199A – the real regulatory story revelations from the proposed regulations – financial tips

The regulations for Section 199A were released on Wednesday morning, so many Tax Advisors are short on sleep and almost ready to roll. These regulations are exceedingly complex and it will take months of study and discussion before the major implications are fully understood. The regulations use a host of abbreviations, from QBI (“Qualified Business Income”) to UBIA (Unadjusted Basis Immediately after Acquisition – referring to Qualified Property).

As a brief reminder, Section 199A provides a 20% deduction for Qualified Business Income from flow-through entities, which includes S corporation, partnership, and Schedule C and E income as reported on a Form 1040 tax returns (commonly known as sole proprietorships). The deduction is subject to limitations based on whether the entity engages in certain services (“Specified Services” – referred to as SSTBs in the proposed regulations) or based on the amount of wages paid or Qualified Property held by the entity, and these limitations begin to apply once a taxpayer’s taxable income exceeds certain thresholds.

Generally, once a taxpayer has significant taxable income ($157,500 for single filers and $315,000 for married filers), they must pass a wages or wages / Qualified Property hurdle to avoid a significant decrease in their Section 199A deduction.

The regulations mention that an estimated 10,000,000 taxpayers will be impacted by this tax provision, and that over 25 million hours will be spent complying with this one code provision. Let’s make sure that the tax savings will be maximized to make all of this worthwhile! Let me know if you would like a copy of our draft white paper in progress on these rules by e-mailing agassman@gassmanpa.com and thanks for what you do for clients and others.

4. The Regulations provide that entities that are set up to provide management, billing, wholesaling, or other services or products to a services business will be considered to be an extension of that business, so that the special limitations that apply to specified service businesses will apply to the separate entity if there is at least 50% common ownership between them under very broad attribution rules.

8. The Regulations create a new method of aggregation of trades or businesses so that taxpayers can combine multiple trades or businesses for the purposes of applying the wage and Qualified Property limitations and maximizing the deduction. In order to be aggregated, the businesses must meet the following requirements: a. The same person or group of persons directly or indirectly own 50% or more of each trade or business;

ii. The trade or businesses share facilities or significant centralized business elements such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources; iii. 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 chains interdependencies).

9. The Regulations enumerate the categories of Specified Service Trades or Businesses, which are treated differently because income derived therefrom by high earner taxpayers (over 157,500 for single filers of $315,000 for married filers) will be limited or not qualify for the deduction. The proposed regulations give some useful examples of what functions are considered to be under these definitions and what functions are not, and we have prepared the following chart to show what they say:

10. The Regulations state that an individual who was formerly treated as an employee for federal income tax purposes, and who is subsequently characterized as an independent contractor and provides services for the same individual or entity, will be presumed to continue to be an employee, or to be ineligible for the Section 199A deduction by reason of being “in the trade or business of performing services as an employee.” 11. For trusts and trust beneficiaries, the $157,500 threshold to allow the deduction to apply to income, notwithstanding whether the entity has paid wages, has Qualified Property, or is a specified trade or business, may only apply cumulatively to all of the income of the trust, including the trust income that is distributed under the “distributable net income” rules.

12. Many taxpayers will establish trusts for children or others that are separately taxed and can own interests in companies and partnerships and qualify for the deduction under situations where the parents would not qualify because of their income levels or other factors. The proposed Regulations specifically state 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.” This is a highly unusual clause and will be very controversial or may be a mistake if the drafters were alluding to the multiple trust rule described below, and did not intend that the savings for a single trust could be set aside.

The proposed regulations under Section 199A were connected to new proposed regulations under the above-referenced multiple trust provision, and the new regulations state that a principle purpose will be presumed if it results in a significant income tax benefit, unless there are significant non-tax purposes that could not have been achieved without the creation of the separate trust.

The Regulations provide that a public hearing is scheduled to discuss the Regulations on October 16, 2018 at 10:00 a.m., and comments may be sent to Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044, or hand delivered at the Courier’s Desk of the Internal Revenue Service Offices at 1111 Constitution Avenue NW, Washington, D.C. 20224, or via the federal eRulemaking which can be found here.