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Tax Cuts and Jobs Act

Final regs on Sec. 199A qualified business income deduction released with corrections

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

Corrected Sec. 199A Final Regs

 Redlined Corrected Sec. 199A Final Regs

IRS has released the corrected draft of final regs on the qualified business income (QBI) deduction under Code Sec. 199A, which was added by the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017). The corrections include, among other minor edits, corrections to the definition and computation of excess section 743(b) basis adjustments for purposes of determining the unadjusted basis immediately after an acquisition of qualified property, as well as corrections to the description of an entity disregarded as separate from its owner for purposes of Code Sec. 199A and Reg § 1.199A-1 through Reg § 1.199A-6.

Background. Generally for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, Code Sec. 199A, as added by the the TCJA, allows a deduction to a non-corporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship. The deduction is the lesser of: (a) the “combined qualified business income amount” of the taxpayer, or (b) 20% of the excess, if any, of the taxable income of the taxpayer for the tax year over the net capital gains. (Code Sec. 199A(a))

The “combined qualified business income amount” means, for any tax year, an amount equal to: (i) the deductible amount for each qualified trade or business of the taxpayer (defined as the lesser of (a) 20% of the taxpayer’s QBI or (b) the greater of two W-2 wage limits, one of which also looks to the unadjusted basis of certain tangible, depreciable “qualified property”); plus (ii) 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income of the taxpayer for the tax year. (Code Sec. 199A(b))

QBI is generally defined as the net amount of “qualified items of income, gain, deduction, and loss” relating to any qualified trade or business of the taxpayer. (Code Sec. 199A(c)(1)) For this purpose, qualified items of income, gain, deduction, and loss are items of income, gain, deduction, and loss to the extent these items are effectively connected with the conduct of a trade or business within the U.S. under Code Sec. 864(c) and included or allowed in determining taxable income for the year. If the net amount of qualified income, gain, deduction, and loss relating to qualified trade or businesses of the taxpayer for any tax year is less than zero, the amount is treated as a loss from a qualified trade or business in the succeeding tax year. (Code Sec. 199A(c)(2))

QBI does not include: certain investment items; reasonable compensation paid to the taxpayer by any qualified trade or business for services rendered with respect to the trade or business; any guaranteed payment to a partner for services to the business under Code Sec. 707(c); or a payment under Code Sec. 707(a) to a partner for services rendered with respect to the trade or business.

Certain limitations apply to the deduction. Except as provided below, the deduction cannot exceed the greater of:

…50% of the W-2 wages with respect to the qualified trade or business (W-2 wage limit), or

…the sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition, of all “qualified property.” Qualified property is defined in Code Sec. 199A(b)(6) as meaning tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year.

The above limit and the disallowance of the deduction for certain specified service trades or businesses of the taxpayer does not apply for taxpayers with taxable income below the “threshold amount” ($315,000 for married individuals filing jointly, $157,500 for other individuals, indexed for inflation after 2018). The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly ($50,000 for other individuals). (Code Sec. 199A(b)(3)) Thus, for 2018, the limit fully applies to married taxpayers with taxable income over $415,000 and other individuals with taxable income over $207,500.

Computation of excess section 743(b) basis adjustments. In the final corrected regs, IRS agrees that section 743(b) basis adjustments should be treated as qualified property to extent the section 743(b) basis adjustment reflects an increase in the fair market value of the underlying qualified property. Accordingly, the final regs define an “excess section 743(b) basis adjustment” as an amount that is determined with respect to each item of qualified property and is equal to an amount that would represent the partner’s section 743(b) basis adjustment with respect to the property as determined under Reg § 1.743-1(b) and Reg § 1.755-1, but calculated as if the adjusted basis of all of the partnership’s property was equal to the unadjusted basis immediately after acquisition (UBIA) of such property. The absolute value of the excess section 743(b) basis adjustment cannot exceed the absolute value of the total section 743(b) basis adjustment with respect to qualified property. The excess section 743(b) basis adjustment is treated as a separate item of qualified property placed in service when the transfer of the partnership interest occurs. This rule is limited solely to the determination of the depreciable period for purposes of Code Sec. 199A and is not applicable to the determination of the placed in service date for depreciation or tax credit purposes. The recovery period for such property is determined under Reg § 1.743-1(j)(4)(i)(B) with respect to positive basis adjustments and Reg § 1.743-1(j)(4)(ii)(B) with respect to negative basis adjustments.

The version of the final regs that existed prior to the current correction had provided that an “excess section 743(b) basis adjustment” was defined as an amount determined with respect to each item of qualified property equal to the excess of the partner’s section 743(b) basis adjustment with respect to each item over an amount that would represent the partner’s section 743(b) basis adjustment with respect to the property, but calculated as if the adjusted basis of all of the partnership’s property was equal to the unadjusted basis immediately after acquisition (UBIA) of qualified property. of such property.

Entities disregarded as separate from their owners. In the final corrected regs, Reg § 1.199A(e)(2) provides that an entity with a single owner that is treated as disregarded as an entity separate from its owner under any other provision of the Code is disregarded for purposes of Code Sec. 199A and Reg § 1.199A-1 through Reg § 1.199A-6. Accordingly, trades or businesses conducted by a disregarded entity will be treated as conducted directly by the owner of the entity for purposes of Code Sec. 199A.

The version of the the final regs that existed prior to the current correction had provided that only an entity with a single owner that is treated as disregarded as an entity separate from its owner under Reg § 301.7701-3 was disregarded for purposes of Code Sec. 199A and Reg § 1.199A-1 through Reg § 1.199A-6.

References: For the Code Sec. 199A deduction, see FTC 2d/FIN ¶L-4305 et seq; United States Tax Reporter ¶199A4.

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