Despite a partial government shutdown, the Treasury Department and the Internal Revenue Service issued final regulations and guidance addressing implementation of the new qualified business income (QBI) deduction (section 199A deduction).

The new QBI deduction, created by the Tax Cuts and Jobs Act (TCJA) allows entrepreneurs, selfemployed individuals, and investors to deduct 20 percent of their business income from their taxable income. It is considered a “below-the-line” deduction, meaning it will not reduce your adjusted gross income.

Eligibility for the qualified business income deduction is dependent on whether your business is considered a specified trade or business and is above or below the required threshold. The structure of your business will also help determine your eligibility. For example, the QBI deduction is not available for wage income or business income earned by a C corporation. Eligible structures include trust and estates, individuals, partnerships, S corporations, and sole proprietors.

Calculating the QBI deduction also depends on whether a business is considered a “specified service.” A Specified Service Trade or Business (SSTB) is any trade or business that involves the performance of services. It is important to note that the rules change if your business is not considered a specified service.

The guidance issued by the IRS is an attempt to simplify this complicated deduction. Although one of the more complex changes in TCJA, this deduction has the potential to cut tax bills by up to one fourth for eligible businesses.

Below, we have summarized the final regulations and guidance issued last week by the IRS:

Confirmations

• Confirmation: Income from originating and selling mortgages is eligible for the deduction.
  Shareholders of mutual funds with real estate investment trust investments also qualify for the deduction.
• Confirmation: Individual REIT investors through mutual funds qualify for the deduction.
• Confirmation: Real estate rental owners qualify for the deduction if they, or someone they hire, spend at least 250 hours a year on the business and keeps a record of their activities. In the final regulations, the IRS has provided a safe harbor test for section 199A and rental real estate. For more detailed information on the safe harbor rules for real estate click here.
• Confirmation: If companies have limited income (less than 10 percent) from ineligible activities, the company can still get a full deduction on all its profits.

Clarifications

• Clarification: Organizations are prohibited from splitting their firms into different entities to lower their tax bills; however, if companies have income that qualifies and some that do not, they are permitted to delineate those activities to receive the deduction on the eligible income.
• Clarification: Businesses can maximize their deduction by allowing companies to combine at the entity level or the owner level.
• Clarification: New proposed regulations for taxpayers that hold interests in regulated investment companies (RICs), charitable remainder trusts, and split-interest trusts.

For some businesses, this deduction will make the rules more manageable, but for others, like larger pass-through entities, these rules will require more planning and additional complexities. There are still many unanswered questions including,

• Can publicly-traded partnership investments held through a mutual fund qualify for the deduction?
• How much of a deduction is available to taxpayers with multiple trades and businesses that exist within the same entity?

The deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026. There is speculation whether a future Congress will uphold individual provisions. To discuss your future options regarding the QBI deduction, call us today.

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