IRS issues proposed regulations on new 20 percent deduction for pass-through businesses (IR-2018-162)

The IRS issued proposed regulations on August 8, 2018, for a new provision allowing many owners of sole proprietorships, partnerships, trusts, and S corporations to deduct 20 percent of their qualified business income. 

The new deduction, referred to as the Section 199A deduction or the deduction for qualified business income, was created by the Tax Cuts and Jobs Act. The deduction is available for tax years beginning after December 31, 2017. Eligible taxpayers can claim it for the first time on the 2018 federal income tax return they file next year. 

12/6/18: It’s not too late for businesses to implement some 2018 tax-saving moves. One is making the most of the new deduction for qualified business income. For tax years starting after 2017, taxpayers other than corporations may be entitled to a Sec. 199A deduction of up to 20% of their qualified business income. For 2018, if taxable income exceeds $315,000 for a married couple filing jointly, or $157,500 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business. 

Qualified Business Income Deduction 101

  • An owner of a S Corporation, partnership or sole proprietorship may take a deduction equal to the lesser 20% of its “combined qualified business income” earned in a trade or business up to certain limitations or the excess of taxable income minus the sum of any net capital gain.
  • The deduction will be limited to either 50% of the business’ W-2 wages allocable to the owner or 20% of the business’ W-2 wages allocable to the owner plus 2.5% of the unadjusted basis of qualified property.
  • Complications with the calculation are significant, but without question, only in certain circumstances will the calculation net a 20% deduction.  In every circumstance, the calculation will increase the compliance cost with pass-through entity tax returns and their owners’ returns. Some of the issues include:
  • The definition of a trade or business is not clarified in the code.
  • There are multiple definitions (i.e. what is Qualified Business Income, allocable portion of wages, qualified property) each calculated separately.
  • There are more nuances associated with the calculation depending on the nature of the business, type of assets held, etc. 
  • Certain service based businesses earning above a certain threshold aren’t even eligible for the deduction.
  • To top it off, the deduction is cumulative at the individual level. Everyone will have to combine all the pass-through businesses.  If you own an interest in 100 pass-through entities that's 101 new calculations.
  • This is a huge overhaul to the current pass-through taxation regime. The only certainty provided by this new deduction is that pass-through owners should check in with their tax accountant many times throughout 2018 to be sure they are maximizing the potential tax savings.  An additional certainty is that a chunk of whatever savings are created will be used to pay tax accountants for compliance.

In addition, Notice 2018-64, also issued Wednesday, provides methods for calculating Form W-2 wages for purposes of the limitations on this deduction. Taxpayers may rely on the rules in these proposed regulations until final regulations are published in the Federal Register.

Download the 2018-19 Tax Planning Guide

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.