount
rate. It is possible that costs will be higher in the first years that
the deduction is allowed and lower in future years once taxpayers have
more experience with the calculations and reporting requirements
associated with the deduction. Finally, the estimates reflect data for
entities of a size and form expected to be impacted by section 199A.
More specifically, because of the scope of the section 199A deduction,
the Treasury Department and the IRS expect the majority of affected
entities to be largely small, and medium in size.
The Treasury Department and the IRS solicit comments on the
assumptions and the methodology used to calculate the compliance costs
imposed by the proposed regulations relative to the baseline. This
includes, among other things, assumptions and methodology regarding the
reporting burden per respondent, the number of impacted entities, and
the hourly labor cost estimate for reporting.
----------------------------------------------------------------------------------------------------------------
Annualized monetized effect on
compliance costs from proposed Years 2018 to 2027 (3% discount rate, Years 2018 to 2027 (7% discount
regulations millions $2018) rate, millions $2018)
----------------------------------------------------------------------------------------------------------------
Estimated Gross Costs.............. $1,317............................... $1,317.
Estimated Savings.................. Not quantified....................... Not quantified.
----------------------------------------------------------------------------------------------------------------
K. Executive Order 13771
The Treasury Department and the IRS request comment on the
Executive Order 13771 designation for these proposed regulations.
Details on the estimated costs of the proposed regulations can be found
in this economic analysis.
II. Regulatory Flexibility Act
It is hereby certified that the collections of information in
proposed Sec. Sec. 1.199A-4 and 1.199A-6 will not have a significant
economic impact on a substantial number of small entities. Although the
Treasury Department and the IRS believe that the proposed regulations
may affect a substantial number of small entities, the economic impact
on small entities as a result of the collections of information in this
notice of proposed rulemaking is not expected to be significant.
The collection in proposed Sec. 1.199A-4 may apply to individuals
and certain trusts or estates that can claim the section 199A deduction
and that choose to aggregate two or more trades or businesses for
purposes of section 199A. If a taxpayer chooses to aggregate its trades
or businesses, the taxpayer, must include an attachment to its tax
return identifying and describing each trade or business aggregated,
describing changes to the aggregated group, and providing other
information as the Commissioner may require in forms, instructions, or
other published guidance. RPEs are not subject to the collection in
proposed Sec. 1.199A-4 because RPEs are not permitted to aggregate
trades or businesses. Aggregation is not required by a person claiming
the section 199A deduction, and therefore the collection of information
in proposed Sec. 1.199A-4 is required only if the person chooses to
aggregate multiple trades or businesses. It is not known how many small
entities will choose to aggregate multiple trades or businesses,
therefore a number of affected entities is not estimated at this time.
[[Page 40909]]
The small entities subject to the collection of information in
proposed Sec. 1.199A-6 are business entities formed as estates,
trusts, partnerships, or S corporations that conduct, directly or
indirectly, one or more trades or businesses. Proposed Sec. 1.199A-6
requires such an entity to attach a statement describing the QBI, W-2
wages, and UBIA of qualified property for each separate trade or
business to the Schedule K-1 required under existing law to be issued
to each beneficiary, partner, or shareholder. Although data is not
available to estimate the number of small entities affected by the
Sec. 1.199A-6 requirements, the Treasury Department and the IRS
believe that number would include a substantial number of small
entities.
As discussed elsewhere in this preamble, the reporting burden is
estimated at 30 minutes to 20 hours, depending on individual
circumstances, with an estimated average of 2.5 hours for all affected
entities, regardless of size. The burden on small entities is expected
to be at the lower end of the range (30 minutes to 2.5 hours). Using
the IRS's taxpayer compliance cost estimates, taxpayers who are self-
employed with multiple businesses are estimated to have a monetization
rate of $39 per hour. Pass-throughs that issue K-1s have a monetization
rate of $53 per hour.
For these reasons, the Treasury Department and the IRS have
determined that the collection of information in this notice of
proposed rulemaking will not have a significant economic impact.
Accordingly, a regulatory flexibility analysis under the Regulatory
Flexibility Act (5 U.S.C. chapter 6) is not required. Notwithstanding
this certification, the Treasury Department and the IRS invite comments
from interested members of the public on both the number of entities
affected and the economic impact on small entities.
Pursuant to section 7805(f) of the Code, this notice of proposed
rulemaking has been submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on its impact on small
business.
Comments and Requests for Public Hearing
The Treasury Department and the IRS request comments on all aspects
of the proposed rules.
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
All comments will be available at www.regulations.gov or upon request.
Drafting Information
The principal authors of these regulations are Frank J. Fisher,
Wendy L. Kribell, Adrienne M. Mikolashek, and Benjamin H. Weaver,
Office of the Associate Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the Treasury Department and
the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 are amended by adding
sectional authorities for Sec. Sec. 1.199A-1 through 1.199A-6 and
Sec. 1.643(f) to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section Sec. 1.199A-1 also issued under 26 U.S.C. 199A(f)(4).
Section Sec. 1.199A-2 also issued under 26 U.S.C. 199A(b)(5),
(f)(1)(A), (f)(4), and (h).
Section Sec. 1.199A-3 also issued under 26 U.S.C. 199A(c)(4)(C)
and (f)(4.)
Section Sec. 1.199A-4 also issued under 26 U.S.C. 199A(f)(4).
Section Sec. 1.199A-5 also issued under 26 U.S.C. 199A(f)(4).
Section Sec. 1.199A-6 also issued under 26 U.S.C. 199A(f)(1)(B)
and (f)(4).
Section 1.643(f) 091 also issued under 26 U.S.C. 643(f).
0
Par. 2. Section 1.199A-0 is added to read as follows:
Sec. 1.199A-0 Table of Contents
This section lists the section headings that appear in Sec. Sec.
1.199A-1 through 1.199A-6.
Sec. 1.199A-1 Operational rules.
(a) Overview.
(1) In general.
(2) Usage of term individual.
(b) Definitions.
(1) Aggregated trade or business.
(2) Applicable percentage.
(3) Phase-in range.
(4) Qualified business income (QBI).
(5) QBI component.
(6) Qualified PTP income.
(7) Qualified REIT dividends.
(8) Reduction amount.
(9) Relevant passthrough entity (RPE).
(10) Specified service trade or business (SSTB).
(11) Threshold amount.
(12) Total QBI amount.
(13) Trade or business.
(14) Unadjusted basis immediately after the acquisition of
qualified property (UBIA of qualified property).
(15) W-2 Wages.
(c) Computation of the section 199A deduction for individuals with
taxable income not exceeding threshold amount.
(1) In general.
(2) Carryover rules.
(i) Negative total QBI amount.
(ii) Negative combined qualified REIT dividends/qualified PTP
income.
(3) Examples.
(d) Computation of the section199A deduction for individuals with
taxable income above the threshold amount.
(1) In general.
(2) QBI component.
(i) SSTB exclusion.
(ii) Aggregated trade or business.
(iii) Netting and carryover.
(A) Netting.
(B) Carryover of negative total QBI amount.
(iv) QBI component calculation.
(A) General rule.
(B) Taxpayers with taxable income within phase-in range.
(3) Carryover of negative combined qualified REIT dividends/
qualified PTP income.
(4) Examples.
(e) Special rules.
(1) Effect of deduction.
(2) Self-employment tax and net investment income tax.
(3) Commonwealth of Puerto Rico.
(4) Coordinated with alternative minimum tax.
(5) Imposition of accuracy-related penalty on underpayments.
(6) Reduction for income received from cooperatives.
(f) Effective/applicability date.
(1) General rule.
(2) Exception for non-calendar year RPE.
Sec. 1.199A-2 Determination of W-2 Wages and unadjusted basis
immediately after acquisition of qualified property.
(a) Scope.
(1) In general.
(2) W-2 Wages.
(3) UBIA of qualified property.
(b) W-2 Wages.
(1) In general.
(2) Definition of W-2 Wages.
(i) In general.
(ii) Wages paid by a person other than a common law employer.
(iii) Requirement that wages must be reported on return filed with
the Social Security Administration.
(A) In general.
[[Page 40910]]
(B) Corrected return filed to correct a return that was filed
within 60 days of the due date.
(C) Corrected return filed to correct a return that was filed later
than 60 days after the due date.
(iv) Methods for calculating W-2 Wages.
(A) In general.
(B) Acquisition or disposition of a trade or business.
(1) In general.
(2) Acquisition or disposition.
(C) Application in the case of a person with a short taxable year.
(1) In general.
(2) Short taxable year that does not include December 31.
(D) Remuneration paid for services performed in the Commonwealth of
Puerto Rico.
(3) Allocation of wages to trades or businesses.
(4) Allocation of wages to QBI.
(5) Non-duplication rule.
(c) UBIA of qualified property.
(1) Qualified property.
(i) In general.
(ii) Improvements to qualified property.
(iii) Adjustments under sections 734(b) and 743(b).
(iv) Property acquired at end of year.
(2) Depreciable period.
(i) In general.
(ii) Additional first-year depreciation under section 168.
(iii) Qualified property acquired in transactions subject to
section 1031 or section 1033.
(iv) Qualified property acquired in transactions subject to section
168(i)(7).
(3) Unadjusted basis immediately after acquisition.
(4) Examples.
(d) Effective/applicability date.
(1) General rule.
(2) Exceptions.
(i) Anti-abuse rules.
(ii) Non-calendar year RPE.
Sec. 1.199A-3 Qualified business income, qualified REIT dividends, and
qualified PTP income.
(a) In general.
(b) Definition of qualified business income.
(1) In general.
(i) Section 751 gain.
(ii) Guaranteed payments for the use of capital.
(iii) Section 481 adjustments.
(iv) Previously disallowed losses
(v) Net operating losses.
(2) Qualified items of income, gain, deduction, and loss.
(i) In general.
(ii) Items not taken into account.
(3) Commonwealth of Puerto Rico.
(4) Wages.
(5) Allocation of items among multiple directly-conducted trades or
businesses.
(c) Qualified REIT dividends and qualified PTP income.
(1) In general.
(2) Qualified REIT dividend.
(3) Qualified PTP income.
(i) In general.
(ii) Special rules.
(d) Effective/applicability date.
(1) General rule.
(2) Exceptions.
(i) Anti-abuse rules.
(ii) Non-calendar year RPE.
Sec. 1.199A-4 Aggregation.
(a) Scope and purpose.
(b) Aggregation rules.
(1) General rule.
(2) Operating rules.
(3) Family attribution.
(c) Reporting and consistency.
(1) In general.
(2) Individual reporting.
(i) Required annual disclosure.
(ii) Failure to disclose.
(d) Examples.
(e) Effective/applicability date.
(1) General rule.
(2) Exception for non-calendar year RPE.
Sec. 199A-5 Specified service trades or businesses and the trade or
business of performing services as an employee.
(a) Scope and effect.
(1) Scope.
(2) Effect of being an SSTB.
(3) Trade or business of performing services as an employee.
(b) Definition of specified service trade or business.
(1) Listed SSTBs.
(2) Additional rules for applying section 199A(d)(2) and paragraph
(b) of this section.
(i) In general.
(ii) Meaning of services performed in the field of health.
(iii) Meaning of services performed in the field of law.
(iv) Meaning of services performed in the field of accounting.
(v) Meaning of services performed in the field of actuarial
science.
(vi) Meaning of services performed in the field of performing arts.
(vii) Meaning of services performed in the field of consulting.
(viii) Meaning of services performed in the field of athletics.
(ix) Meaning of services performed in the field of financial
services.
(x) Meaning of services performed in the field of brokerage
services.
(xi) Meaning of the provision of services in investing and
investment management.
(xii) Meaning of the provision of services in trading.
(xiii) Meaning of the provision of services in dealing.
(A) Dealing in securities.
(B) Dealing in commodities.
(C) Dealing in partnership interests.
(xiv) Meaning of trade or business where the principal asset of
such trade or business is the reputation or skill of one or more of its
employees or owners.
(3) Examples.
(c) Special rules.
(1) De minimis rule.
(i) Gross receipts of $25 million or less.
(ii) Gross receipts of greater than $25 million.
(2) Services or property provided to an SSTB.
(i) In general.
(ii) Less than substantially all of property or services provided.
(iii) 50 percent or more common ownership
(iv) Example.
(3) Incidental to specified service trade or business.
(i) In general.
(ii) Example.
(d) Trade or business of performing services as an employee.
(1) In general.
(2) Employer's Federal employment tax classification of employee
immaterial.
(3) Presumption that former employees are still employees.
(i) Presumption.
(ii) Examples.
(e) Effective/applicability date.
(1) General rule.
(2) Exceptions.
(i) Anti-abuse rules.
(ii) Non-calendar year RPE.
Sec. 1.199A-6 Relevant passthrough entities (RPEs), publicly traded
partnerships (PTPs), trusts, and estates.
(a) Overview.
(b) Computational and reporting rules for RPEs.
(1) In general.
(2) Computational rules.
(3) Reporting rules for RPEs.
(i) Trade or business directly engaged in.
(ii) Other items.
(iii) Failure to report information.
(c) Computational and reporting rules for PTPs.
(1) Computational rules.
(2) Reporting rules.
(d) Application to trusts, estates, and beneficiaries.
(1) In general.
(2) Grantor trusts.
(3) Non-grantor trusts and estates.
[[Page 40911]]
(i) Calculation at entity level.
(ii) Allocation among trust or estate and beneficiaries.
(iii) Threshold amount.
(iv) Electing small business trusts.
(v) Anti-abuse rule for creation of multiple trusts to avoid
exceeding the threshold amount.
(vi) Example.
(e) Effective/applicability date.
(1) General rule.
(2) Exceptions.
(i) Anti-abuse rules.
(ii) Non-calendar year RPE
0
Par. 3. Section 1.199A-1 is added to read as follows:
Sec. 1.199A-1 Operational rules.
(a) Overview--(1) In general. This section provides operational
rules for calculating the section 199A(a) qualified business income
deduction (section 199A deduction) under section 199A of the Internal
Revenue Code (Code). This section refers to the rules in Sec. Sec.
1.199A-2 through 1.199A-6. This paragraph (a) provides an overview of
this section. Paragraph (b) of this section provides definitions that
apply for purposes of section 199A and Sec. Sec. 1.199A-1 through
1.199A-6. Paragraph (c) of this section provides computational rules
and examples for individuals whose taxable income does not exceed the
threshold amount. Paragraph (d) of this section provides computational
rules and examples for individuals whose taxable income exceeds the
threshold amount. Paragraph (e) of this section provides special rules
for purposes of section 199A and Sec. Sec. 1.199A-1 through 1.199A-6.
This section and Sec. Sec. 1.199A-2 through 1.199A-6 do not apply for
purposes of calculating the deduction in section 199A(g) for specified
agricultural and horticultural cooperatives.
(2) Usage of term individual. For purposes of applying the rules of
Sec. Sec. 1.199A-1 through 1.199A-6, a reference to an individual
includes a reference to a trust (other than a grantor trust) or an
estate to the extent that the section 199A deduction is determined by
the trust or estate under the rules of Sec. 1.199A-6.
(b) Definitions. For purposes of section 199A and Sec. Sec.
1.199A-1 through 1.199A-6, the following definitions apply:
(1) Aggregated trade or business means two or more trades or
businesses that have been aggregated pursuant to Sec. 1.199A-4.
(2) Applicable percentage means, with respect to any taxable year,
100 percent reduced (not below zero) by the percentage equal to the
ratio that the taxable income of the individual for the taxable year in
excess of the threshold amount, bears to $50,000 (or $100,000 in the
case of a joint return).
(3) Phase-in range means a range of taxable income, the lower limit
of which is the threshold amount, and the upper limit of which is the
threshold amount plus $50,000 (or $100,000 in the case of a joint
return).
(4) Qualified business income (QBI) means the net amount of
qualified items of income, gain, deduction, and loss with respect to
any trade or business as determined under the rules of Sec. 1.199A-
3(b).
(5) QBI component means the amount determined under paragraph
(d)(2) of this section.
(6) Qualified PTP income is defined in Sec. 1.199A-3(c)(3).
(7) Qualified REIT dividends are defined in Sec. 1.199A-3(c)(2).
(8) Reduction amount means, with respect to any taxable year, the
excess amount multiplied by the ratio that the taxable income of the
individual for the taxable year in excess of the threshold amount,
bears to $50,000 (or $100,000 in the case of a joint return). For
purposes of this paragraph (b)(8), the excess amount is 20 percent of
QBI over the greater of 50 percent of W-2 wages or the sum of 25
percent of W-2 wages plus 2.5 percent of the UBIA of qualified
property.
(9) Relevant passthrough entity (RPE) means a partnership (other
than a PTP) or an S corporation that is owned, directly or indirectly
by at least one individual, estate, or trust. A trust or estate is
treated as an RPE to the extent it passes through QBI, W-2 wages, UBIA
of qualified property, qualified REIT dividends, or qualified PTP
income.
(10) Specified service trade or business (SSTB) means a specified
service trade or business as defined in Sec. 1.199A-5(b).
(11) Threshold amount means, for any taxable year beginning before
2019, $157,500 (or $315,000 in the case of a taxpayer filing a joint
return). In the case of any taxable year beginning after 2018, the
threshold amount is the dollar amount in the preceding sentence
increased by an amount equal to such dollar amount, multiplied by the
cost-of-living adjustment determined under section 1(f)(3) of the Code
for the calendar year in which the taxable year begins, determined by
substituting ``calendar year 2017'' for ``calendar year 2016'' in
section 1(f)(3)(A)(ii). The amount of any increase under the preceding
sentence is rounded as provided in section 1(f)(7) of the Code.
(12) Total QBI amount means the net total QBI from all trades or
businesses (including the individual's share of QBI from trades or
business conducted by RPEs).
(13) Trade or business means a section 162 trade or business other
than the trade or business of performing services as an employee. In
addition, rental or licensing of tangible or intangible property
(rental activity) that does not rise to the level of a section 162
trade or business is nevertheless treated as a trade or business for
purposes of section 199A, if the property is rented or licensed to a
trade or business which is commonly controlled under Sec. 1.199A-
4(b)(1)(i) (regardless of whether the rental activity and the trade or
business are otherwise eligible to be aggregated under Sec. 1.199A-
4(b)(1)).
(14) Unadjusted basis immediately after acquisition of qualified
property (UBIA of qualified property) is defined in Sec. 1.199A-2(c).
(15) W-2 wages means a trade or business's W-2 wages properly
allocable to QBI as defined in Sec. 1.199A-2(b).
(c) Computation of the Sec. 199A deduction for individuals with
taxable income not exceeding threshold amount--(1) In general. The
section 199A deduction is determined for individuals with taxable
income for the taxable year that does not exceed the threshold amount
by adding 20 percent of the total QBI amount (including QBI
attributable to an SSTB) and 20 percent of the combined amount of
qualified REIT dividends and qualified PTP income (including the
individual's share of qualified REIT dividends, and qualified PTP
income from RPEs). That sum is then compared to 20 percent of the
amount by which the individual's taxable income exceeds net capital
gain. The lesser of these two amounts is the individual's section 199A
deduction.
(2) Carryover rules--(i) Negative total QBI amount. If the total
QBI amount is less than zero, the portion of the individual's section
199A deduction related to QBI is zero for the taxable year. The
negative total QBI amount is treated as negative QBI from a separate
trade or business in the succeeding taxable year of the individual for
purposes of section 199A and this section. This carryover rule does not
affect the deductibility of the loss for purposes of other provisions
of the Code.
(ii) Negative combined qualified REIT dividends/qualified PTP
income. If the combined amount of REIT dividends and qualified PTP
income is less than zero, the portion of the individual's section 199A
deduction related to qualified REIT dividends and qualified PTP income
is zero for the taxable year. The negative combined amount must be
[[Page 40912]]
carried forward and used to offset the combined amount of REIT
dividends and qualified PTP income in the succeeding taxable year of
the individual for purposes of section 199A and this section. This
carryover rule does not affect the deductibility of the loss for
purposes of other provisions of the Code.
(3) Examples. The following examples illustrate the provisions of
this paragraph (c). For purposes of these examples, unless indicated
otherwise, assume that all of the trades or businesses are trades or
businesses as defined in paragraph (b)(1) of this section and all of
tax items are effectively connected to a trade or business within the
United States within the meaning of section 864(c). Total taxable
income does not include the section 199A deduction.
Example 1 to paragraph (c)(3). A, an unmarried individual, owns
and operates a computer repair shop as a sole proprietorship. The
business generated $100,000 in net taxable income from operations in
2018. A has no capital gains or losses. After allowable deductions
not relating to the business, A's total taxable income for 2018 is
$81,000. The business's QBI is $100,000, the net amount of its
qualified items of income, gain, deduction, and loss. A's section
199A deduction for 2018 is equal to $16,200, the lesser of 20% of
A's QBI from the business ($100,000 x 20% = $20,000) and 20% of A's
total taxable income for the taxable year ($81,000 x 20% = $16,200).
Example 2 to paragraph (c)(3). Assume the same facts as in
Example 1 of this paragraph (c)(3), except that A also has $7,000 in
net capital gain for 2018 and that, after allowable deductions not
relating to the business, A's taxable income for 2018 is $74,000.
A's taxable income minus net capital gain is $67,000 ($74,000-
$7,000). A's section 199A deduction is equal to $13,400, the lesser
of 20% of A's QBI from the business ($100,000 x 20% = $20,000) and
20% of A's total taxable income minus net capital gain for the
taxable year ($67,000 x 20% = $13,400).
Example 3 to paragraph (c)(3). B and C are married and file a
joint individual income tax return. B earned $500,000 in wages as an
employee of an unrelated company in 2018. C owns 100% of the shares
of X, an S corporation that provides landscaping services. X
generated $100,000 in net income from operations in 2018. X paid C
$150,000 in wages in 2018. B and C have no capital gains or losses.
After allowable deductions not related to X, B and C's total taxable
income for 2018 is $270,000. B's and C's wages are not considered to
be income from a trade or business for purposes of the section 199A
deduction. Because X is an S corporation, its QBI is determined at
the S corporation level. X's QBI is $100,000, the net amount of its
qualified items of income, gain, deduction, and loss. The wages paid
by X to C are considered to be a qualified item of deduction for
purposes of determining X's QBI. The section 199A deduction with
respect to X's QBI is then determined by C, X's sole shareholder,
and is claimed on the joint return filed by B and C. B and C's
section 199A deduction is equal to $20,000, the lesser of 20% of C's
QBI from the business ($100,000 x 20% = $20,000) and 20% of B and
C's total taxable income for the taxable year ($270,000 x 20% =
$54,000).
Example 4 to paragraph (c)(3). Assume the same facts as in
Example 3 of this paragraph (c)(3) except that B also earns $1,000
in qualified REIT dividends and $500 in qualified PTP income in
2018, increasing taxable income to $271,500. B and C's section 199A
deduction is equal to $20,300, the lesser of (i) 20% of C's QBI from
the business ($100,000 x 20% = $20,000) plus 20% of B's combined
qualified REIT dividends and qualified PTP income ($1,500 x 20% =
$300) and (ii) 20% of B and C's total taxable for the taxable year
($271,500 x 20% = $54,300).
(d) Computation of the Sec. 199A deduction for individuals with
taxable income above threshold amount--(1) In general. The section 199A
deduction is determined for individuals with taxable income for the
taxable year that exceeds the threshold amount by adding the QBI
component and 20 percent of the combined amount of qualified REIT
dividends and qualified PTP income (including the individual's share of
qualified REIT dividends and qualified PTP income from RPEs). That sum
is then compared to 20 percent of the amount by which the individual's
taxable income exceeds net capital gain. The lesser of these two
amounts is the individual's section 199A deduction.
(2) QBI component. An individual with taxable income for the
taxable year that exceeds the threshold amount determines the QBI
component using the following computational rules, which are to be
applied in the order they appear.
(i) SSTB exclusion. If the individual's taxable income is within
the phase-in range, then only the applicable percentage of QBI, W-2
wages, and UBIA of qualified property for each SSTB is taken into
account for purposes of determining the individual's section 199A
deduction. If the individual's taxable income exceeds the phase-in
range, then none of the individual's share of QBI, W-2 wages, or UBIA
of qualified property attributable to an SSTB may be taken into account
for purposes of determining the individual's section 199A deduction.
(ii) Aggregated trade or business. If an individual chooses to
aggregate trades or businesses under the rules of Sec. 1.199A-4, the
individual must combine the QBI, W-2 wages, and UBIA of qualified
property of each trade or business within an aggregated trade or
business prior to applying the W-2 wages and UBIA of qualified property
limitations described in paragraph (d)(2)(iv) of this section.
(iii) Netting and Carryover--(A) Netting. If an individual's QBI
from at least one trade or business is less than zero, the individual
must offset the QBI attributable to each trade or business that
produced net positive QBI with the QBI from each trade or business that
produced net negative QBI in proportion to the relative amounts of net
QBI in the trades or businesses with positive QBI. The adjusted QBI is
then used in paragraph (d)(2)(iv) of this section. The W-2 wages and
UBIA of qualified property from the trades or businesses which produced
net negative QBI are not taken into account for purposes of this
paragraph (d) and are not carried over to the subsequent year.
(B) Carryover of negative total QBI amount. If an individual's QBI
from all trades or businesses combined is less than zero, the QBI
component is zero for the taxable year. This negative amount is treated
as negative QBI from a separate trade or business in the succeeding
taxable year of the individual for purposes of section 199A and this
section. This carryover rule does not affect the deductibility of the
loss for purposes of other provisions of the Code. The W-2 wages and
UBIA of qualified property from the trades or businesses which produced
net negative QBI are not taken into account for purposes of this
paragraph (d) and are not carried over to the subsequent year.
(iv) QBI component calculation--(A) General rule. Except as
provided in paragraph (d)(iv)(B) of this section, the QBI component is
the sum of the amounts determined under this paragraph (d)(2)(iv)(A)
for each trade or business. For each trade or business (including
trades or businesses operated through RPEs) the individual must
determine the lesser of--
(1) 20 percent of the QBI for that trade or business; or
(2) The greater of--
(i) 50 percent of W-2 wages with respect to that trade or business,
or
(ii) the sum of 25 percent of W-2 wages with respect to that trade
or business plus 2.5 percent of the UBIA of qualified property with
respect to that trade or business.
(B) Taxpayers with taxable income within phase-in range. If the
individual's taxable income is within the phase-in range and the amount
determined under paragraph (d)(2)(iv)(A)(2) of this section for a trade
or business is less than the amount determined under paragraph
(d)(2)(iv)(A)(1) of this section for that trade or business, the amount
[[Page 40913]]
determined under paragraph (d)(2)(iv)(A) of this section for such trade
or business is modified. Instead of the amount determined under
paragraph (d)(2)(iv)(A)(2) of this section, the QBI component for the
trade or business is the amount determined under paragraph
(d)(2)(iv)(A)(1) of this section reduced by the reduction amount as
defined in paragraph (b)(8) of this section. This reduction amount does
not apply if the amount determined in paragraph (d)(2)(iv)(A)(2) of
this section is greater than the amount determined under paragraph
(d)(2)(iv)(A)(1) of this section (in which circumstance the QBI
component for the trade or business will be the unreduced amount
determined in paragraph (d)(2)(iv)(A)(1) of this section).
(3) Negative combined qualified REIT dividends/qualified PTP
income. If the combined amount of REIT dividends and qualified PTP
income is less than zero, the portion of the individual's section 199A
deduction related to qualified REIT dividends and qualified PTP income
is zero for the taxable year. The negative combined amount must be
carried forward and used to offset the combined amount of REIT
dividends/qualified PTP income in the succeeding taxable year of the
individual for purposes of section 199A and this section. This
carryover rule does not affect the deductibility of the loss for
purposes of other provisions of the Code.
(4) Examples. The following examples illustrate the provisions of
this paragraph (d). For purposes of these examples, unless indicated
otherwise, assume that all of the trades or businesses are trades or
businesses as defined in paragraph (b)(13) of this section, none of the
trades or businesses are SSTBs as defined in paragraph (b)(10) of this
section and Sec. 1.199A-5(b); and all of the tax items associated with
the trades or businesses are effectively connected to a trade or
business within the United States within the meaning of section 864(c).
Also assume that the taxpayers report no capital gains or losses or
other tax items not specified in the examples. Total taxable income
does not include the section 199A deduction.
Example 1 to paragraph (d)(4). D, an unmarried individual, owns
several parcels of land that D manages and which are leased to
several suburban airports for parking lots. The business generated
$1,000,000 of QBI in 2018. The business paid no wages and the
property was not qualified property because it was not depreciable.
After allowable deductions unrelated to the business, D's total
taxable income for 2018 is $980,000. Because D's taxable income
exceeds the applicable threshold amount, D's section 199A deduction
is subject to the W-2 wage and UBIA of qualified property
limitations. D's section 199A deduction is limited to zero because
the business paid no wages and held no qualified property.
Example 2 to paragraph (d)(4). Assume the same facts as in
Example 1 of this paragraph (d)(4), except that D developed the land
parcels in 2019, expending a total of $10,000,000 to build parking
structures on each of the parcels, all of which is depreciable.
During 2020, D leased the parking structures and the land to the
suburban airports. D reports $4,000,000 of QBI for 2020. After
allowable deductions unrelated to the business, D's total taxable
income for 2020 is $3,980,000. Because D's taxable income is above
the threshold amount, the QBI component of D's section 199A
deduction is subject to the W-2 wage and UBIA of qualified property
limitations. Because the business has no W-2 wages, the QBI
component of D's section 199A deduction will be limited to the
lesser of 20% of the business's QBI or 2.5% of its UBIA of qualified
property. Twenty percent of the $4,000,000 of QBI is $800,000. Two
and one-half percent of the $10,000,000 UBIA of qualified property
is $250,000. The QBI component of D's section 199A deduction is thus
limited to $250,000. D's section 199A deduction is equal to the
lesser of (i) 20% of the QBI from the business as limited ($250,000)
or (ii) 20% of D's taxable income ($3,980,000 x 20% = $796,000).
Therefore, D's section 199A deduction for 2020 is $250,000.
Example 3 to paragraph (d)(4). E, an unmarried individual, is a
30% owner of LLC, which is classified as a partnership for Federal
income tax purposes. In 2018, the LLC has a single trade or business
and reported QBI of $3,000,000. The LLC paid total W-2 wages of
$1,000,000, and its total UBIA of qualified property is $100,000. E
is allocated 30% of all items of the partnership. For the 2018
taxable year, E reports $900,000 of QBI from the LLC. After
allowable deductions unrelated to LLC, E's taxable income is
$880,000. Because E's taxable income is above the threshold amount,
the QBI component of E's section 199A deduction will be limited to
the lesser of 20% of E's share of LLC's QBI or the greater of the W-
2 wage or UBIA of qualified property limitations. Twenty percent of
E's share of QBI of $900,000 is $180,000. The W-2 wage limitation
equals 50% of E's share of the LLC's wages ($300,000) or $150,000.
The UBIA of qualified property limitation equals $75,750, the sum of
25% of E's share of LLC's wages ($300,000) or $75,000 plus 2.5% of
E's share of UBIA of qualified property ($30,000) or $750. The
greater of the limitation amounts ($150,000 and $75,750) is
$150,000. The QBI component of E's section 199A deduction is thus
limited to $150,000, the lesser of 20% of QBI ($180,000) and the
greater of the limitations amounts ($150,000). E's section 199A
deduction is equal to the lesser of 20% of the QBI from the business
as limited ($150,000) or 20% of E's taxable income ($880,000 x 20% =
$176,000). Therefore, E's section 199A deduction is $150,000 for
2018.
Example 4 to paragraph (d)(4). F, an unmarried individual, owns
a 50% interest in Z, an S corporation for Federal income tax
purposes that conducts a single trade or business. In 2018, Z
reported QBI of $6,000,000. Z paid total W-2 wages of $2,000,000,
and its total UBIA of qualified property is $200,000. For the 2018
taxable year, F reports $3,000,000 of QBI from Z. F is not an
employee of Z and receives no wages or reasonable compensation from
Z. After allowable deductions unrelated to Z and a deductible
qualified net loss from a PTP of ($10,000), F's taxable income is
$1,880,000. Because F's taxable income is above the threshold
amount, the QBI component of F's section 199A deduction will be
limited to the lesser of 20% of F's share of Z's QBI or (ii) the
greater of the W-2 wage and UBIA of qualified property limitations.
Twenty percent of F's share of QBI of $3,000,000 is $600,000. The W-
2 wage limitation equals 50% of F's share of Z's W-2 wages
($1,000,000) or $500,000. The UBIA of qualified property limitation
equals $252,500, the sum of 25% of F's share of Z's W-2 wages
($1,000,000) or $250,000 plus 2.5% of E's share of UBIA of qualified
property ($100,000) or $2,500. The greater of the limitation amounts
($500,000 and $252,500) is $500,000. The QBI component of F's
section 199A deduction is thus limited to $500,000, the lesser of
20% of QBI ($600,000) and the greater of the limitations amounts
($500,000). F reported a qualified loss from a PTP and has no
qualified REIT dividend. F does not net the ($10,000) loss against
QBI. Instead, the portion of F's section 199A deduction related to
qualified REIT dividends and qualified PTP income is zero for 2018.
F's section is 199A deduction is equal to the lesser of 20% of the
QBI from the business as limited ($500,000) or 20% of F's taxable
income over net capital gain ($1,880,000 x 20% = $376,000).
Therefore, F's section 199A deduction is $376,000 for 2018. F must
also carry forward the $(10,000) qualified loss from a PTP to be
netted against F's qualified REIT dividends and qualified PTP income
in the succeeding taxable year.
Example 5 to paragraph (d)(4). Phase-in range. (i) B and C are
married and file a joint individual income tax return. B is a
shareholder in M, an entity taxed as an S corporation for Federal
income tax purposes that conducts a single trade or business. M
holds no qualified property. B's share of the M's QBI is $300,000 in
2018. B's share of the W-2 wages from M in 2018 is $40,000. C earns
wage income from employment by an unrelated company. After allowable
deductions unrelated to M, B and C's taxable income for 2018 is
$375,000. B and C are within the phase-in range because their
taxable income exceeds the applicable threshold amount, $315,000,
but does not exceed the threshold amount plus $100,000, or $415,000.
Consequently, the QBI component of B and C's section 199A deduction
may be limited by the W-2 wage and UBIA of qualified property
limitations but the limitations will be phased in.
(ii) The UBIA of qualified property limitation amount is zero
because M does not hold qualified property. B and C must apply the
W-2 wage limitation by first determining 20% of B's share of M's
QBI. Twenty percent of B's share of M's QBI of $300,000 is
[[Page 40914]]
$60,000. Next, B and C must determine 50% of B's share of M's W-2
wages. Fifty percent of B's share of M's W-2 wages of $40,000 is
$20,000. Because 50% of B's share of M's W-2 wages ($20,000) is less
than 20% of B's share of M's QBI ($60,000), B and C must determine
the QBI component of their section 199A deduction by reducing 20% of
B's share of M's QBI by the reduction amount.
(iii) B and C are 60% through the phase-in range (that is, their
taxable income exceeds the threshold amount by $60,000 and their
phase-in range is $100,000). B and C must determine the excess
amount, which is the excess of 20% of B's share of M's QBI, or
$60,000, over 50% of B's share of M's W-2 wages, or $20,000. Thus,
the excess amount is $40,000. The reduction amount is equal to 60%
of the excess amount, or $24,000. Thus, the QBI component of B and
C's section 199A deduction is equal to $36,000, 20% of B's $300,000
share M's QBI (that is, $60,000), reduced by $24,000. B and C's
section 199A deduction is equal to the lesser of 20% of the QBI from
the business as limited ($36,000) or (ii) 20% of B and C's taxable
income ($375,000 x 20% = $75,000). Therefore, B and C's section 199A
deduction is $36,000 for 2018.
Example 6 to paragraph (d)(4). (i) Assume the same facts as in
Example 5 to paragraph (d)(4), except that M was engaged in an SSTB.
Because B and C are within the phase-in range, B must reduce the QBI
and W-2 wages allocable to B from M to the applicable percentage of
those items. B and C's applicable percentage is 100% reduced by the
percentage equal to the ratio that their taxable income for the
taxable year ($375,000) exceeds their threshold amount ($315,000),
or $60,000, bears to $100,000. Their applicable percentage is 40%.
The applicable percentage of B's QBI is ($300,000 x 40% =) $120,000,
and the applicable percentage of B's share of W-2 wages is ($40,000
x 40% =) $16,000. These reduced numbers must then be used to
determine how B's section 199A deduction is limited.
(ii) B and C must apply the W-2 wage limitation by first
determining 20% of B's share of M's QBI as limited by paragraph (i)
of this example. Twenty percent of B's share of M's QBI of $120,000
is $24,000. Next, B and C must determine 50% of B's share of M's W-2
wages. Fifty percent of B's share of M's W-2 wages of $16,000 is
$8,000. Because 50% of B's share of M's W-2 wages ($8,000) is less
than 20% of B's share of M's QBI ($24,000), B and C's must determine
the QBI component of their section 199A deduction by reducing 20% of
B's share of M's QBI by the reduction amount.
(iii) B and C are 60% through the phase-in range (that is, their
taxable income exceeds the threshold amount by $60,000 and their
phase-in range is $100,000). B and C must determine the excess
amount, which is the excess of 20% of B's share of M's QBI, as
adjusted in paragraph (i) of this example or $24,000, over 50% of
B's share of M's W-2 wages, as adjusted in paragraph (i) of this
example, or $8,000. Thus, the excess amount is $16,000. The
reduction amount is equal to 60% of the excess amount or $9,600.
Thus, the QBI component of B and C's section 199A deduction is equal
to $14,400, 20% of B's share M's QBI of $24,000, reduced by $9,600.
B and C's section 199A deduction is equal to the lesser of 20% of
the QBI from the business as limited ($14,400) or 20% of B's and C's
taxable income ($375,000 x 20% = $75,000). Therefore, B and C's
section 199A deduction is $14,400 for 2018.
Example 7 to paragraph (d)(4). (i) F, an unmarried individual,
owns as a sole proprietor 100 percent of three trades or businesses,
Business X, Business Y, and Business Z. None of the businesses hold
qualified property. F does not aggregate the trades or businesses
under Sec. 1.199A-4. For taxable year 2018, Business X generates $1
million of QBI and pays $500,000 of W-2 wages with respect to the
business. Business Y also generates $1 million of QBI but pays no
wages. Business Z generates $2,000 of QBI and pays $500,000 of W-2
wages with respect to the business. F also has $750,000 of wage
income from employment with an unrelated company. After allowable
deductions unrelated to the businesses, F's taxable income is
$2,722,000.
(ii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. These limitations
must be applied on a business-by-business basis. None of the
businesses hold qualified property, therefore only the 50% of W-2
wage limitation must be calculated. Because QBI from each business
is positive, F applies the limitation by determining the lesser of
20% of QBI and 50% of W-2 wages for each business. For Business X,
the lesser of 20% of QBI ($1,000,000 x 20 percent = $200,000) and
50% of Business X's W-2 wages ($500,000 x 50% = $250,000) is
$200,000. Business Y pays no W-2 wages. The lesser of 20% of
Business Y's QBI ($1,000,000 x 20% = $200,000) and 50% of its W-2
wages (zero) is zero. For Business Z, the lesser of 20% of QBI
($2,000 x 20% = $400) and 50% of W-2 wages ($500,000 x 50% =
$250,000) is $400.
(iii) Next, F must then combine the amounts determined in
paragraph (ii) of this example and compare that sum to 20% of F's
taxable income. The lesser of these two amounts equals F's section
199A deduction. The total of the combined amounts in paragraph (ii)
is $200,400 ($200,000 + 0 + 400). Twenty percent of F's taxable
income is $544,400 ($2,722,000 x 20%). Thus, F's section 199A
deduction for 2018 is $200,400.
Example 8 to paragraph (d)(4). (i) Assume the same facts as in
Example 7 of this paragraph (d)(4), except that F aggregates
Business X, Business Y, and Business Z under the rules of Sec.
1.199A-4.
(ii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. Because the
businesses are aggregated, these limitations are applied on an
aggregated basis. None of the businesses holds qualified property,
therefore only the W-2 wage limitation must be calculated. F applies
the limitation by determining the lesser of 20% of the QBI from the
aggregated businesses, which is $400,400 ($2,002,000 x 20%) and 50%
of W-2 wages from the aggregated businesses, which is $500,000
($1,000,000 x 50%). F's section 199A deduction is equal to the
lesser of $400,400 and 20% of F's taxable income ($2,722,000 x 20% =
$544,400). Thus, F's section 199A deduction for 2018 is $400,400.
Example 9 to paragraph (d)(4). (i) Assume the same facts as in
Example 7 of this paragraph (d)(4), except that for taxable year
2018, Business Z generates a loss that results in ($600,000) of
negative QBI and pays $500,000 of W-2 wages. After allowable
deductions unrelated to the businesses, F's taxable income is
$2,120,000. Because Business Z had negative QBI, F must offset the
positive QBI from Business X and Business Y with the negative QBI
from Business Z in proportion to the relative amounts of positive
QBI from Business X and Business Y. Because Business X and Business
Y produced the same amount of positive QBI, the negative QBI from
Business Z is apportioned equally among Business X and Business Y.
Therefore, the adjusted QBI for each of Business X and Business Y is
$700,000 ($1 million plus 50% of the negative QBI of $600,000). The
adjusted QBI in Business Z is $0, because its negative QBI has been
fully apportioned to Business X and Business Y.
(ii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. These limitations
must be applied on a business-by-business basis. None of the
businesses hold qualified property, therefore only the 50% of W-2
wage limitation must be calculated. For Business X, the lesser of
20% of QBI ($700,000 x 20% = $140,000) and 50% of W-2 wages
($500,000 x 50% = $250,000) is $140,000. Business Y pays no W-2
wages. The lesser of 20% of Business Y's QBI ($700,000 x 20% =
$140,000) and 50% of its W-2 wages (zero) is zero.
(iii) F must combine the amounts determined in paragraph (ii) of
this example and compare the sum to 20% of taxable income. F's
section 199A deduction equals the lesser of these two amounts. The
combined amount from paragraph (ii) of this example is $140,000
($140,000 + $0) and 20% of F's taxable income is $424,000
($2,120,000 x 20%). Thus, F's section 199A deduction for 2018 is
$140,000. There is no carryover of any loss into the following
taxable year for purposes of section 199A.
Example 10 to paragraph (d)(4). (i) Assume the same facts as in
Example 9 of this paragraph (d)(4), except that F aggregates
Business X, Business Y, and Business Z under the rules of Sec.
1.199A-4.
(ii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. Because the
businesses are aggregated, these limitations are applied on an
aggregated basis. None of the businesses holds qualified property,
therefore only the W-2 wage limitation must be calculated. F applies
the limitation by determining the lesser of 20% of the QBI from the
aggregated businesses ($1,400,000 x 20% = $280,000)
[[Page 40915]]
and 50% of W-2 wages from the aggregated businesses ($1,000,000 x
50% = $500,000), or $280,000. F's section 199A deduction is equal to
the lesser of $280,000 and 20% of F's taxable income ($2,120,000 x
20% = $424,000). Thus, F's section 199A deduction for 2018 is
$280,000. There is no carryover of any loss into the following
taxable year for purposes of section 199A.
Example 11 to paragraph (d)(4). (i) Assume the same facts as in
Example 7 of this paragraph (d)(4), except that Business Z generates
a loss that results in ($2,150,000) of negative QBI and pays
$500,000 of W-2 wages with respect to the business in 2018. Thus, F
has a negative combined QBI of ($150,000) when the QBI from all of
the businesses are added together ($1 million plus $1 million minus
the loss of ($2,150,000)). Because F has a negative combined QBI for
2018, F has no section 199A deduction with respect to any trade or
business for 2018. Instead, the negative combined QBI of ($150,000)
carries forward and will be treated as negative QBI from a separate
trade or business for purposes of computing the section 199A
deduction in the next taxable year. None of the W-2 wages carry
forward. However, for income tax purposes, the $150,000 loss may
offset F's $750,000 of wage income (assuming the loss is otherwise
allowable under the Code).
(ii) In taxable year 2019, Business X generates $200,000 of net
QBI and pays $100,000 of W-2 wages with respect to the business.
Business Y generates $150,000 of net QBI but pays no wages. Business
Z generates a loss that results in ($120,000) of negative QBI and
pays $500 of W-2 wages with respect to the business. F also has
$750,000 of wage income from employment with an unrelated company.
After allowable deductions unrelated to the businesses, F's taxable
income is $960,000. Pursuant to paragraph (d)(2)(iii)(B) of this
section, the ($150,000) of negative QBI from 2018 is treated as
arising in 2019 from a separate trade or business. Thus, F has
overall net QBI of $80,000 when all trades or businesses are taken
together ($200,000 plus $150,000 minus $120,000 minus the carryover
loss of $150,000). Because Business Z had negative QBI and F also
has a negative QBI carryover amount, F must offset the positive QBI
from Business X and Business Y with the negative QBI from Business Z
and the carryover amount in proportion to the relative amounts of
positive QBI from Business X and Business Y. Because Business X
produced 57.14% of the total QBI from Business X and Business Y,
57.14% of the negative QBI from Business Z and the negative QBI
carryforward must be apportioned to Business X, and the remaining
42.86% allocated to Business Y. Therefore, the adjusted QBI in
Business X is $45,722 ($200,000 minus 57.14% of the loss from
Business Z ($68,568), minus 57.14% of the carryover loss ($85,710)).
The adjusted QBI in Business Y is $34,278 ($150,000, minus 42.86% of
the loss from Business Z ($51,432) minus one third of the carryover
loss ($64,290)). The adjusted QBI in Business Z is $0, because its
negative QBI has been apportioned to Business X and Business Y.
(iii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. These limitations
must be applied on a business-by-business basis. None of the
businesses hold qualified property, therefore only the 50% of W-2
wage limitation must be calculated. For Business X, 20% of QBI is
$9,144 ($45,722 x 20%) and 50% of W-2 wages is $50,000 ($100,000 x
50%), so the lesser amount is $9,144. Business Y pays no W-2 wages.
Twenty percent of Business Y's QBI is $6,856 ($34,278 x 20%) and 50%
of its W-2 wages (zero) is zero, so the lesser amount is zero.
(iv) F must then compare the combined amounts determined in
paragraph (iii) of this example to 20% of F's taxable income. The
section 199A deduction equals the lesser of these amounts. F's
combined amount from paragraph (iii) of this example is $9,144
($9,144 plus zero) and 20% of F's taxable income is $192,000
($960,000 x 20%) Thus, F's section 199A deduction for 2019 is
$9,144. There is no carryover of any negative QBI into the following
taxable year for purposes of section 199A.
Example 12 to paragraph (d)(4). (i) Assume the same facts as in
Example 11 of this paragraph (d)(4), except that F aggregates
Business X, Business Y, and Business Z under the rules of Sec.
1.199A-4. For 2018, F's QBI from the aggregated trade or business is
($150,000). Because F has a combined negative QBI for 2018, F has no
section 199A deduction with respect to any trade or business for
2018. Instead, the negative combined QBI of ($150,000) carries
forward and will be treated as negative QBI from a separate trade or
business for purposes of computing the section 199A deduction in the
next taxable year. However, for income tax purposes, the $150,000
loss may offset taxpayer's $750,000 of wage income (assuming the
loss is otherwise allowable under the Code).
(ii) In taxable year 2019, F will have QBI of $230,000 and W-2
wages of $100,500 from the aggregated trade or business. F also has
$750,000 of wage income from employment with an unrelated company.
After allowable deductions unrelated to the businesses, F's taxable
income is $960,000. F must treat the negative QBI carryover loss
($150,000) from 2018 as a loss from a separate trade or business for
purposes of section 199A. This loss will offset the positive QBI
from the aggregated trade or business, resulting in an adjusted QBI
of $80,000 ($230,000 - $150,000).
(iii) Because F's taxable income is above the threshold amount,
the QBI component of F's section 199A deduction is subject to the W-
2 wage and UBIA of qualified property limitations. These limitations
must be applied on a business-by-business basis. None of the
businesses hold qualified property, therefore only the 50% of W-2
wage limitation must be calculated. For the aggregated trade or
business, the lesser of 20% of QBI ($80,000 x 20% = $16,000) and 50%
of W-2 wages ($100,500 x 50% = $50,250) is $16,000. F's section 199A
deduction equals the lesser of these amounts ($16,000) and 20% of
F's taxable income ($960,000 x 20% = $192,000). Thus, F's section
199A deduction for 2019 is $16,000. There is no carryover of any
negative QBI into the following taxable year for purposes of section
199A.
(e) Special rules--(1) Effect of deduction. In the case of a
partnership or S corporation, section 199A is applied at the partner or
shareholder level. The section 199A deduction has no effect on the
adjusted basis of a partner's interest in the partnership, the adjusted
basis of a shareholder's stock in an S corporation, or an S
corporation's accumulated adjustments account.
(2) Self-employment tax and net investment income tax. The
deduction under section 199A does not reduce net earnings from self-
employment under section 1402 or net investment income under section
1411.
(3) Commonwealth of Puerto Rico. If all of an individual's QBI from
sources within the Commonwealth of Puerto Rico is taxable under section
1 of the Code for a taxable year, then for purposes of determining the
QBI of such individual for such taxable year, the term ``United
States'' includes the Commonwealth of Puerto Rico.
(4) Coordination with alternative minimum tax. For purposes of
determining alternative minimum taxable income under section 55, the
deduction allowed under section 199A(a) for a taxable year is equal in
amount to the deduction allowed under section 199A(a) in determining
taxable income for that taxable year (that is, without regard to any
adjustments under sections 56 through 59).
(5) Imposition of accuracy-related penalty on underpayments. For
rules related to the imposition of the accuracy-related penalty on
underpayments for taxpayers who claim the deduction allowed under
section 199A, see section 6662(d)(1)(C).
(6) Reduction for income received from cooperatives. In the case of
any trade or business of a patron of a specified agricultural or
horticultural cooperative, as defined in section 199A(g)(4), the amount
of section 199A deduction determined under paragraphs (c) or (d) of
this section with respect to such trade or business must be reduced by
the lesser of:
(i) Nine percent of the QBI with respect to such trade or business
as is properly allocable to qualified payments received from such
cooperative, or
(ii) 50 percent of the W-2 wages with respect to such trade or
business as are so allocable as determined under Sec. 1.199A-2.
(f) Effective/applicability date--(1) General rule. Except as
provided in paragraph (f)(2) of this section, the provisions of this
section apply to
[[Page 40916]]
taxable years ending after the date the Treasury decision adopting
these regulations as final regulations is published in the Federal
Register. However, taxpayers may rely on the rules of this section
until the date the Treasury decision adopting these regulations as
final regulations is published in the Federal Register.
(2) Exception for non-calendar year RPE. For purposes of
determining QBI, W-2 wages, and UBIA of qualified property, if an
individual receives any of these items from an RPE with a taxable year
that begins before January 1, 2018 and ends after December 31, 2017,
such items are treated as having been incurred by the individual during
the individual's taxable year in which or with which such RPE taxable
year ends.
0
Par. 4. Section 1.199A-2 is added to read as follows:
Sec. 1.199A-2 Determination of W-2 wages and unadjusted basis
immediately after acquisition of qualified property.
(a) Scope--(1) In general. This section provides guidance on
calculating a trade or business's W-2 wages properly allocable to QBI
(W-2 wages) and the trade or business's unadjusted basis immediately
after acquisition of all qualified property (UBIA of qualified
property). The provisions of this section apply solely for purposes of
section 199A of the Internal Revenue Code (Code).
(2) W-2 wages. Paragraph (b) of this section provides guidance on
the determination of W-2 wages. The determination of W-2 wages must be
made for each trade or business by the individual or RPE that directly
conducts the trade or business before applying the aggregation rules of
Sec. 1.199A-4. In the case of W-2 wages paid by an RPE, the RPE must
determine and report W-2 wages for each trade or business conducted by
the RPE. W-2 wages are presumed to be zero if not determined and
reported for each trade or business.
(3) UBIA of qualified property. Paragraph (c) of this section
provides guidance on the determination of the UBIA of qualified
property. The determination of the UBIA of qualified property must be
made for each trade or business by the individual or RPE that directly
conducts the trade or business before applying the aggregation rules of
Sec. 1.199A-4. In the case of qualified property held by an RPE, each
partner's or shareholder's share of the UBIA of qualified property is
an amount which bears the same proportion to the total UBIA of
qualified property as the partner's or shareholder's share of tax
depreciation bears to the RPE's total tax depreciation with respect to
the property for the year. In the case of qualified property held by a
partnership which does not produce tax depreciation during the year
(for example, property that has been held for less than 10 years but
whose recovery period has ended), each partner's share of the UBIA of
qualified property is based on how gain would be allocated to the
partners pursuant to sections 704(b) and 704(c) if the qualified
property were sold in a hypothetical transaction for cash equal to the
fair market value of the qualified property. In the case of qualified
property held by an S corporation which does not produce tax
depreciation during the year, each shareholder's share of the UBIA of
qualified property is a share of the unadjusted basis proportionate to
the ratio of shares in the S corporation held by the shareholder over
the total shares of the S corporation. The UBIA of qualified property
is presumed to be zero if not determined and reported for each trade or
business.
(b) W-2 wages--(1) In general. Section 199A(b)(2)(B) provides
limitations on the section 199A deduction based on the W-2 wages paid
with respect each trade or business. Section 199A(b)(4)(B) provides
that W-2 wages do not include any amount which is not properly
allocable to QBI for purposes of section 199A(c)(1). This section
provides a three step process for determining the W-2 wages paid with
respect to a trade or business that are properly allocable to QBI.
First, each individual or RPE must determine its total W-2 wages paid
for the taxable year under the rules in paragraph (b)(2) of this
section. Second, each individual or RPE must allocate its W-2 wages
between or among one or more trades or businesses under the rules in
paragraph (b)(3) of this section. Third, each individual or RPE must
determine the amount of such wages with respect to each trade or
business that are allocable to the QBI of the trade or business under
the rules in paragraph (b)(4) of this section.
(2) Definition of W-2 wages--(i) In general. Section 199A(b)(4)(A)
provides that the term W-2 wages means with respect to any person for
any taxable year of such person, the amounts described in section
6051(a)(3) and (8) paid by such person with respect to employment of
employees by such person during the calendar year ending during such
taxable year. Thus, the term W-2 wages includes the total amount of
wages as defined in section 3401(a) plus the total amount of elective
deferrals (within the meaning of section 402(g)(3)), the compensation
deferred under section 457, and the amount of designated Roth
contributions (as defined in section 402A). For this purpose, except as
provided in paragraphs (b)(2)(iv)(C)(2) and (b)(2)(iv)(D) of this
section, the Forms W-2, ``Wage and Tax Statement,'' or any subsequent
form or document used in determining the amount of W-2 wages are those
issued for the calendar year ending during the individual's or RPE's
taxable year for wages paid to employees (or former employees) of the
individual or RPE for employment by the individual or RPE. For purposes
of this section, employees of the individual or RPE are limited to
employees of the individual or RPE as defined in section 3121(d)(1) and
(2). (For purposes of section 199A, this includes officers of an S
corporation and employees of an individual or RPE under common law.)
(ii) Wages paid by a person other than a common law employer. In
determining W-2 wages, an individual or RPE may take into account any
W-2 wages paid by another person and reported by the other person on
Forms W-2 with the other person as the employer listed in Box c of the
Forms W-2, provided that the W-2 wages were paid to common law
employees or officers of the individual or RPE for employment by the
individual or RPE. In such cases, the person paying the W-2 wages and
reporting the W-2 wages on Forms W-2 is precluded from taking into
account such wages for purposes of determining W-2 wages with respect
to that person. For purposes of this paragraph, persons that pay and
report W-2 wages on behalf of or with respect to others can include
certified professional employer organizations under section 7705,
statutory employers under section 3401(d)(1), and agents under section
3504.
(iii) Requirement that wages must be reported on return filed with
the Social Security Administration (SSA)--(A) In general. Pursuant to
section 199A(b)(4)(C), the term W-2 wages does not include any amount
that is not properly included in a return filed with SSA on or before
the 60th day after the due date (including extensions) for such return.
Under Sec. 31.6051-2 of this chapter, each Form W-2 and the
transmittal Form W-3, ``Transmittal of Wage and Tax Statements,''
together constitute an information return to be filed with SSA.
Similarly, each Form W-2c, ``Corrected Wage and Tax Statement,'' and
the transmittal Form W-3 or W-3c, ``Transmittal of Corrected Wage and
Tax Statements,'' together constitute an information return to be filed
with SSA. In determining whether any amount has been properly included
in a return filed with SSA on or before
[[Page 40917]]
the 60th day after the due date (including extensions) for such return,
each Form W-2 together with its accompanying Form W-3 will be
considered a separate information return and each Form W-2c together
with its accompanying Form W-3 or Form W-3c will be considered a
separate information return. Section 6071(c) provides that Forms W-2
and W-3 must be filed on or before January 31 of the year following the
calendar year to which such returns relate (but see the special rule in
Sec. 31.6071(a)-1T(a)(3)(1) of this chapter for monthly returns filed
under Sec. 31.6011(a)-5(a) of this chapter). Corrected Forms W-2 are
required to be filed with SSA on or before January 31 of the year
following the year in which the correction is made.
(B) Corrected return filed to correct a return that was filed
within 60 days of the due date. If a corrected information return
(Return B) is filed with SSA on or before the 60th day after the due
date (including extensions) of Return B to correct an information
return (Return A) that was filed with SSA on or before the 60th day
after the due date (including extensions) of the information return
(Return A) and paragraph (b)(2)(iii)(C) of this section does not apply,
then the wage information on Return B must be included in determining
W-2 wages. If a corrected information return (Return D) is filed with
SSA later than the 60th day after the due date (including extensions)
of Return D to correct an information return (Return C) that was filed
with SSA on or before the 60th day after the due date (including
extensions) of the information return (Return C), and if Return D
reports an increase (or increases) in wages included in determining W-2
wages from the wage amounts reported on Return C, then such increase
(or increases) on Return D will be disregarded in determining W-2 wages
(and only the wage amounts on Return C may be included in determining
W-2 wages). If Return D reports a decrease (or decreases) in wages
included in determining W-2 wages from the amounts reported on Return
C, then, in determining W-2 wages, the wages reported on Return C must
be reduced by the decrease (or decreases) reflected on Return D.
(C) Corrected return filed to correct a return that was filed later
than 60 days after the due date. If an information return (Return F) is
filed to correct an information return (Return E) that was not filed
with SSA on or before the 60th day after the due date (including
extensions) of Return E, then Return F (and any subsequent information
returns filed with respect to Return E) will not be considered filed on
or before the 60th day after the due date (including extensions) of
Return F (or the subsequent corrected information return). Thus, if a
Form W-2c (or corrected Form W-2) is filed to correct a Form W-2 that
was not filed with SSA on or before the 60th day after the due date
(including extensions) of the information return including the Form W-2
(or to correct a Form W-2c relating to an information return including
a Form W-2 that had not been filed with SSA on or before the 60th day
after the due date (including extensions) of the information return
including the Form W-2), then the information return including this
Form W-2c (or corrected Form W-2) will not be considered to have been
filed with SSA on or before the 60th day after the due date (including
extensions) for this information return including the Form W-2c (or
corrected Form W-2), regardless of when the information return
including the Form W-2c (or corrected Form W-2) is filed.
(iv) Methods for calculating W-2 wages--(A) In general. The
Secretary may provide for methods to be used in calculating W-2 wages,
including W-2 wages for short taxable years by publication in the
Internal Revenue Bulletin (see Sec. 601.601(d)(2)(ii)(b) of this
chapter).
(B) Acquisition or disposition of a trade or business--(1) In
general. In the case of an acquisition or disposition of a trade or
business, the major portion of a trade or business, or the major
portion of a separate unit of a trade or business that causes more than
one individual or entity to be an employer of the employees of the
acquired or disposed of trade or business during the calendar year, the
W-2 wages of the individual or entity for the calendar year of the
acquisition or disposition are allocated between each individual or
entity based on the period during which the employees of the acquired
or disposed of trade or business were employed by the individual or
entity, regardless of which permissible method is used for reporting
predecessor and successor wages on Form W-2, ``Wage and Tax
Statement.'' For this purpose, the period of employment is determined
consistently with the principles for determining whether an individual
is an employee described in Sec. 1.199A-2(b).
(2) Acquisition or disposition. For purposes of this paragraph
(b)(2)(iv)(B), the term acquisition or disposition includes an
incorporation, a formation, a liquidation, a reorganization, or a
purchase or sale of assets.
(C) Application in the case of a person with a short taxable year--
(1) In general. In the case of an individual or RPE with a short
taxable year, subject to the rules of paragraph (b)(2) of this section,
the W-2 wages of the individual or RPE for the short taxable year
include only those wages paid during the short taxable year to
employees of the individuals or RPE, only those elective deferrals
(within the meaning of section 402(g)(3)) made during the short taxable
year by employees of the individual or RPE and only compensation
actually deferred under section 457 during the short taxable year with
respect to employees of the individual or RPE.
(2) Short taxable year that does not include December 31. If an
individual or RPE has a short taxable year that does not contain a
calendar year ending during such short taxable year, wages paid to
employees for employment by such individual or RPE during the short
taxable year are treated as W-2 wages for such short taxable year for
purposes of paragraph (b) of this section (if the wages would otherwise
meet the requirements to be W-2 wages under this section but for the
requirement that a calendar year must end during the short taxable
year).
(D) Remuneration paid for services performed in the Commonwealth of
Puerto Rico. In the case of an individual or RPE that conducts a trade
or business in the Commonwealth of Puerto Rico, the determination of W-
2 wages of such individual or RPE will be made without regard to any
exclusion under section 3401(a)(8) for remuneration paid for services
performed in the Commonwealth of Puerto Rico. The individual or RPE
must maintain sufficient documentation (for example, Forms 499R-2/W-
2PR) to substantiate the amount of remuneration paid for services
performed in the Commonwealth of Puerto Rico that is used in
determining the W-2 wages of such individual or RPE with respect to any
trade or business conducted in the Commonwealth of Puerto Rico.
(3) Allocation of wages to trades or businesses. After calculating
total W-2 wages for a taxable year, each individual or RPE that
directly conducts more than one trade or business must allocate those
wages among its various trades or businesses. W-2 wages must be
allocated to the trade or business that generated those wages. In the
case of W-2 wages that are allocable to more than one trade or
business, the portion of the W-2 wages allocable to each trade or
business is determined in the same manner as the expenses associated
with those wages are allocated among the trades or businesses under
Sec. 1.199A-3(b)(5).
[[Page 40918]]
(4) Allocation of wages to QBI. Once W-2 wages for each trade or
business have been determined, each individual or RPE must identify the
amount of W-2 wages properly allocable to QBI for each trade or
business. W-2 wages are properly allocable to QBI if the associated
wage expense is taken into account in computing QBI under Sec. 1.199A-
3. In the case of an RPE, the wage expense must be allocated and
reported to the partners or shareholders of the RPE as required by the
Code, including subchapters K and S. The RPE must also identify and
report the associated W-2 wages to its partners or shareholders.
(5) Non-duplication rule. Amounts that are treated as W-2 wages for
a taxable year under any method cannot be treated as W-2 wages of any
other taxable year. Also, an amount cannot be treated as W-2 wages by
more than one trade or business.
(c) UBIA of qualified property--(1) Qualified property--(i) In
general. The term qualified property means, with respect to any trade
or business of an individual or RPE for a taxable year, tangible
property of a character subject to the allowance for depreciation under
section 167(a)--
(A) Which is held by, and available for use in, the trade or
business at the close of the taxable year,
(B) Which is used at any point during the taxable year in the trade
or business's production of QBI, and
(C) The depreciable period for which has not ended before the close
of the individual's or RPE's taxable year.
(ii) Improvements to qualified property. In the case of any
addition to, or improvement of, qualified property that has already
been placed in service by the individual or RPE, such addition or
improvement is treated as separate qualified property first placed in
service on the date such addition or improvement is placed in service
for purposes of paragraph (c)(2) of this section.
(iii) Adjustments under sections 734(b) and 743(b). Basis
adjustments under sections 734(b) and 743(b) are not treated as
qualified property.
(iv) Property acquired at end of year. Property is not qualified
property if the property is acquired within 60 days of the end of the
taxable year and disposed of within 120 days without having been used
in a trade or business for at least 45 days prior to disposition,
unless the taxpayer demonstrates that the principal purpose of the
acquisition and disposition was a purpose other than increasing the
section 199A deduction.
(2) Depreciable period--(i) In general. The term depreciable period
means, with respect to qualified property of a trade or business, the
period beginning on the date the property was first placed in service
by the individual or RPE and ending on the later of--
(A) The date that is 10 years after such date, or
(B) The last day of the last full year in the applicable recovery
period that would apply to the property under section 168(c),
regardless of any application of section 168(g).
(ii) Additional first-year depreciation under section 168. The
additional first-year depreciation deduction allowable under section
168 (for example, under section 168(k) or (m)) does not affect the
applicable recovery period under this paragraph for the qualified
property.
(iii) Qualified property acquired in transactions subject to
section 1031 or section 1033. For purposes of paragraph (c)(2)(i) of
this section, qualified property that is acquired in a like-kind
exchange, as defined in Sec. 1.168(i)-6(b)(11), or in an involuntary
conversion, as defined in Sec. 1.168(i)-6(b)(12), is treated as
replacement MACRS property as defined in Sec. 1.168(i)-6(b)(1). For
purposes of paragraph (c)(2)(i) of this section, the date on which the
replacement MACRS property was first placed in service by the
individual or RPE is determined as follows--
(A) Except as provided in paragraph (c)(2)(iii)(C) of this section,
the date the exchanged basis, as defined in Sec. 1.168(i)-6(b)(7), in
the replacement MACRS property was first placed in service by the trade
or business is the date on which the relinquished property was first
placed in service by the individual or RPE; and
(B) Except as provided in paragraph (c)(2)(iii)(C) of this section,
the date the excess basis, as defined in Sec. 1.168(i) 6(b)(8), in the
replacement MACRS property was first placed in service by the
individual or RPE is the date on which the replacement MACRS property
was first placed in service by the individual or RPE; or
(C) If the individual or RPE makes an election under Sec.
1.168(i)-096(i)(1) (the election not to apply Sec. 1.168(i)-096)), the
date the exchanged basis and excess basis in the replacement MACRS
property was first placed in service by the trade or business is the
date on which the replacement MACRS property was first placed in
service by the individual or RPE.
(iv) Qualified property acquired in transactions subject to section
168(i)(7). If an individual or RPE acquires qualified property in a
transaction described in section 168(i)(7)(B) (pertaining to treatment
of transferees in certain nonrecognition transactions), the individual
or RPE must determine the date on which the qualified property was
first placed in service for purposes of paragraph (c)(2)(i) of this
section as follows--
(A) For the portion of the transferee's unadjusted basis in the
qualified property that does not exceed the transferor's unadjusted
basis in such property, the date such portion was first placed in
service by the transferee is the date on which the transferor first
placed the qualified property in service; and
(B) For the portion of the transferee's unadjusted basis in the
qualified property that exceeds the transferor's unadjusted basis in
such property, such portion is treated as separate qualified property
that the transferee first placed in service on the date of the
transfer.
(3) Unadjusted basis immediately after acquisition. The term
unadjusted basis immediately after acquisition (UBIA) means the basis
on the placed in service date of the property as determined under
section 1012 or other applicable sections of Chapter 1, including
subchapters O (relating to gain or loss on dispositions of property), C
(relating to corporate distributions and adjustments), K (relating to
partners and partnerships), and P (relating to capital gains and
losses). UBIA is determined without regard to any adjustments described
in section 1016(a)(2) or (3), to any adjustments for tax credits
claimed by the individual or RPE (for example, under section 50(c)), or
to any adjustments for any portion of the basis for which the
individual or RPE has elected to treat as an expense (for example,
under sections 179, 179B, or 179C). However, UBIA does reflect the
reduction in basis for the percentage of the individual's or RPE's use
of property for the taxable year other than in the trade or business.
(4) Examples. The provisions of this paragraph (c) are illustrated
by the following examples:
Example 1 to paragraph (c)(4). (i) On January 5, 2012, A
purchases for $1 million and places in service Real Property X in
A's trade or business. A's trade or business is not an SSTB. A's
basis in Real Property X under section 1012 is $1 million. Real
Property X is qualified property within the meaning of section
199A(b)(6). As of December 31, 2018, A's basis in Real Property X,
as adjusted under section 1016(a)(2) for depreciation deductions
under section 168(a), is $821,550.
(ii) For purposes of section 199A(b)(2)(B)(ii) and this section,
A's UBIA of Real Property X is its $1 million cost basis under
section 1012, regardless of any later depreciation deductions under
section 168(a) and resulting basis adjustments under section
1016(a)(2).
[[Page 40919]]
Example 2 to paragraph (c)(4). The facts are the same as in
Example 1 of this paragraph (c)(4), except that on January 15, 2019,
A enters into a like-kind exchange under section 1031 in which A
exchanges Real Property X for Real Property Y. Real Property Y has a
value of $1 million. No cash or other property is involved in the
exchange. As of January 15, 2019, A's basis in Real Property X, as
adjusted under section 1016(a)(2) for depreciation deductions under
section 168(a), is $820,482. A's UBIA in Real Property Y is $820,482
as determined under section 1031(d) (A's adjusted basis in Real
Property X carried over to Real Property Y). Pursuant to paragraph
(c)(2)(iii)(A) of this section, Real Property Y is first placed in
service by A on January 5, 2012, which is the date on which Property
X was first placed in service by A.
Example 3 to paragraph (c)(4). (i) C operates a trade or
business that is not an SSTB as a sole proprietorship. On January 5,
2011, C purchases for $10,000 and places in service Machinery Y in
C's trade or business. C's basis in Machinery Y under section 1012
is $10,000. Machinery Y is qualified property within the meaning of
section 199A(b)(6). Assume that Machinery Y's recovery period under
section 168(c) is 10 years, and C depreciates Machinery Y under the
general depreciation system by using the straight-line depreciation
method, a 10-year recovery period, and the half-year convention. As
of December 31, 2018, C's basis in Machinery Y, as adjusted under
section 1016(a)(2) for depreciation deductions under section 168(a),
is $2,500. On January 1, 2019, C incorporates the sole
proprietorship and elects to treat the newly formed entity as an S
corporation for Federal income tax purposes. C contributes Machinery
Y and all other assets of the trade or business to the S corporation
in a non-recognition transaction under section 351. The S
corporation immediately places all the assets in service.
(ii) For purposes of section 199A(b)(2)(B)(ii) and this section,
C's UBIA of Machinery Y from 2011 through 2018 is its $10,000 cost
basis under section 1012, regardless of any later depreciation
deductions under section 168(a) and resulting basis adjustments
under section 1016(a)(2). Pursuant to paragraph (c)(3) of this
section, S corporation's UBIA of Machinery Y is determined under the
applicable rules of subchapter C as of date the S corporation places
it in service. Therefore, the S corporation's UBIA of Machinery Y is
$2,500, the basis of the property under section 362 at the time the
S corporation places the property in service. Pursuant to paragraph
(c)(2)(iv)(A) of this section, for purposes of determining the
depreciable period of Machinery Y, the S corporation's placed in
service date will be the date C originally placed the property in
service in 2011. Therefore, Machinery Y may be qualified property of
the S corporation (assuming it continues to be used in the business)
for 2019 and 2020 and will not be qualified property of the S
corporation after 2020, because its depreciable period will have
expired.
(d) Effective/applicability date--(1) General rule. Except as
provided in paragraph (d)(2) of this section, the provisions of this
section apply to taxable years ending after the date the Treasury
decision adopting these regulations as final regulations is published
in the Federal Register. However, taxpayers may rely on the rules of
this section until the date the Treasury decision adopting these
regulations as final regulations is published in the Federal Register.
(2) Exceptions-(i) Anti-abuse rules. The provisions of paragraph
(c)(1)(iv) of this section apply to taxable years ending after December
22, 2017.
(ii) Non-calendar year RPE. For purposes of determining QBI, W-2
wages, and UBIA of qualified property, if an individual receives any of
these items from an RPE with a taxable year that begins before January
1, 2018 and ends after December 31, 2017, such items are treated as
having been incurred by the individual during the individual's taxable
year in which or with which such RPE taxable year ends.
0
Par. 5. Section 1.199A-3 is added to read as follows:
Sec. 1.199A-3 Qualified business income, qualified REIT dividends,
and qualified PTP income.
(a) In general. This section provides rules on the determination of
a trade or business's QBI, as well as the determination of qualified
REIT dividends and qualified PTP income. The provisions of this section
apply solely for purposes of section 199A of the Internal Revenue Code
(Code). Paragraph (b) of this section provides rules for the
determination of QBI. Paragraph (c) of this section provides rules for
the determination of qualified REIT dividends and qualified PTP income.
QBI must be determined and reported for each trade or business by the
individual or RPE that directly conducts the trade or business before
applying the aggregation rules of Sec. 1.199A-4.
(b) Definition of qualified business income--(1) In general. For
purposes of this section, the term qualified business income (QBI)
means, for any taxable year, the net amount of qualified items of
income, gain, deduction, and loss with respect to any trade or business
of the taxpayer as described in paragraph (b)(2) of this section,
provided the other requirements of this section and section 199A are
satisfied (including, for example, the exclusion of income not
effectively connected with a United States trade or business).
(i) Section 751 gain. With respect to a partnership, if section
751(a) or (b) applies, then gain or loss attributable to assets of the
partnership giving rise to ordinary income under section 751(a) or (b)
is considered attributable to the trades or businesses conducted by the
partnership, and is taken into account for purposes of computing QBI.
(ii) Guaranteed payments for the use of capital. Income
attributable to a guaranteed payment for the use of capital is not
considered to be attributable to a trade or business, and thus is not
taken into account for purposes of computing QBI; however, the
partnership's deduction associated with the guaranteed payment will be
taken into account for purposes of computing QBI if such deduction is
properly allocable to the trade or business and is otherwise deductible
for Federal income tax purposes.
(iii) Section 481 adjustments. Section 481 adjustments (whether
positive or negative) are taken into account for purposes of computing
QBI to the extent that the requirements of this section and section
199A are otherwise satisfied, but only if the adjustment arises in
taxable years ending after December 31, 2017.
(iv) Previously disallowed losses. Generally, previously disallowed
losses or deductions (including under sections 465, 469, 704(d), and
1366(d)) allowed in the taxable year are taken into account for
purposes of computing QBI. However, losses or deductions that were
disallowed, suspended, limited, or carried over from taxable years
ending before January 1, 2018 (including under sections 465, 469,
704(d), and 1366(d)), are not taken into account in a later taxable
year for purposes of computing QBI.
(v) Net operating losses. Generally, a deduction under section 172
for a net operating loss is not considered with respect to a trade or
business and therefore, is not taken into account in computing QBI.
However, to the extent that the net operating loss is disallowed under
section 461(l), the net operating loss is taken into account for
purposes of computing QBI.
(2) Qualified items of income, gain, deduction, and loss--(i) In
general. The term qualified items of income, gain, deduction, and loss
means items of gross income, gain, deduction, and loss to the extent
such items are--
(A) Effectively connected with the conduct of a trade or business
within the United States (within the meaning of section 864(c),
determined by substituting ``trade or business (within the meaning of
section 199A)'' for ``nonresident alien individual or a foreign
corporation'' or for ``a foreign corporation'' each place it appears),
and
(B) Included or allowed in determining taxable income for the
taxable year.
[[Page 40920]]
(ii) Items not taken into account. Notwithstanding paragraph
(b)(2)(i) of this section and in accordance with section 199A(c)(3)(B),
the following items are not taken into account as a qualified item of
income, gain, deduction, or loss:
(A) Any item of short-term capital gain, short-term capital loss,
long-term capital gain, long-term capital loss, including any item
treated as one of such items, such as gains or losses under section
1231 which are treated as capital gains or losses.
(B) Any dividend, income equivalent to a dividend, or payment in
lieu of dividends described in section 954(c)(1)(G). Any amount
described in section 1385(a)(1) is not treated as described in this
clause.
(C) Any interest income other than interest income which is
properly allocable to a trade or business. For purposes of section 199A
and this section, interest income attributable to an investment of
working capital, reserves, or similar accounts is not properly
allocable to a trade or business.
(D) Any item of gain or loss described in section 954(c)(1)(C)
(transactions in commodities) or section 954(c)(1)(D) (excess foreign
currency gains) applied in each case by substituting ``trade or
business'' for ``controlled foreign corporation.''
(E) Any item of income, gain, deduction, or loss taken into account
under section 954(c)(1)(F) (income from notional principal contracts)
determined without regard to section 954(c)(1)(F)(ii) and other than
items attributable to notional principal contracts entered into in
transactions qualifying under section 1221(a)(7).
(F) Any amount received from an annuity which is not received in
connection with the trade or business.
(G) Any qualified REIT dividends as defined in paragraph (c)(2) of
this section or qualified PTP income as defined in paragraph (c)(3) of
this section.
(H) Reasonable compensation received by a shareholder from an S
corporation. However, the S corporation's deduction for such reasonable
compensation will reduce QBI if such deduction is properly allocable to
the trade or business and is otherwise deductible for Federal income
tax purposes.
(I) Any guaranteed payment described in section 707(c) received by
a partner for services rendered with respect to the trade or business,
regardless of whether the partner is an individual or an RPE. However,
the partnership's deduction for such guaranteed payment will reduce QBI
if such deduction is properly allocable to the trade or business and is
otherwise deductible for Federal income tax purposes.
(J) Any payment described in section 707(a) received by a partner
for services rendered with respect to the trade or business, regardless
of whether the partner is an individual or an RPE. However, the
partnership's deduction for such payment will reduce QBI if such
deduction is properly allocable to the trade or business and is
otherwise deductible for Federal income tax purposes.
(3) Commonwealth of Puerto Rico. For the purposes of determining
QBI, the term United States includes the Commonwealth of Puerto Rico in
the case of any taxpayer with QBI for any taxable year from sources
within the Commonwealth of Puerto Rico, if all of such receipts are
taxable under section 1 for such taxable year. This paragraph only
applies as provided in section 199A(f)(1)(C).
(4) Wages. Expenses for all wages paid (or incurred in the case of
an accrual method taxpayer) must to be taken into account in computing
QBI (if the requirements of this section and section 199A are
satisfied) regardless of the application of the W-2 wage limitation
described in Sec. 1.199A-1(d)(2)(iv).
(5) Allocation of items among directly-conducted trades or
businesses-- If an individual or an RPE directly conducts multiple
trades or businesses, and has items of QBI which are properly
attributable to more than one trade or business, the individual or RPE
must allocate those items among the several trades or businesses to
which they are attributable using a reasonable method based on all the
facts and circumstances. The individual or RPE may use a different
reasonable method for different items of income, gain, deduction, and
loss. The chosen reasonable method for each item must be consistently
applied from one taxable year to another and must clearly reflect the
income and expenses of each trade or business. The overall combination
of methods must also be reasonable based on all facts and
circumstances. The books and records maintained for a trade or business
must be consistent with any allocations under this paragraph.
(c) Qualified REIT Dividends and Qualified PTP Income--(1) In
general. Qualified REIT dividends and qualified PTP income are the sum
of qualified REIT dividends as defined in Sec. 1.199A-3(c)(2) earned
directly or through an RPE and the net amount of qualified PTP income
as defined in Sec. 1.199A-3(c)(3) earned directly or through an RPE.
(2) Qualified REIT dividend--(i) The term qualified REIT dividend
means any dividend from a REIT received during the taxable year which--
(A) Is not a capital gain dividend, as defined in section
857(b)(3), and
(B) Is not qualified dividend income, as defined in section
1(h)(11).
(ii) A REIT dividend is not a qualified REIT dividend if the stock
with respect to which it is received is held for fewer than 45 days,
taking into account the principles of section 246(c)(3) and (4).
(3) Qualified PTP income--(i) In general. The term qualified PTP
income means the sum of--
(A) The net amount of such taxpayer's allocable share of income,
gain, deduction, and loss from a PTP as defined in section 7704(b) that
is not taxed as a corporation under section 7704(a), plus
(B) Any gain or loss attributable to assets of the PTP giving rise
to ordinary income under section 751(a) or (b) that is considered
attributable to the trades or businesses conducted by the partnership.
(ii) Special rules. The rules applicable to the determination of
QBI described in paragraph (b) of this section also apply to the
determination of a taxpayer's allocable share of income, gain,
deduction, and loss from a PTP. An individual's allocable share of
income from a PTP, and any section 751 gain or loss is qualified PTP
income only to the extent the items meet the qualifications of section
199A and this section including the requirement that the item is
included or allowed in determining taxable income for the taxable year,
and the requirement that the item be effectively connected with the
conduct of a trade or business within the United States. For example,
if an individual owns an interest in a PTP, and for the taxable year is
allocated a distributive share of net loss which is disallowed under
the passive activity rules of section 469, such loss is not taken into
account for purposes of section 199A. Furthermore, each PTP is required
to determine its qualified PTP income for each trade or business and
report that information to its owners as described in Sec. 1.199A-
6(b)(3).
(d) Effective/applicability date--(1) General rule. Except as
provided in paragraph (d)(2) of this section, the provisions of this
section apply to taxable years ending after the date the Treasury
decision adopting these regulations as final regulations is published
in the Federal Register. However, taxpayers may rely on the rules of
this section until the date the Treasury decision adopting these
[[Page 40921]]
regulations as final regulations is published in the Federal Register.
(2) Exceptions--(i) Anti-abuse rules. The provisions of paragraph
(c)(2)(ii) of this section apply to taxable years ending after December
22, 2017.
(ii) Non-calendar year RPE. For purposes of determining QBI, W-2
wages, and UBIA of qualified property, if an individual receives any of
these items from an RPE with a taxable year that begins before January
1, 2018 and ends after December 31, 2017, such items are treated as
having been incurred by the individual during the individual's taxable
year in which or with which such RPE taxable year ends.
0
Par. 6. Section 1.199A-4 is added to read as follows:
Sec. 1.199A-4 Aggregation.
(a) Scope and purpose. An individual or Relevant Passthrough Entity
(RPE) may be engaged in more than one trade or business. Except as
provided in this section, each trade or business is a separate trade or
business for purposes of applying the limitations described in Sec.
1.199A-1(d)(2)(iv). This section sets forth rules to allow individuals
to aggregate trades or businesses, treating the aggregate as a single
trade or business for purposes of applying the limitations described in
Sec. 1.199A-1(d)(2)(iv). Trades or businesses may be aggregated only
to the extent provided in this section, but aggregation by taxpayers is
not required.
(b) Aggregation rules--(1) General rule. Except as provided in
paragraph (b)(3) of this section, trades or businesses may be
aggregated only if an individual can demonstrate that--
(i) The same person or group of persons, directly or indirectly,
owns 50 percent or more of each trade or business to be aggregated,
meaning in the case of such trades or businesses owned by an S
corporation, 50 percent or more of the issued and outstanding shares of
the corporation, or, in the case of such trades or businesses owned by
a partnership, 50 percent or more of the capital or profits in the
partnership;
(ii) The ownership described in paragraph (b)(1)(i) of this section
exists for a majority of the taxable year in which the items
attributable to each trade or business to be aggregated are included in
income;
(iii) All of the items attributable to each trade or business to be
aggregated are reported on returns with the same taxable year, not
taking into account short taxable years;
(iv) None of the trades or businesses to be aggregated is a
specified service trade or business (SSTB) as defined in Sec. 1.199A-
5; and
(v) The trades or businesses to be aggregated satisfy at least two
of the following factors (based on all of the facts and circumstances):
(A) The trades or businesses provide products and services that are
the same or customarily offered together.
(B) The trades or businesses share facilities or share significant
centralized business elements, such as personnel, accounting, legal,
manufacturing, purchasing, human resources, or information technology
resources.
(C) The trades or businesses are operated in coordination with, or
reliance upon, one or more of the businesses in the aggregated group
(for example, supply chain interdependencies).
(2) Operating rules. An individual may aggregate trades or
businesses operated directly and the individual's share of QBI, W-2
wages, and UBIA of qualified property from trades or businesses
operated through RPEs. Multiple owners of an RPE need not aggregate in
the same manner. For those trades or businesses directly operated by
the individual, the individual computes QBI, W-2 wages, and UBIA of
qualified property for each trade or business before applying these
aggregation rules. If an individual aggregates multiple trades or
businesses under paragraph (b)(1) of this section, the individual must
combine the QBI, W-2 wages, and UBIA of qualified property for all
aggregated trades or businesses for purposes of applying the W-2 wage
and UBIA of qualified property limitations described in Sec. 1.199A-
1(d)(2)(iv).
(3) Family attribution. For purposes of determining ownership under
paragraph (b)(1)(i) of this section an individual is considered as
owning the interest in each trade or business owned, directly or
indirectly, by or for--
(i) The individual's spouse (other than a spouse who is legally
separated from the individual under a decree of divorce or separate
maintenance), and
(ii) The individual's children, grandchildren, and parents.
(c) Reporting and consistency--(1) In general. Once an individual
chooses to aggregate two or more trades or businesses, the individual
must consistently report the aggregated trades or businesses in all
subsequent taxable years. However, an individual may add a newly
created or newly acquired (including through non-recognition transfers)
trade or business to an existing aggregated trade or business if the
requirements of paragraph (b)(1) of this section are satisfied. In a
subsequent year, if there is a change in facts and circumstances such
that an individual's prior aggregation of trades or businesses no
longer qualifies for aggregation under the rules of this section, then
the trades or businesses will no longer be aggregated within the
meaning of this section, and the individual must reapply the rules in
paragraph (b)(1) of this section to determine a new permissible
aggregation (if any).
(2) Individual disclosure--(i) Required annual disclosure. For each
taxable year, individuals must attach a statement to their returns
identifying each trade or business aggregated under paragraph (b)(1) of
this section. The statement must contain--
(A) A description of each trade or business;
(B) The name and EIN of each entity in which a trade or business is
operated;
(C) Information identifying any trade or business that was formed,
ceased operations, was acquired, or was disposed of during the taxable
year; and
(D) Such other information as the Commissioner may require in
forms, instructions, or other published guidance.
(ii) Failure to disclose. If an individual fails to attach the
statement required in paragraph (c)(2)(i) of this section, the
Commissioner may disaggregate the individual's trades or businesses.
(d) Examples. The following examples illustrate the principles of
this section. For purposes of these examples, assume the taxpayer is a
United States citizen, all individuals and RPEs use a calendar taxable
year, there are no ownership changes during the taxable year, all
trades or businesses satisfy the requirements under section 162, all
tax items are effectively connected to a trade or business within the
United States within the meaning of section 864(c), and none of the
trades or businesses is an SSTB within the meaning of Sec. 1.199A-5.
Except as otherwise specified, a single letter denotes an individual
taxpayer.
Example 1 to paragraph (d). (i) Facts. A wholly owns and
operates a catering business and a restaurant through separate
disregarded entities. The catering business and the restaurant share
centralized purchasing to obtain volume discounts and a centralized
accounting office that performs all of the bookkeeping, tracks and
issues statements on all of the receivables, and prepares the
payroll for each business. A maintains a website and print
advertising materials that reference both the catering business and
the restaurant. A uses the restaurant kitchen to prepare food for
the catering business. The catering business employs its own staff
and owns equipment and trucks that are not used or associated with
the restaurant.
(ii) Analysis. Because the restaurant and catering business are
held in disregarded
[[Page 40922]]
entities, A will be treated as operating each of these businesses
directly and thereby satisfies paragraph (b)(1)(i) of this section.
Under paragraph (b)(1)(v) of this section, A satisfies the following
factors: Paragraph (b)(1)(v)(A) is met as both businesses offer
prepared food to customers; and paragraph (b)(1)(v)(B) of this
section is met because the two businesses share the same kitchen
facilities in addition to centralized purchasing, marketing, and
accounting. Having satisfied paragraph (b)(1)(i) through(v) of this
section, A may treat the catering business and the restaurant as a
single trade or business for purposes of applying Sec. 199A-1(d).
Example 2 to paragraph (d). (i) Facts. Assume the same facts as
in Example 1 of this paragraph, but the catering and restaurant
businesses are owned in separate partnerships and A, B, C, and D
each own a 25% interest in the capital and profits of each of the
two partnerships. A, B, C, and D are unrelated.
(ii) Analysis. Because under paragraph (b)(1)(i) of this section
A, B, C, and D together own more than 50% of the capital and profits
in each of the two partnerships, they may each treat the catering
business and the restaurant as a single trade or business for
purposes of applying Sec. 1.199A-1(d).
Example 3 to paragraph (d). (i) Facts. W owns a 75% interest in
S1, an S corporation, and a 75% interest in the capital and profits
of PRS, a partnership. S1 manufactures clothing and PRS is a retail
pet food store. W manages S1 and PRS.
(ii) Analysis. W owns more than 50% of the stock of S1 and more
than 50% of the capital and profits of PRS thereby satisfying
paragraph (b)(1)(i) of this section. Although W manages both S1 and
PRS, W is not able to satisfy the requirements of paragraph
(b)(1)(v) of this section as the two businesses do not provide goods
or services that are the same or customarily offered together; there
are no significant centralized business elements; and no facts
indicate that the businesses are operated in coordination with, or
reliance upon, one another. W must treat S1 and PRS as separate
trades or businesses for purposes of applying Sec. 1.199A-1(d).
Example 4 to paragraph (d). (i) Facts. E owns a 60% interest in
the capital and profits of each of four partnerships (PRS1, PRS2,
PRS3, and PRS4). Each partnership operates a hardware store. A team
of executives oversees the operations of all four of the businesses
and controls the policy decisions involving the business as a whole.
Human resources and accounting are centralized for the four
businesses. E reports PRS1, PRS3, and PRS4 as an aggregated trade or
business under paragraph (b)(1) of this section and reports PRS2 as
a separate trade or business. Only PRS2 generates a net taxable
loss.
(ii) Analysis. E owns more than 50% of the capital and profits
of each partnership thereby satisfying paragraph (b)(1)(i) of this
section. Under paragraph (b)(1)(v) of this section, the following
factors are satisfied: Paragraph (b)(1)(v)(A) of this section
because each partnership operates a hardware store; and paragraph
(b)(1)(v)(B) of this section because the businesses share accounting
and human resource functions. E's decision to aggregate only PRS1,
PRS3, and PRS4 into a single trade or business for purposes of
applying Sec. 1.199A-1(d) is permissible. The loss from PRS2 will
be netted against the aggregate profits of PRS1, PRS3 and PRS4
pursuant to Sec. 1.199A-1(d)(2)(iii).
Example 5 to paragraph (d). (i) Facts. Assume the same facts as
Example 4 of this paragraph, and that F owns a 10% interest in the
capital and profits of PRS1, PRS2, PRS3, and PRS4.
(ii) Analysis. Because under paragraph (b)(1)(i) of this section
E owns more than 50% of the capital and profits in the four
partnerships, F may aggregate PRS 1, PRS2, PRS3, and PRS4 as a
single trade or business for purposes of applying Sec. 1.199A-1(d),
provided that F can demonstrate that the ownership test is met by E.
Example 6 to paragraph (d). (i) Facts. D owns 75% of the stock
of S1, S2, and S3, each of which is an S corporation. Each S
corporation operates a grocery store in a separate state. S1 and S2
share centralized purchasing functions to obtain volume discounts
and a centralized accounting office that performs all of the
bookkeeping, tracks and issues statements on all of the receivables,
and prepares the payroll for each business. S3 is operated
independently from the other businesses.
(ii) Analysis. D owns more than 50% of the stock of each S
corporation thereby satisfying paragraph (b)(1)(i) of this section.
Under paragraph (b)(1)(v) of this section, the grocery stores
satisfy paragraph (b)(1)(v)(A) of this section because they are in
the same trade or business. Only S1 and S2 satisfy paragraph
(b)(1)(v)(B) of this section because of their centralized purchasing
and accounting offices. D is only able to show that the requirements
of paragraph (b)(1)(v)(B) of this section are satisfied for S1 and
S2; therefore, D only may aggregate S1 and S2 into a single trade or
business for purposes of Sec. 1.199A-1(d). D must report S3 as a
separate trade or business for purposes of applying Sec. 1.199A-
1(d).
Example 7 to paragraph (d). (i) Facts. Assume the same facts as
Example 6 of this paragraph except each store is independently
operated and S1 and S2 do not have centralized purchasing or
accounting functions.
(ii) Analysis. Although the stores provide the same products and
services within the meaning of paragraph (b)(1)(v)(A) of this
section, D cannot show that another factor under paragraph (b)(1)(v)
of this section is present. Therefore, D must report S1, S2, and S3
as separate trades or businesses for purposes of applying Sec.
1.199A-1(d).
Example 8 to paragraph (d). (i) Facts. G owns 80% of the stock
in S1, an S corporation and 80% of the capital and profits in LLC1
and LLC2, each of which is a partnership for Federal tax purposes.
LLC1 manufactures and supplies all of the widgets sold by LLC2. LLC2
operates a retail store that sells LLC1's widgets. S1 owns the real
property leased to LLC1 and LLC2 for use by the factory and retail
store. The entities share common advertising and management.
(ii) Analysis. G owns more than 50% of the stock of S1 and more
than 50% of the capital and profits in LLC1 and LLC2 thus satisfying
paragraph (b)(1)(i) of this section. LLC1, LLC2, and S1 share
significant centralized business elements and are operated in
coordination with, or in reliance upon, one or more of the
businesses in the aggregated group. G can treat the business
operations of LLC1 and LLC2 as a single trade or business for
purposes of applying Sec. 1.199A-1(d). S1 is eligible to be
included in the aggregated group because it leases property to a
trade or business within the aggregated trade or business as
described in Sec. 1.199A-1(b)(13) and meets the requirements of
paragraph (b)(1) of this section.
Example 9 to paragraph (d). (i) Facts. Same facts as Example 8
of this paragraph, except G owns 80% of the stock in S1 and 20% of
the capital and profits in each of LLC1 and LLC2. B, G's son, owns a
majority interest in LLC2, and M, G's mother, owns a majority
interest in LLC1. B does not own an interest in S1 or LLC1, and M
does not own an interest in S1 or LLC2.
(ii) Analysis. Under the rules in paragraph (b)(3) of this
section, B and M's interest in LLC2 and LLC1, respectively, are
attributable to G and G is treated as owning a majority interest in
LLC2 and LLC; G thus satisfies paragraph (b)(1)(i) of this section.
G may aggregate his interests in LLC1, LLC2, and S1 as a single
trade or business for purposes of applying Sec. 1.199A-1(d). Under
paragraph (b)(3) of this section, S1 is eligible to be included in
the aggregated group because it leases property to a trade or
business within the aggregated trade or business as described in
Sec. 1.199A-1(b)(13) and meets the requirements of paragraph (b)(1)
of this section.
Example 10 to paragraph (d). (i) Facts. F owns a 75% interest
and G owns a 5% interest in the capital and profits of five
partnerships (PRS1-PRS5). H owns a 10% interest in the capital and
profits of PRS1 and PRS2. Each partnership operates a restaurant and
each restaurant separately constitutes a trade or business for
purposes of section 162. G is the executive chef of all of the
restaurants and as such he creates the menus and orders the food
supplies.
(ii) Analysis. F owns more than 50% of capital and profits in
the partnerships thereby satisfying paragraph (b)(1)(i) of this
section. Under paragraph (b)(1)(v) of this section, the restaurants
satisfy paragraph (b)(1)(v)(A) of this section because they are in
the same trade or business, and paragraph (b)(1)(v)(B) of this
section is satisfied as G is the executive chef of all of the
restaurants and the businesses share a centralized function for
ordering food and supplies. F can show the requirements under
paragraph (b)(1) of this section are satisfied as to all of the
restaurants. Because F owns a majority interest in each of the
partnerships, G can demonstrate that paragraph (b)(1)(i) of this
section is satisfied. G can also aggregate all five restaurants into
a single trade or business for purposes of applying Sec. 1.199A-
1(d). H, however, only owns an interest in PRS1 and PRS2. Like G, H
satisfies paragraph (b)(1)(i) of this section because F owns a
majority interest. H can, therefore, aggregate PRS1 and PRS2 into a
single trade or business for purposes of applying Sec. 1.199A-1(d).
Example 11 to paragraph (d). (i) Facts. H, J, K, and L own
interests in PRS1 and PRS2,
[[Page 40923]]
each a partnership, and S1 and S2, each an S corporation. H, J, K
and L also own interests in C, an entity taxable as a C corporation.
H owns 30%, J owns 20%, K owns 5%, L owns 45% of each of the five
entities. All of the entities satisfy 2 of the 3 factors under
paragraph (b)(1)(v) of this section. For purposes of section 199A
the taxpayers report the following aggregated trades or businesses:
H aggregates PRS1 and S1 together and aggregates PRS2 and S2
together; J aggregates PRS1, S1 and S2 together and reports PRS2
separately; K aggregates PRS1 and PRS2 together and aggregates S1
and S2 together; and L aggregates S1, S2, and PRS2 together and
reports PRS1 separately. C cannot be aggregated.
(ii) Analysis. Under paragraph (b)(1)(i) of this section,
because H, J, and K together own a majority interest in PRS1, PRS2,
S1, and S2, H, J, K, and L are permitted to aggregate under
paragraph (b)(1). Further, the aggregations reported by the
taxpayers are permitted, but not required for each of H, J, K, and
L. C's income is not eligible for the section 199A deduction and it
cannot be aggregated for purposes of applying Sec. 1.199A-1(d).
Example 12 to paragraph (d). (i) Facts. L owns 60% of the
profits and capital interests in PRS1, a partnership, a business
that sells non-food items to grocery stores. L also owns 55% of the
profits and capital interests in PRS2, a partnership, which owns and
operates a distribution trucking business. The predominant portion
of PRS2's business is transporting goods for PRS1.
(ii) Analysis. L is able to meet (b)(1)(i) as the majority owner
of PRS1 and PRS2. Under paragraph (b)(1)(v) of this section, L is
only able to show the operations of PRS1 and PRS2 are operated in
reliance of one another under paragraph (b)(1)(v)(C) of this
section. For purposes of applying Sec. 1.199A-1(d), L must treat
PRS1 and PRS2 as separate trades or businesses.
Example 13 to paragraph (d). (i) Facts. C owns a majority
interest in a sailboat racing team and also owns an interest in PRS1
which operates a marina. PRS1 is a trade or business under section
162, but the sailboat racing team is not a trade or business within
the meaning of section 162.
(ii) Analysis. C has only one trade or business for purposes of
section 199A and, therefore, cannot aggregate the interest in the
racing team with PRS1 under paragraph (b)(1) of this section.
Example 14 to paragraph (d). (i) Facts. Trust wholly owns LLC1,
LLC2, and LLC3. LLC1 operates a trucking company that delivers
lumber and other supplies sold by LLC2. LLC2 operates a lumber yard
and supplies LLC3 with building materials. LLC3 operates a
construction business. LLC1, LLC2, and LLC3 have a centralized human
resources department, payroll, and accounting department.
(ii) Analysis. Because Trust owns 100% of the interests in LLC1,
LLC2, and LLC3, Trust satisfies paragraph (b)(1)(i) of this section.
Trust can also show that it satisfies paragraph (b)(1)(v)(B) of this
section as the trades or businesses have a centralized human
resources department, payroll, and accounting department. Trust also
can show is meets paragraph (b)(1)(v)(C) of this section as the
trades or businesses are operated in coordination, or reliance upon,
one or more in the aggregated group. Trust can aggregate LLC1, LLC2,
and LLC3 for purposes of applying Sec. 1.199A-1(d).
(e) Effective/applicability date--(1) General rule. Except as
provided in paragraph (e)(2) of this section, the provisions of this
section apply to taxable years ending after the date the Treasury
decision adopting these regulations as final regulations is published
in the Federal Register. However, taxpayers may rely on the rules of
this section until the date the Treasury decision adopting these
regulations as final regulations is published in the Federal Register.
(2) Exception for non-calendar year RPE. For purposes of
determining QBI, W-2 wages, and UBIA of qualified property, if an
individual receives any of these items from an RPE with a taxable year
that begins before January 1, 2018 and ends after December 31, 2017,
such items are treated as having been incurred by the individual during
the individual's taxable year in which or with which such RPE taxable
year ends.
0
Par. 7. Section 1.199A-5 is added to read as follows:
Sec. 1.199A-5 Specified service trades or businesses and the trade or
business of performing services as an employee.
(a) Scope and Effect--(1) Scope. This section provides guidance on
specified service trades or businesses (SSTBs) and the trade or
business of performing services as an employee. This paragraph (a)
describes the effect of being an SSTB or the trade or business of
performing services as an employee. Paragraph (b) of this section
provides definitional guidance on SSTBs. Paragraph (c) of this section
provides special rules related to SSTBs. Paragraph (d) of this section
provides guidance on the trade or business of performing services as an
employee. The provisions of this section apply solely for purposes of
section 199A of the Internal Revenue Code (Code).
(2) Effect of being an SSTB. If a trade or business is an SSTB, no
QBI, W-2 wages, or UBIA of qualified property from the SSTB may be
taken into account by any individual whose taxable income exceeds the
phase-in range as defined in Sec. 1.199A-1(b)(3), even if the item is
derived from an activity that is not itself a specified service
activity. If a trade or business conducted by a relevant passthrough
entity (RPE) is an SSTB, this limitation applies to any direct or
indirect individual owners of the business, regardless of whether the
owner is passive or participated in any specified service activity.
However, the SSTB limitation does not apply to individuals with taxable
income below the threshold amount as defined in Sec. 1.199A-1(b)(11).
A phase-in rule, provided in Sec. 1.199A-1(d)(2), applies to
individuals with taxable income within the phase-in range, allowing
them to take into account a certain ``applicable percentage'' of QBI,
W-2 wages, and UBIA of qualified property from an SSTB. A direct or
indirect owner of a trade or business engaged in the performance of a
specified service is engaged in the performance of the specified
service for purposes of section 199A and this section, regardless of
whether the owner is passive or participated in the specified service
activity.
(3) Trade or business of performing services as an employee. The
trade or business of performing services as an employee is not a trade
or business for purposes of section 199A and the regulations
thereunder. Therefore, no items of income, gain, loss, or deduction
from the trade or business of performing services as an employee
constitute QBI within the meaning of section 199A and Sec. 1.199A-3.
No taxpayer may claim a section 199A deduction for wage income,
regardless of the amount of taxable income.
(b) Definition of specified service trade or business. Except as
provided in paragraph (c)(1) of this section, the term specified
service trade or business (SSTB) means any of the following:
(1) Listed SSTBs. Any trade or business involving the performance
of services in one or more of the following fields:
(i) Health as described in paragraph (b)(2)(ii) of this section;
(ii) Law as described in paragraph (b)(2)(iii) of this section;
(iii) Accounting as described in paragraph (b)(2)(iv) of this
section;
(iv) Actuarial science as described in paragraph (b)(2)(v) of this
section;
(v) Performing arts as described in paragraph (b)(2)(vi) of this
section;
(vi) Consulting as described in paragraph (b)(2)(vii) of this
section;
(vii) Athletics as described in paragraph (b)(2)(viii) of this
section;
(viii) Financial services as described in paragraph (b)(2)(ix) of
this section;
(ix) Brokerage services as described in paragraph (b)(2)(x) of this
section;
(x) Investing and investment management as described in paragraph
(b)(2)(xi) of this section;
(xi) Trading as described in paragraph (b)(2)(xii) of this section;
[[Page 40924]]
(xii) Dealing in securities (as defined in section 475(c)(2)),
partnership interests, or commodities (as defined in section 475(e)(2))
as described in paragraph (b)(2)(xiii) of this section; or
(xiii) Any trade or business where the principal asset of such
trade or business is the reputation or skill of one or more of its
employees or owners as defined in paragraph (b)(2)(xiv) of this
section.
(2) Additional rules for applying section 199A(d)(2) and paragraph
(b) of this section--(i) In general. This paragraph (b)(2) provides
additional rules for determining whether a business is an SSTB within
the meaning of section 199A(d)(2) and paragraph (b) of this section
only. The rules of this paragraph (b)(2) may not be taken into account
for purposes of applying any provision of law or regulation other than
section 199A and the regulations thereunder except to the extent such
provision expressly refers to section 199A(d) or this section.
(ii) Meaning of services performed in the field of health. For
purposes of section 199A(d)(2) and paragraph (b)(1)(i) of this section
only, the performance of services in the field of health means the
provision of medical services by individuals such as physicians,
pharmacists, nurses, dentists, veterinarians, physical therapists,
psychologists and other similar healthcare professionals performing
services in their capacity as such who provide medical services
directly to a patient (service recipient). The performance of services
in the field of health does not include the provision of services not
directly related to a medical services field, even though the services
provided may purportedly relate to the health of the service recipient.
For example, the performance of services in the field of health does
not include the operation of health clubs or health spas that provide
physical exercise or conditioning to their customers, payment
processing, or the research, testing, and manufacture and/or sales of
pharmaceuticals or medical devices.
(iii) Meaning of services performed in the field of law. For
purposes of section 199A(d)(2) and paragraph (b)(1)(ii) of this section
only, the performance of services in the field of law means the
performance of services by individuals such as lawyers, paralegals,
legal arbitrators, mediators, and similar professionals performing
services in their capacity as such. The performance of services in the
field of law does not include the provision of services that do not
require skills unique to the field of law, for example, the provision
of services in the field of law does not include the provision of
services by printers, delivery services, or stenography services.
(iv) Meaning of services performed in the field of accounting. For
purposes of section 199A(d)(2) and paragraph (b)(1)(iii) of this
section only, the performance of services in the field of accounting
means the provision of services by individuals such as accountants,
enrolled agents, return preparers, financial auditors, and similar
professionals performing services in their capacity as such.
(v) Meaning of services performed in the field of actuarial
science. For purposes of section 199A(d)(2) and paragraph (b)(1)(iv) of
this section only, the performance of services in the field of
actuarial science means the provision of services by individuals such
as actuaries and similar professionals performing services in their
capacity as such.
(vi) Meaning of services performed in the field of performing arts.
For purposes of section 199A(d)(2) and paragraph (b)(1)(v) of this
section only, the performance of services in the field of the
performing arts means the performance of services by individuals who
participate in the creation of performing arts, such as actors,
singers, musicians, entertainers, directors, and similar professionals
performing services in their capacity as such. The performance of
services in the field of performing arts does not include the provision
of services that do not require skills unique to the creation of
performing arts, such as the maintenance and operation of equipment or
facilities for use in the performing arts. Similarly, the performance
of services in the field of the performing arts does not include the
provision of services by persons who broadcast or otherwise disseminate
video or audio of performing arts to the public.
(vii) Meaning of services performed in the field of consulting. For
purposes of section 199A(d)(2) and paragraph (b)(1)(vi) of this section
only, the performance of services in the field of consulting means the
provision of professional advice and counsel to clients to assist the
client in achieving goals and solving problems. Consulting includes
providing advice and counsel regarding advocacy with the intention of
influencing decisions made by a government or governmental agency and
all attempts to influence legislators and other government officials on
behalf of a client by lobbyists and other similar professionals
performing services in their capacity as such. The performance of
services in the field of consulting does not include the performance of
services other than advice and counsel, such as sales or economically
similar services or the provision of training and educational courses.
For purposes of the preceding sentence, the determination of whether a
person's services are sales or economically similar services will be
based on all the facts and circumstances of that person's business.
Such facts and circumstances include, for example, the manner in which
the taxpayer is compensated for the services provided. Performance of
services in the field of consulting does not include the performance of
consulting services embedded in, or ancillary to, the sale of goods or
performance of services on behalf of a trade or business that is
otherwise not an SSTB (such as typical services provided by a building
contractor) if there is no separate payment for the consulting
services.
(viii) Meaning of services performed in the field of athletics. For
purposes of section 199A(d)(2) and paragraph (b)(1)(vii) of this
section only, the performance of services in the field of athletics
means the performance of services by individuals who participate in
athletic competition such as athletes, coaches, and team managers in
sports such as baseball, basketball, football, soccer, hockey, martial
arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and
field, billiards, and racing. The performance of services in the field
of athletics does not include the provision of services that do not
require skills unique to athletic competition, such as the maintenance
and operation of equipment or facilities for use in athletic events.
Similarly, the performance of services in the field of athletics does
not include the provision of services by persons who broadcast or
otherwise disseminate video or audio of athletic events to the public.
(ix) Meaning of services performed in the field of financial
services. For purposes of section 199A(d)(2) and paragraph (b)(1)(viii)
of this section only, the performance of services in the field of
financial services means the provision of financial services to clients
including managing wealth, advising clients with respect to finances,
developing retirement plans, developing wealth transition plans, the
provision of advisory and other similar services regarding valuations,
mergers, acquisitions, dispositions, restructurings (including in title
11 or similar cases), and raising financial capital by underwriting, or
acting as a client's agent in the issuance of securities and similar
services. This includes services provided by financial advisors,
investment bankers, wealth planners,
[[Page 40925]]
and retirement advisors and other similar professionals performing
services in their capacity as such.
(x) Meaning of services performed in the field of brokerage
services. For purposes of section 199A(d)(2) and paragraph (b)(1)(ix)
of this section only, the performance of services in the field of
brokerage services includes services in which a person arranges
transactions between a buyer and a seller with respect to securities
(as defined in section 475(c)(2)) for a commission or fee. This
includes services provided by stock brokers and other similar
professionals, but does not include services provided by real estate
agents and brokers, or insurance agents and brokers.
(xi) Meaning of the provision of services in investing and
investment management. For purposes of section 199A(d)(2) and paragraph
(b)(1)(x) of this section only, the performance of services that
consist of investing and investment management refers to a trade or
business involving the receipt of fees for providing investing, asset
management, or investment management services, including providing
advice with respect to buying and selling investments. The performance
of services of investing and investment management does not include
directly managing real property.
(xii) Meaning of the provision of services in trading. For purposes
of section 199A(d)(2) and paragraph (b)(1)(xi) of this section only,
the performance of services that consist of trading means a trade or
business of trading in securities (as defined in section 475(c)(2)),
commodities (as defined in section 475(e)(2)), or partnership
interests. Whether a person is a trader in securities, commodities, or
partnership interests is determined by taking into account all relevant
facts and circumstances, including the source and type of profit that
is associated with engaging in the activity regardless of whether that
person trades for the person's own account, for the account of others,
or any combination thereof. A taxpayer, such as a manufacturer or a
farmer, who engages in hedging transactions as part of their trade or
business of manufacturing or farming is not considered to be engaged in
the trade or business of trading commodities.
(xiii) Meaning of the provision of services in dealing--(A) Dealing
in securities. For purposes of section 199A(d)(2) and paragraph
(b)(1)(xii) of this section only, the performance of services that
consist of dealing in securities (as defined in section 475(c)(2))
means regularly purchasing securities from and selling securities to
customers in the ordinary course of a trade or business or regularly
offering to enter into, assume, offset, assign, or otherwise terminate
positions in securities with customers in the ordinary course of a
trade or business. For purposes of the preceding sentence, however, a
taxpayer that regularly originates loans in the ordinary course of a
trade or business of making loans but engages in no more than
negligible sales of the loans is not dealing in securities for purposes
of section 199A(d)(2) and this section. See Sec. 1.475(c)-1(c)(2) and
(4) for the definition of negligible sales.
(B) Dealing in commodities. For purposes of section 199A(d)(2) and
paragraph (b)(1)(xii) of this section only, the performance of services
that consist of dealing in commodities (as defined in section
475(e)(2)) means regularly purchasing commodities from and selling
commodities to customers in the ordinary course of a trade or business
or regularly offering to enter into, assume, offset, assign, or
otherwise terminate positions in commodities with customers in the
ordinary course of a trade or business.
(C) Dealing in partnership interests. For purposes of section
199A(d)(2) and paragraph (b)(1)(xii) of this section only, the
performance of services that consist of dealing in partnership
interests means regularly purchasing partnership interests from and
selling partnership interests to customers in the ordinary course of a
trade or business or regularly offering to enter into, assume, offset,
assign, or otherwise terminate positions in partnership interests with
customers in the ordinary course of a trade or business.
(xiv) Meaning of trade or business where the principal asset of
such trade or business is the reputation or skill of one or more
employees or owners. For purposes of section 199A(d)(2) and paragraph
(b)(1)(xiii) of this section only, the term any trade or business where
the principal asset of such trade or business is the reputation or
skill of one or more of its employees or owners means any trade or
business that consists of any of the following (or any combination
thereof):
(A) A trade or business in which a person receives fees,
compensation, or other income for endorsing products or services,
(B) A trade or business in which a person licenses or receives
fees, compensation or other income for the use of an individual's
image, likeness, name, signature, voice, trademark, or any other
symbols associated with the individual's identity,
(C) Receiving fees, compensation, or other income for appearing at
an event or on radio, television, or another media format.
(D) For purposes of paragraph (b)(2)(xiv)(A) through (C) of this
section, the term fees, compensation, or other income includes the
receipt of a partnership interest and the corresponding distributive
share of income, deduction, gain or loss from the partnership, or the
receipt of stock of an S corporation and the corresponding income,
deduction, gain or loss from the S corporation stock.
(3) Examples. The following examples illustrate the rules in
paragraphs (a) and (b) of this section. The examples do not address all
types of services that may or may not qualify as specified services.
Unless otherwise provided, the individual in each example has taxable
income in excess of the threshold amount.
Example 1 to paragraph (b)(3). A, a singer, records a song. A
is paid a mechanical royalty when the song is licensed or streamed.
A is also paid a performance royalty when the recorded song is
played publicly. A is engaged in the performance of services in an
SSTB in the field of performing arts within the meaning of
paragraphs (b)(1)(v) and (b)(2)(vi) of this section. The royalties
that A receives for the song are not eligible for a deduction under
section 199A.
Example 2 to paragraph (b)(3). B is a partner in Partnership,
which solely owns and operates a professional sports team.
Partnership employs athletes and sells tickets to the public to
attend games in which the sports team competes. Therefore,
Partnership is engaged in the performance of services in an SSTB in
the field of athletics within the meaning of paragraphs (b)(1)(vii)
and (b)(2)(viii) of this section. B is a passive owner in
Partnership and B does not provide any services with respect to
Partnership or the sports team. However, because Partnership is
engaged in an SSTB in the field of athletics, B's distributive share
of the income, gain, loss, and deduction with respect to Partnership
is not eligible for a deduction under section 199A.
Example 3 to paragraph (b)(3). C is in the business of providing
services that assist unrelated entities in making their personnel
structures more efficient. C studies its client's organization and
structure and compares it to peers in its industry. C then makes
recommendations and provides advice to its client regarding possible
changes in the client's personnel structure, including the use of
temporary workers. C is engaged in the performance of services in an
SSTB in the field of consulting within the meaning of paragraphs
(b)(1)(vi) and (b)(2)(vii) of this section.
Example 4 to paragraph (b)(3). D is in the business of licensing
software to customers. D discusses and evaluates the customer's
software needs with the customer. The taxpayer advises the customer
on the particular software products it licenses. D is
[[Page 40926]]
paid a flat price for the software license. After the customer
licenses the software, D helps to implement the software. D is
engaged in the trade or business of licensing software and not
engaged in an SSTB in the field of consulting within the meaning of
paragraphs (b)(1)(vi) and (b)(2)(vii) of this section.
Example 5 to paragraph (b)(3). E is in the business of providing
services to assist clients with their finances. E will study a
particular client's financial situation, including, the client's
present income, savings and investments, and anticipated future
economic and financial needs. Based on this study, E will then
assist the client in making decisions and plans regarding the
client's financial activities. Such financial planning includes the
design of a personal budget to assist the client in monitoring the
client's financial situation, the adoption of investment strategies
tailored to the client's needs, and other similar services. E is
engaged in the performance of services in an SSTB in the field of
financial services within the meaning of paragraphs (b)(1)(viii) and
(b)(2)(ix) of this section.
Example 6 to paragraph (b)(3). F is in the business of executing
transactions for customers involving various types of securities or
commodities generally traded through organized exchanges or other
similar networks. Customers place orders with F to trade securities
or commodities based on the taxpayer's recommendations. F's
compensation for its services typically is based on completion of
the trade orders. F is engaged in an SSTB in the field of brokerage
services within the meaning of paragraphs (b)(1)(ix) and (b)(2)(x)
of this section.
Example 7 to paragraph (b)(3). G owns 100% of Corp, an S
corporation, which operates a bicycle sales and repair business.
Corp has 8 employees, including G. Half of Corp's net income is
generated from sales of new and used bicycles and related goods,
such as helmets, and bicycle-related equipment. The other half of
Corp's net income is generated from bicycle repair services
performed by G and Corp's other employees. Corp's assets consist of
inventory, fixtures, bicycle repair equipment, and a leasehold on
its retail location. Several of the employees and G have worked in
the bicycle business for many years, and have acquired substantial
skill and reputation in the field. Customers often consult with the
employees on the best bicycle for purchase. G is in the business of
sales and repairs of bicycles and is not engaged in an SSTB within
the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this
section.
Example 8 to paragraph (b)(3). H is a well-known chef and the
sole owner of multiple restaurants each of which is owned in a
disregarded entity. Due to H's skill and reputation as a chef, H
receives an endorsement fee of $500,000 for the use of H's name on a
line of cooking utensils and cookware. H is in the trade or business
of being a chef and owning restaurants and such trade or business is
not an SSTB. However, H is also in the trade or business of
receiving endorsement income. H's trade or business consisting of
the receipt of the endorsement fee for H's skill and/or reputation
is an SSTB within the meaning of paragraphs (b)(1)(xiii) and
(b)(2)(xiv) of this section.
Example 9 to paragraph (b)(3). J is a well-known actor. J
entered into a partnership with Shoe Company, in which J contributed
her likeness and the use of her name to the partnership in exchange
for a 50% interest in the capital and profits of the partnership and
a guaranteed payment. J's trade or business consisting of the
receipt of the partnership interest and the corresponding
distributive share with respect to the partnership interest for J's
likeness and the use of her name is an SSTB within the meaning of
paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section.
(c) Special rules. (1) De minimis rule.--(i) Gross receipts of $25
million or less. For a trade or business with gross receipts of $25
million dollars or less for the taxable year, a trade or business is
not an SSTB if less than 10 percent of the gross receipts of the trade
or business are attributable to the performance of services in a field
described in paragraph (b) of this section. For purposes of determining
whether this 10 percent test is satisfied, the performance of any
activity incident to the actual performance of services in the field is
considered the performance of services in that field.
(ii) Gross receipts of greater than $25 million. For a trade or
business with gross receipts of greater than $25 million for the
taxable year, the rules of paragraph (c)(1)(i) of this section are
applied by substituting ``5 percent'' for ``10 percent'' each place it
appears.
(2) Services or property provided to an SSTB--(i) In general. An
SSTB includes any trade or business that provides 80 percent or more of
its property or services to an SSTB if there is 50 percent or more
common ownership of the trades or businesses.
(ii) Less than substantially all of property or services provided.
If a trade or business provides less than 80 percent of its property or
services to an SSTB within the meaning of this section and there is 50
percent or more common ownership of the trades or businesses, that
portion of the trade or business of providing property or services to
the 50 percent or more commonly-owned SSTB is treated as a part of the
SSTB.
(iii) 50 percent or more common ownership. For purposes of
paragraphs (c)(2)(i) and (ii) of this section, 50 percent or more
common ownership includes direct or indirect ownership by related
parties within the meaning of sections 267(b) or 707(b).
(iv) Example. Law Firm is a partnership that provides legal
services to clients, owns its own office building and employs its
own administrative staff. Law Firm divides into three partnerships.
Partnership 1 performs legal services to clients. Partnership 2 owns
the office building and rents the entire building to Partnership 1.
Partnership 3 employs the administrative staff and through a
contract with Partnership 1 provides administrative services to
Partnership 1 in exchange for fees. All three of the partnerships
are owned by the same people (the original owners of Law Firm).
Because there is 50% or more common ownership of each of the three
partnerships, Partnership 2 provides substantially all of its
property to Partnership 1, and Partnership 3 provides substantially
all of its services to Partnership 1, Partnerships 1, 2, and 3 will
be treated as one SSTB under paragraph (a)(6) of this section.
(3) Incidental to specified service trade or business--(i) In
general. If a trade or business (that would not otherwise be treated as
an SSTB) has 50 percent or more common ownership with an SSTB,
including related parties (within the meaning of sections 267(b) or
707(b)), and has shared expenses with the SSTB, including shared wage
or overhead expenses, then such trade or business is treated as
incidental to and, therefore, part of the SSTB within the meaning of
this section if the gross receipts of the trade or business represents
no more than 5 percent of the total combined gross receipts of the
trade or business and the SSTB in a taxable year.
(ii) Example. A, a dermatologist, provides medical services to
patients on a regular basis through Dermatology LLC, a disregarded
entity owned by A. In addition to providing medical services,
Dermatology LLC also sells skin care products to A's patients. The
same employees and office space are used for the medical services
and sale of skin care products. The gross receipts with respect to
the skin care product sales do not exceed 5% of the gross receipts
of Dermatology LLC. Accordingly, the sale of the skin care products
is treated as incidental to A's SSTB of performing services in the
field of health (within the meaning of paragraph (b)(1)(i) and
(b)(2)(ii) of this section) and is treated under paragraph (c)(3) of
this section as part of such SSTB.
(d) Trade or business of performing services as an employee--(1) In
general. The trade or business of performing services as an employee is
not a trade or business for purposes of section 199A and the
regulations thereunder. Therefore, no items of income, gain, loss, and
deduction from the trade or business of performing services as an
employee constitute QBI within the meaning of section 199A and Sec.
1.199A-3. Except as provided in paragraph (d)(3) of this section,
income from the trade or business of performing services as an employee
refers to all wages (within the meaning of section 3401(a)) and other
income earned in a capacity as an employee, including payments
described in Sec. 1.6041-2(a)(1) (other than
[[Page 40927]]
payments to individuals described in section 3121(d)(3)) and Sec.
1.6041-2(b)(1).
(2) Employer's Federal employment tax classification of employee
immaterial. For purposes of determining whether wages are earned in a
capacity as an employee as provided in paragraph (d)(1) of this
section, the treatment of an employee by an employer as anything other
than an employee for Federal employment tax purposes is immaterial.
Thus, if a worker should be properly classified as an employee, it is
of no consequence that the employee is treated as a non-employee by the
employer for Federal employment tax purposes.
(3) Presumption that former employees are still employees--(i)
Presumption. Solely for purposes of section 199A(d)(1)(B) and paragraph
(d)(1) of this section, an individual that was properly treated as an
employee for Federal employment tax purposes by the person to which he
or she provided services and who is subsequently treated as other than
an employee by such person with regard to the provision of
substantially the same services directly or indirectly to the person
(or a related person), is presumed to be in the trade or business of
performing services as an employee with regard to such services. This
presumption may be rebutted upon a showing by the individual that,
under Federal tax law, regulations, and principles (including common-
law employee classification rules), the individual is performing
services in a capacity other than as an employee. This presumption
applies regardless of whether the individual provides services directly
or indirectly through an entity or entities.
(ii) Examples. The following examples illustrate the provision of
paragraph (b)(3)(i) of this section. Unless otherwise provided, the
individual in each example has taxable income in excess of the
threshold amount.
Example 1 to paragraph (d)(3). A is employed by PRS, a
partnership, as a fulltime employee and is treated as such for
Federal employment tax purposes. A quits his job for PRS and enters
into a contract with PRS under which A provides substantially the
same services that A previously provided to PRS in A's capacity as
an employee. Because A was treated as an employee for services he
provided to PRS, and now is no longer treated as an employee with
regard to such services, A is presumed (solely for purposes of
section 199A(d)(1)(B) and paragraphs (a)(3) and (d) of this section)
to be in the trade or business of performing services as an employee
with regard to his services performed for PRS. Unless the
presumption is rebutted with a showing that, under Federal tax law,
regulations, and principles (including the common-law employee
classification rules), A is not an employee, any amounts paid by PRS
to A with respect to such services will not be QBI for purposes of
section 199A. The presumption would apply even if, instead of
contracting directly with PRS, A formed a disregarded entity, or an
S corporation, and the disregarded entity or the S corporation
entered into the contract with PRS.
Example 2 to paragraph (d)(3). C is an attorney employed as an
associate in a law firm (Law Firm 1) and was treated as such for
Federal employment tax purposes. C and the other associates in Law
Firm 1 have taxable income below the threshold amount. Law Firm 1
terminates its employment relationship with C and its other
associates. C and the other former associates form a new
partnership, Law Firm 2, which contracts to perform legal services
for Law Firm 1. Therefore, in form, C is now a partner in Law Firm 2
which earns income from providing legal services to Law Firm 1. C
continues to provide substantially the same legal services to Law
Firm 1 and its clients. Because C was previously treated as an
employee for services she provided to Law Firm 1, and now is no
longer treated as an employee with regard to such services, C is
presumed (solely for purposes of section 199A(d)(1)(B) and
paragraphs (a)(3) and (d) of this section) to be in the trade or
business of performing services as an employee with respect to the
services C provides to Law Firm 1 indirectly through Law Firm 2.
Unless the presumption is rebutted with a showing that, under
Federal tax law, regulations, and principles (including common-law
employee classification rules), C's distributive share of Law Firm 2
income (including any guaranteed payments) will not be QBI for
purposes of section 199A. The results in this example would not
change if, instead of contracting with Law Firm 1, Law Firm 2 was
instead admitted as a partner in Law Firm 1.
Example 3 to paragraph (d)(3). E is an engineer employed as a
senior project engineer in an engineering firm, Engineering Firm.
Engineering Firm is a partnership and structured such that after 10
years, senior project engineers are considered for partner if
certain career milestones are met. After 10 years, E meets those
career milestones and is admitted as a partner in Engineering Firm.
As a partner in Engineering Firm, E shares in the net profits of
Engineering Firm, and also otherwise satisfies the requirements
under Federal tax law, regulations, and principles (including
common-law employee classification rules) to be respected as a
partner. E is presumed (solely for purposes of section 199A(d)(1)(B)
and paragraphs (a)(3) and (d) of this section) to be in the trade or
business of performing services as an employee with respect to the
services E provides to Engineering Firm. However, E is able to rebut
the presumption by showing that E became a partner in Engineering
Firm as a career milestone, shares in the overall net profits in
Engineering Firm, and otherwise satisfies the requirements under
Federal tax law, regulations, and principles (including common-law
employee classification rules) to be respected as a partner.
(e) Effective/applicability date--(1) General rule. Except as
provided in paragraph (e)(2) of this section, the provisions of this
section apply to taxable years ending after the date the Treasury
decision adopting these regulations as final regulations is published
in the Federal Register. However, taxpayers may rely on the rules of
this section until the date the Treasury decision adopting these
regulations as final regulations is published in the Federal Register.
(2) Exceptions--(i) Anti-abuse rules. The provisions of paragraphs
(c)(2), (c)(3), and (d)(3) of this section apply to taxable years
ending after December 22, 2017.
(ii) Non-calendar year RPE. For purposes of determining QBI, W-2
wages, and UBIA of qualified property, if an individual receives any of
these items from an RPE with a taxable year that begins before January
1, 2018 and ends after December 31, 2017, such items are treated as
having been incurred by the individual during the individual's taxable
year in which or with which such RPE taxable year ends.
0
Par. 8. Section 1.199A-6 is added to read as follows:
Sec. 1.199A-6 Relevant passthrough entities (RPEs), publicly traded
partnerships (PTPs), trusts, and estates.
(a) Overview. This section provides special rules for RPEs, PTPs,
trusts, and estates necessary for the computation of the section 199A
deduction of their owners or beneficiaries. Paragraph (b) of this
section provides computational and reporting rules for RPEs necessary
for individuals who own interests in RPEs to calculate their section
199A deduction. Paragraph (c) of this section provides computational
and reporting rules for PTPs necessary for individuals who own
interests in PTPs to calculate their section 199A deduction. Paragraph
(d) of this section provides computational and reporting rules for
trusts (other than grantor trusts) and estates necessary for their
beneficiaries to calculate their section 199A deduction.
(b) Computational and reporting rules for RPEs--(1) In general. An
RPE must determine and report information attributable to any trades or
businesses it is engaged in necessary for its owners to determine their
section 199A deduction.
(2) Computational rules. Using the following four rules, an RPE
must determine the items necessary for individuals who own interests in
the RPE to calculate their section 199A deduction under Sec. 1.199A-
1(c) or (d):
[[Page 40928]]
(i) First, the RPE must determine if it is engaged in one or more
trades or businesses. The RPE must also determine whether any of its
trades or businesses is an SSTB under the rules of Sec. 1.199A-5.
(ii) Second, the RPE must apply the rules in Sec. 1.199A-3 to
determine the QBI for each trade or business engaged in directly.
(iii) Third, the RPE must apply the rules in Sec. 1.199A-2 to
determine the W-2 wages and UBIA of qualified property for each trade
or business engaged in directly.
(iv) Fourth, the RPE must determine whether it has any qualified
REIT dividends as defined in 1.199A-3(c)(1) earned directly or through
another RPE. The RPE must also determine the net amount of qualified
PTP income as defined in Sec. 1.199A-3(c)(2) earned directly or
indirectly through investments in PTPs.
(3) Reporting rules for RPEs--(i) Trade or business directly
engaged in. An RPE must separately identify and report on the Schedule
K-1 issued to its owners for any trade or business engaged in directly
by the RPE--
(A) Each owner's allocable share of QBI, W-2 wages, and UBIA of
qualified property attributable to each such trade or business, and
(B) Whether any of the trades or businesses described in paragraph
(b)(3)(i)(A) of this section is an SSTB.
(ii) Other items. An RPE must also report on an attachment to the
Schedule K-1, any QBI, W-2 wages, UBIA of qualified property, or SSTB
determinations, reported to it by any RPE in which the RPE owns a
direct or indirect interest. The RPE must also report each owner's
allocated share of any qualified REIT dividends or qualified PTP income
or loss received by the RPE (including through another RPE).
(iii) Failure to report information. If an RPE fails to separately
identify or report on the Schedule K-1 (or any attachments thereto)
issued to an owner any items described in paragraph (b)(3)(i) of this
section, the owner's share (and the share of any upper-tier indirect
owner) of positive QBI, W-2 wages, and UBIA of qualified property
attributable to trades or businesses engaged in by that RPE will be
presumed to be zero.
(c) Computational and reporting rules for PTPs--(1) Computational
rules. Each PTP must determine its QBI under the rules of Sec. 1.199A-
3 for each trade or business in which the PTP is engaged in directly.
The PTP must also determine whether any of the trades or businesses it
is engaged in directly is an SSTB.
(2) Reporting rules. Each PTP is required to separately identify
and report the information described in paragraph (c)(1) of this
section on Schedules K-1 issued to its partners. Each PTP must also
determine and report any qualified REIT dividends or qualified PTP
income or loss received by the PTP including through an RPE, a REIT, or
another PTP. A PTP is not required to determine or report W-2 wages or
the UBIA of qualified property attributable to trades or businesses it
is engaged in directly.
(d) Application to trusts, estates, and beneficiaries--(1) In
general. A trust or estate computes its section 199A deduction based on
the QBI, W-2 wages, UBIA of qualified property, qualified REIT
dividends, and qualified PTP income that are allocated to the trust or
estate. An individual beneficiary of a trust or estate takes into
account any QBI, W-2 wages, UBIA of qualified property, qualified REIT
dividends, and qualified PTP income allocated from a trust or estate in
calculating the beneficiary's section 199A deduction, in the same
manner as though the items had been allocated from an RPE. For purposes
of this section and Sec. Sec. 1.199A-1 through 1.199A-5, a trust or
estate is treated as an RPE to the extent it allocates QBI and other
items to its beneficiaries, and is treated as an individual to the
extent it retains the QBI and other items.
(2) Grantor trusts. To the extent that the grantor or another
person is treated as owning all or part of a trust under sections 671
through 679, such person computes its section 199A deduction as if that
person directly conducted the activities of the trust with respect to
the portion of the trust treated as owned by the grantor or another
person.
(3) Non-grantor trusts and estates--(i) Calculation at entity
level. A trust or estate must calculate its QBI, W-2 wages, UBIA of
qualified property, qualified REIT dividends, and qualified PTP income.
The QBI of a trust or estate must be computed by allocating qualified
items of deduction described in section 199A(c)(3) in accordance with
the classification of those deductions under Sec. 1.652(b)-3(a), and
deductions not directly attributable within the meaning of Sec.
1.652(b)-3(b) (other deductions) are allocated in a manner consistent
with the rules in Sec. 1.652(b)-3(b). Any depletion and depreciation
deductions described in section 642(e) and any amortization deductions
described in section 642(f) that otherwise are properly included in the
computation of QBI are included in the computation of QBI of the trust
or estate, regardless of how those deductions may otherwise be
allocated between the trust or estate and its beneficiaries for other
purposes of the Code.
(ii) Allocation among trust or estate and beneficiaries. The QBI
(including any amounts that may be less than zero as calculated at the
trust or estate level), W-2 wages, UBIA of qualified property,
qualified REIT dividends, and qualified PTP income of a trust or estate
are allocated to each beneficiary and to the trust or estate based on
the relative proportion of the trust's or estate's distributable net
income (DNI), as defined by section 643(a), for the taxable year that
is distributed or required to be distributed to the beneficiary or is
retained by the trust or estate. For this purpose, the trust's or
estate's DNI is determined with regard to the separate share rule of
section 663(c), but without regard to section 199A. If the trust or
estate has no DNI for the taxable year, any QBI, W-2 wages, UBIA of
qualified property, qualified REIT dividends, and qualified PTP income
are allocated entirely to the trust or estate.
(iii) Threshold amount. The threshold amount applicable to a trust
or estate is $157,500 for any taxable year beginning before 2019. For
taxable years beginning after 2018, the threshold amount shall be
$157,500 increased by the cost-of-living adjustment as outlined in
Sec. 1.199A-1(b)(11). For purposes of determining whether a trust or
estate has taxable income that exceeds the threshold amount, the
taxable income of a trust or estate is determined before taking into
account any distribution deduction under sections 651 or 661.
(iv) Electing small business trusts. An electing small business
trust (ESBT) is entitled to the deduction under section 199A. The S
portion of the ESBT must take into account the QBI and other items from
any S corporation owned by the ESBT, the grantor portion of the ESBT
must take into account the QBI and other items from any assets treated
as owned by a grantor or another person (owned portion) of a trust
under sections 671 through 679, and the non-S portion of the ESBT must
take into account any QBI and other items from any other entities or
assets owned by the ESBT. See Sec. 1.641(c)-1.
(v) Anti-abuse rule for creation of multiple trusts to avoid
exceeding the threshold amount. Trusts formed or funded with a
significant purpose of receiving a deduction under section 199A will
not be respected for purposes of section 199A. See also Sec. 1.643(f)-
1 of the regulations.
(vi) The following example illustrates the application of paragraph
(d) of this section.
[[Page 40929]]
Example 1 to (d)(3)(vi). (i) Computation of DNI and inclusion
and deduction amounts. (A) Trust's distributive share of partnership
items. Trust, an irrevocable testamentary complex trust, is a 25%
partner in PRS, a family partnership that operates a restaurant that
generates QBI and W-2 wages. In 2018, PRS properly allocates gross
income from the restaurant of $55,000, and expenses directly
allocable to the restaurant of $50,000 (including W-2 wages of
$25,000, miscellaneous expenses of $20,000, and depreciation
deductions of $5,000) to Trust. These items are properly included in
Trust's DNI. Trust's share of PRS' unadjusted basis of qualified
depreciable property is $125,000. PRS distributes $5,000 of cash to
Trust in 2018.
(B) Trust's activities. In addition to its interest in PRS,
Trust also operates a family bakery conducted through an LLC wholly-
owned by the Trust that is treated as a disregarded entity. In 2018,
the bakery produced $100,000 of gross income and $150,000 of
expenses directly allocable to operation of the bakery (including W-
2 wages of $50,000, rental expense of $75,000, and miscellaneous
expenses of $25,000). (The net loss from the bakery operations is
not subject to any loss disallowance provisions outside of section
199A.) Trust also has zero unadjusted basis of qualified depreciable
property in the bakery. For purposes of computing its section 199A
deduction, Trust has properly chosen to aggregate the family
restaurant conducted through PRS with the bakery conducted directly
by Trust under Sec. 1.199A-4. Trust also owns various investment
assets that produce portfolio-type income consisting of dividends
($25,000), interest ($15,000), and tax-exempt interest ($15,000).
Accordingly, Trust has the following items which are properly
included in Trust's DNI:
Interest Income.............................................. 15,000
Dividends.................................................... 25,000
Tax-exempt interest.......................................... 15,000
Net business loss from PRS and bakery........................ (45,000)
Trustee commissions.......................................... 3,000
State and local taxes........................................ 5,000
(C) Allocation of deductions under Sec. 1.652(b)-3. (1)
Directly attributable expenses. In computing Trust's DNI for the
taxable year, the distributive share of expenses of PRS are directly
attributable under Sec. 1.652(b)-3(a) to the distributive share of
income of PRS. Accordingly, Trust has gross business income of
$155,000 (55,000 from PRS and 100,000 from the bakery) and direct
business expenses of $200,000 ($50,000 from PRS and $150,000 from
the bakery). In addition, $1,000 of the trustee commissions and
$1,000 of state and local taxes are directly attributable under
Sec. 1.652(b)-3(a) to Trust's business income. Accordingly, Trust
has excess business deductions of $47,000. Pursuant to its authority
recognized under Sec. 1.652(b)-3(d), Trust allocates the $47,000
excess business deductions as follows: $15,000 to the interest
income, resulting in $0 interest income, $25,000 to the dividends,
resulting in $0 dividend income, and $7,000 to the tax exempt
interest.
(2) Non-directly attributable expenses. The trustee must
allocate the sum of the balance of the trustee commissions ($2,000)
and state and local taxes ($4,000) to Trust's remaining tax-exempt
interest income, resulting in $2,000 of tax exempt interest.
(D) Amounts included in taxable income. For 2018, Trust has DNI
of $2,000. Pursuant to Trust's governing instrument, Trustee
distributes 50%, or $1,000, of that DNI to A, an individual who is a
discretionary beneficiary of Trust. In addition, Trustee is required
to distribute 25%, or $500, of that DNI to B, a current income
beneficiary of Trust. Trust retains the remaining 25% of DNI.
Consequently, with respect to the $1,000 distribution A receives
from Trust, A properly excludes $1,000 of tax-exempt interest income
under section 662(b). With respect to the $500 distribution B
receives from Trust, B properly excludes $500 of tax exempt interest
income under section 662(b). Because the DNI consists entirely of
tax-exempt income, Trust deducts $0 under section 661 with respect
to the distributions to A and B.
(ii) Section 199A deduction. (A) Trust's W-2 wages and QBI. For
the 2018 taxable year, Trust has $75,000 ($25,000 from PRS + $50,000
of Trust) of W-2 wages. Trust also has $125,000 of unadjusted basis
in qualified depreciable property. Trust has negative QBI of
($47,000) ($155,000 gross income from aggregated businesses less the
sum of $200,000 direct expenses from aggregated businesses and
$2,000 directly attributable business expenses from Trust under the
rules of Sec. 1.652(b)-3(a)).
(B) Section 199A deduction computation. (1) A's computation.
Because the $1,000 Trust distribution to A equals one-half of
Trust's DNI, A has W-2 wages from Trust of $37,500. A also has W-2
wages of $2,500 from a trade or business outside of Trust (computed
without regard to A's interest in Trust), which A has properly
aggregated under Sec. 1.199A-4 with the Trust's trade or businesses
(the family's restaurant and bakery), for a total of $40,000 of W-2
wages from the aggregate trade or businesses. A has $100,000 of QBI
from non-Trust trade or businesses in which A owns an interest.
Because the $1,000 Trust distribution to A equals one-half of
Trust's DNI, A has (negative) QBI from Trust of ($23,500). A's total
QBI is determined by combining the $100,000 QBI from non-Trust
sources with the ($23,500) QBI from Trust for a total of $76,500 of
QBI. Assume that A's taxable income exceeds the threshold amount for
2018 by $200,000. A's tentative deduction is $15,300 (.20 x
$76,500), limited under the W-2 wage limitation to $20,000 (50% x
$40,000 W-2 wages). Accordingly, A's section 199A deduction for 2018
is $15,300.
(2) B's computation. For 2018, B's taxable income is below the
threshold amount so B is not subject to the W-2 wage limitation.
Because the $500 Trust distribution to B equals one-quarter of
Trust's DNI, B has a total of ($11,750) of QBI. B also has no QBI
from non-Trust trades or businesses, so B has a total of ($11,750)
of QBI. Accordingly, B's section 199A deduction for 2018 is zero.
The ($11,750) of QBI is carried over to 2019 as a loss from a
qualified business in the hands of B pursuant to section 199A(c)(2).
(3) Trust's computation. For 2018, Trust's taxable income is
below the threshold amount so it is not subject to the W-2 wage
limitation. Because Trust retained 25% of Trust's DNI, Trust is
allocated 25% of its QBI, which is ($11,750). Trust's section 199A
deduction for 2018 is zero. The ($11,750) of QBI is carried over to
2019 as a loss from a qualified business in the hands of Trust
pursuant to section 199A(c)(2).
(e) Effective/applicability date--(1) General rule. Except as
provided in paragraph (e)(2) of this section, the provisions of this
section apply to taxable years ending after the date the Treasury
decision adopting these regulations as final regulations is published
in the Federal Register. However, taxpayers may rely on the rules of
this section until the date the Treasury decision adopting these
regulations as final regulations is published in the Federal Register.
(2) Exceptions--(i) Anti-abuse rules. The provisions of paragraph
(d)(3)(v) of this section apply to taxable years ending after December
22, 2017.
(ii) Non-calendar year RPE. For purposes of determining QBI, W-2
wages, and UBIA of qualified property, if an individual receives any of
these items from an RPE with a taxable year that begins before January
1, 2018 and ends after December 31, 2017, such items are treated as
having been incurred by the individual during the individual's taxable
year in which or with which such RPE taxable year ends.
0
Par. 9. Section 1.643(f)-1 is added to read as follows:
Sec. 1.643(f)-1 Treatment of multiple trusts.
(a) General rule. For purposes of subchapter J of chapter 1 of
Title 26 of the United States Code, two or more trusts will be
aggregated and treated as a single trust if such trusts have
substantially the same grantor or grantors and substantially the same
primary beneficiary or beneficiaries, and if a principal purpose for
establishing such trusts or for contributing additional cash or other
property to such trusts is the avoidance of Federal income tax. For
purposes of applying this rule, spouses will be treated as one person.
(b) A principal purpose. A principal purpose for establishing or
funding a trust will be presumed if it results in a significant income
tax benefit unless there is a significant non-tax (or non-income tax)
purpose that could not have been achieved without the creation of these
separate trusts.
(c) Examples. The following examples illustrate the application of
this section:
Example 1 to paragraph (c). (i) A owns and operates a pizzeria
and several gas
[[Page 40930]]
stations. A's annual income from these businesses and other sources
exceeds the threshold amount in section 199A(e)(2), and the W-2
wages properly allocable to these businesses are not sufficient for
A to maximize the deduction allowable under section 199A. A reads an
article in a magazine that suggests that taxpayers can avoid the W-2
wage limitation of section 199A by contributing portions of their
family businesses to multiple identical trusts established for
family members. Based on this advice, in 2018, A establishes three
irrevocable, non-grantor trusts: Trust 1 for the benefit of A's
sister, B, and A's brothers, C and D; Trust 2 for the benefit of A's
second sister, E, and for C and D; and Trust 3 for the benefit of E.
Under each trust instrument, the trustee is given discretion to pay
any current or accumulated income to any one or more of the
beneficiaries. The trust agreements otherwise have nearly identical
terms. But for the enactment of section 199A and A's desire to avoid
the W-2 wage limitation of that provision, A would not have created
or funded such trusts. A names A's oldest son, F, as the trustee for
each trust. A forms a family limited partnership, and contributes
the ownership interests in the pizzeria and gas stations to the
partnership in exchange for a 50-percent general partner interest
and a 50-percent limited partner interest. A later contributes to
each trust a 15% limited partner interest. Under the partnership
agreement, the trustee does not have any power or discretion to
manage the partnership or any of its businesses on behalf of the
trusts, or to dispose of the limited partnership interests without
the approval of the general partner. Each of the trusts claims the
section 199A deduction on its Form 1041 in full based on the amount
of qualified business income (QBI) allocable to that trust from the
limited partnership, as if such trust was not subject to the wage
limitation in section 199A(b)(2)(B).
(ii) Under these facts, for Federal income tax purposes under
this section, Trust 1, Trust 2, and Trust 3 would be aggregated and
treated as a single trust.
Example 2 to paragraph (c). (i) X establishes two irrevocable
trusts: One for the benefit of X's son, G, and the other for X's
daughter, H. G is the income beneficiary of the first trust and the
trustee is required to apply all income currently to G for G's life.
H is the remainder beneficiary of the first trust. H is an income
beneficiary of the second trust and the trust instrument permits the
trustee to accumulate or to pay income, in its discretion, to H for
H's education, support, and maintenance. The trustee also may pay
income or corpus for G's medical expenses. H is the remainder
beneficiary of the second trust and will receive the trust corpus
upon G's death.
(ii) Under these facts, there are significant non-tax
differences between the substantive terms of the two trusts, so tax
avoidance will not be presumed to be a principal purpose for the
establishment or funding of the separate trusts. Accordingly, in the
absence of other facts or circumstances that would indicate that a
principal purpose for creating the two separate trusts was income
tax avoidance, the two trusts will not be aggregated and treated as
a single trust for Federal income tax purposes under this section.
(d) Effective/applicability date. The provisions of this section
apply to taxable years ending after August 16, 2018.
Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-17276 Filed 8-10-18; 4:15 pm]
BILLING CODE 4830-01-P