One of the most significant aspects of the Tax Cuts and Jobs Act (TCJA) was the creation of a new deduction in Section 199A, the qualified business income deduction (QBID). This deduction is claimed by individuals, trusts, and estates, and is equal to up to 20 percent of qualifying domestic business income from S corporations, partnerships, and sole proprietorships plus 20 percent of certain REIT dividends and publicly traded partnership income.
The Treasury Department and IRS provided guidance on the QBID in August 2018 through the issuance of proposed regulations. Now, they've provided further QBID guidance in the form of final regulations, additional proposed regulations, a revenue procedure on the measurement of W-2 wages, and a notice providing a new safe harbor for certain real estate activities.
Here is an executive summary of the top ten things you need to know about the new QBID guidance:
Aggregation of businesses
In addition to the ability to aggregate certain related businesses at the individual level, the final regulations adopted requests by practitioners to allow entity level aggregation. This will help simplify reporting, especially in multi-tiered structures.
Trade or business
The final regulations retained the requirement that QBID can only be computed with respect to activities that rise to the level of a trade or business under general tax principles, which may exclude start-up businesses or certain real estate activities. There’s an exception for related party rental of tangible or intangible property, but this exception won’t apply in all cases.
Rental real estate safe harbor
A new safe harbor was created for rental of real estate to third parties, which would not qualify for the self-rental rule. Specifically, the IRS issued a notice describing the amount and nature of real estate activities that will be considered a trade or business for QBID.
Definitions of specified service trades or businesses (SSTBs)
Taxpayers engaged in SSTBs will lose the benefit of QBID when their taxable income exceeds the threshold amount. In response to the many comments received, Treasury modified a number of the definitions and provided additional clarity and examples. Some of the areas addressed include architecture, engineering, health, athletics, financial services, banking, and franchising.
Overlaps of SSTBs and non-SSTBs
The final regulations retain the de minimis rule, which allows a business to have less than 5 percent of its gross receipts from a specified service activity (or 10 percent if gross receipts are less than $25 million). Specified service gross receipts in excess of that amount will cause the entire trade or business to be an SSTB. The final regulations also removed or relaxed some SSTB anti-abuse rules.
The final regulations and additional proposed regulations provide additional guidance on application of QBID when taxpayers have suspended losses due to passive activity rules, at-risk basis limitations, and standard basis limitations. While the rules provide some clarity, the application will require substantial effort to track these tax attributes for future tax years.
Reasonable compensation, guaranteed payments, section 707(a) payments, and treatment of other deductions
The final regulations retain the rules that reasonable compensation of S corporation shareholders, guaranteed payments to partners, and other payments to partners for services are not treated as qualified business income. Additionally, any deductions attributable to the business that are deducted at the individual level are also reductions to QBI. This includes the deductible portion of self-employment taxes, self-employed health insurance, and contributions to a qualified retirement plan.
W-2 wages and unadjusted basis in assets (UBIA)
For taxpayers with taxable income above the threshold amount, the QBID generated by any trade or business is limited to the greater of (a) 50% of the W-2 wages of that business or (b) the combination of 25% of W-2 wages plus 2.5% of UBIA from that trade or business. While the rules regarding wages remain largely unchanged, the calculation and allocation of UBIA among owners were clarified and modified. These changes include the treatment of departing owners, contributed property, section 743(b) “step up” adjustments in partnerships, like-kind exchanges, and involuntary conversions.
Schedule K-1 reporting and amended return
A pass-through entity is required to report QBI, W-2 wages, UBIA, and other items necessary for owners to calculate QBID. If a pass-through entity fails to report a single item of QBID information, that item is presumed to be zero, but the other reported items can still be utilized by the owners. Pass-through entities can amend their returns to report or correct QBID information as long as the statute of limitations remains open.
REIT, RICs, PTPs, and trusts
REIT dividends are generally eligible for QBID and the proposed regulations provide a look-through for REIT stock held through a mutual fund taxed as a RIC. The proposed regulations did not provide similar treatment for PTP’s held by RICs but indicate that the matter is under further consideration.