Moving on from Section 199A — What's Next

By Benjamin Aspir, CPA, MST, Eisneramper LLP – January 6, 2020
Moving on from Section 199A — What Almost two years have passed since §199A was enacted under the Tax Cuts and Jobs Act (TCJA). Following much public input and anticipation, proposed and final regulations were issued by the Treasury Department. Where do we stand today on the §199A/qualified business income (QBI) deduction?

What Qualifies

QBI is defined as all domestic business income other than: investment income (e.g.,dividends other than REIT dividends), capital gains,commodities and foreign currency gains. QBI does not include reasonable compensation from an S corporation or guaranteed payments made to the tax payer.

Material participation under the passive activity rules is not required for the QBI deduction. The QBI deduction will also not reduce an owner’s tax basis in their share of ownership.

An optional taxpayer election is available to aggregate multiple trades or businesses in order to maximize the QBI deduction. In order to claim the election, four key tests must be met:

  1. Control (50 percent) for a majority of the tax year.
  2. Each trade or business must have the same tax year.
  3. All the businesses being aggregated must be a non-SSTB.
  4. There must be a business connection between the entities being aggregated.

Prior to the issuance of a safe harbor election and regulations, there was considerable uncertainty surrounding §199A eligibility for the real estate industry. The IRS has declined to define when a real estate business rises to the level of a trade or business and, therefore, has issued a real estate safe harbor election. If the qualifications are met, the operations would be deemed a trade or business for the QBI deduction. The IRS stated that if a company fails to satisfy the requirements of the safe harbor,the rental real estate enterprise
may still be treated as a trade or business for purposes of 199A if they otherwise would meet the definition of trade or business.

For taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the TCJA allows a deduction from taxable income of 20 percent of a taxpayer's domestic QBI from a partnership, LLC taxed as a partnership, S corporation or sole proprietorship. The 20 percent deduction is allowed for a taxpayer’s qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.

For taxpayers whose taxable income is above certain thresholds, the 20-percent deduction for QBI is disallowed if earned from a “specified service trade or business” (SSTB).

What are SSTBs?

Individual taxpayers with SSTB income above the annual limits will not be able to utilize the QBI deduction for related SSTB income. An SSTB is defined as any trade or business (other than architecture or engineering) 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.

Subsequent §199A regulations attempted to clarify the SSTB categories written into the original law. The table below provides a general outline of what falls into the SSTB categories.

FIELD

SSTB

Non-SSTB

Accounting

Accountants/tax preparers

Payment processing and billing analysis

Actuarial service

Actuaries and other similar professionals

Analysts, economists, mathematicians

Athletics

Athletes, coaches, team managers and owners

Maintenance and operation of equipment or facilities for use in the athletic events

Brokerage services

Stockbrokers and other similar professionals

Real estate agents and brokers; insurance agents and brokers

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.

Trade or business that consists of any one of the three below:

  • Receives fees, compensation or income for endorsing products or services
  • Licenses, receives fees, compensation or other income for use of individual’s image, likeness, name signature, voice, trademark or any symbol associated with individual’s identity
  • Receives fees, compensation or other income for appearing at an event or on radio, television or other media format.

Any other skill-based services such as plumbers, electricians, beauticians

Consulting

Professionals who provide advice and counsel to assist clients in achieving goals and solving problems

Sales; training or educational services; and consulting services embedded in, or ancillary to, the sale of goods or performance of non-SSTB services if there is no separate payment for the consulting services

Financial services

Financial advisors, investment bankers, wealth planners, retirement advisors and arranging lending transactions between lender and borrower

Accepting deposits and making loans

Health

Physicians, pharmacists, nurses, dentists, veterinarians, physical/occupational therapists, psychologists

Health clubs or spas; persons who provide physical exercise or conditioning to customers; research, testing, manufacture and sales of pharmaceuticals or medical devices

Investment management

Providing investing, asset management or investment management services

Real estate property managers

Law

Lawyers and paralegals

Couriers or stenographers

Performing arts

Actors, singers, musicians, entertainers and directors

Maintenance and operation of equipment or facilities for use in the performing arts

Trading and dealing

Traders or dealers in securities, commodities or partnership interests

For 2018 filings for SSTBs, the deduction is phased out for joint filers with
taxable income between $315,000 and $415,000, and for individual filers earning between $157,500 and $207,500. The threshold is indexed for inflation annually.

Taxpayers below this income threshold who generate QBI may deduct the
20 percent. Taxpayers above this income threshold who are engaged in non-SSTB may still deduct the 20 percent but are subject to the following limitations:

The QBI deduction is limited to the lesser of 20 percent of QyBI or the greater of:

  1. 50 percent of the W-2 wages paid with
    respect to the qualified trade or business

    Or
  2. The sum of 25 percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition (UBIA), of all qualified property.

After taking all the above into consideration, the overall QBI deduction claimed is limited to 20 percent of overall taxable income in excess of net capital gains. Excess QBI not claimed due to the 20 percent taxable income limit cannot be carried forward to future tax years.

What Reduces QBI?

  • §1231 losses relating to the sale or exchange of property (§1231 gains do not increase QBI). A §1231 gain/loss is the result of property sold that is use in a trade or business (subject to the allowance for depreciation).
  • Deductible §179 expense. §179 allows taxpayers to deduct the cost of certain property as an expense when the property is placed in service.
  • Self-employed health insurance premiums deducted on form 1040.
  • Self-employment tax deducted on form 1040.
  • Deductible unreimbursed partnership expenses.
  • Contributions to qualified retirement plans on form 1040.
  • Deductible losses from a qualified trade or business.

What Doesn't Reduce QBI?

  • Losses or deductions that were disallowed, suspended, limited or carried over from taxable years ending before Jan. 1, 2018, (under IRC Sections 465,
    469, 704(d), and 1366(d)), are not taken into account in a later taxable year for purposes of computing QBI.
  • Post 2017 suspended losses will not reduce QBI until utilized.
  • Capital losses

It’s important to note that if a partner sells a partnership interest and some portion of the gain is re-characterized as ordinary income under the "hot asset" rules of §751,the gain will increase QBI.

The QBI deduction has changed the tax landscape for many business owners and tax practitioners. The tax consequences of choosing a business structure has completely changed due to TCJA. It is important to to note that the §199A deduction is not permanent in its current form.


Benjamin  Aspir

Benjamin Aspir

Benjamin Aspir, CPA, MST, is a senior manager at EisnerAmper LLP. He is the vice chair of the NJCPA Federal Taxation Interest Group, a member of the NJCPA Emerging Leaders Council and Cannabis Advisory Group. Benjamin can be reached at benjamin.aspir@eisneramper.com.

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This article appeared in the January/February 2020 issue of New Jersey CPA magazine. Read the full issue.