IRS Issues Proposed Regulations for QBI under Section 199A

August 2018

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Summary

On August 8, the Internal Revenue Service issued widely anticipated proposed regulations (REG-107892-18) (Proposed Regulations) concerning the deduction for qualified business income (QBI) under Section 199A. The purpose of the Proposed Regulations is to provide taxpayers with computational, definitional, and anti-avoidance guidance regarding the application of Section 199A.
 

Details

Overview of the QBI deduction
For taxable years beginning after December 31, 2017, taxpayers other than a corporation with taxable income (before computing the QBI deduction) at or below the Threshold Amount,[1] are entitled to a Section 199A deduction equal to the lesser of:
  1. The combined QBI amount of the taxpayer, or
  2. An amount equal to 20 percent of the excess, if any, of the taxable income of the taxpayer for the taxable year over the net capital gain of the taxpayer for such taxable year.
The combined QBI amount is generally equal to the sum of (A) 20 percent of the taxpayer’s QBI with respect to each qualified trade or business plus (B) 20 percent of the aggregate amount of the qualified REIT dividends and qualified publicly traded partnership income of the taxpayer for the taxable year.

QBI with respect to each qualified trade or business is generally defined to mean any item of domestic income, gain, loss, and deduction attributable to a qualified trade or business. A qualified trade or business is further defined to include any trade or business except for a specified service trade or business (SSTB). However, the exception for QBI generated from an SSTB does not apply where the owner has taxable income below the Threshold Amount. This exception is subject to the phase-in described above. The statute, as enacted, doesn’t define the meaning of the term SSTB.

Additionally, taxpayers with taxable income (calculated before the QBI Deduction) in excess of the Threshold Amount may be subject to a limitation based on the amount W-2 wages or W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property (Wages & Capital Limitation) attributable to the QBI generated from each qualified trade or business.

Calculating the QBI Deduction and applying the Wages & Capital Limitation and SSTB exclusion are deceptively simple. In practice, however, an accurate calculation of the QBI Deduction has been virtually impossible without additional guidance. The Proposed Regulations are intended to provide this necessary guidance.
 

BDO Insights & Observations

While the Proposed Regulations provide much-needed guidance, taxpayers will face a number of important considerations and decisions as they calculate their QBI Deductions. Significant analysis will likely be needed to ensure an accurate calculation of the QBI Deduction as well as meeting the potentially cumbersome reporting obligations. Key areas of consideration and expected analysis addressed within the Proposed Regulations include:
  • General Computational Rules: The Proposed Regulations provide extensive computational rules that will greatly assist taxpayers in determining their QBI Deduction. These rules, however, also highlight the importance of ensuring proper identification and calculation of QBI, W-2 wages, and UBIA of qualified property. It will also be important for a relevant passthrough entity (RPE) to ensure the accuracy of the allocation of this information among partners. 
  • Determination of Wages Allocable to QBI: These rules are generally taxpayer-favorable and should not result in the need for restructuring of business operations in order to maximize the QBI Deduction. However, complexities may arise where common paymaster structures are used in connection with multiple trades or businesses. 
  • Determination of UBIA of Qualified Property Allocable to QBI: These rules appear to be relatively straightforward and taxpayers should have readily available information to determine the amounts in total. The rules of Section 704(c) may come into play requiring partnerships to ensure accurate tracking of partner’s capital accounts.  Additionally, special rules apply with respect to property acquired in a like-kind exchange.
  • Definition & Determination of QBI: The Proposed Regulations generally provide clarification around the meaning of the term QBI. However, the importance of determining each separate trade or business, as defined under Section 162, may create complexity in ensuring compliance with the rules.
  • Allocation of Items Among Directly-Conducted Trades or Businesses: Where multiple trades or business are operated, taxpayers are likely to be faced with the need to allocate certain items, e.g., income, expense, and property, among the separate trades or business. The Proposed Regulations provide taxpayers with flexibility to determine these allocations. However, documentation and implementation of a selected reasonable method will be important.
  • Aggregation of Trades or Businesses: The Proposed Regulations create an opportunity for taxpayers to aggregate multiple trades or businesses. Taxpayers will not be required to apply grouping methods similar to passive active rules. Rather, the Proposed Regulations provide flexibility allowing taxpayers to determine an appropriate aggregation method for purposes of the QBI Deduction. While this will be of significant benefit where the QBI Deduction would otherwise be limited, the aggregation rules may create a significant record-keeping and reporting obligation.
  • Definition of SSTB: One of the most anticipated parts of the Proposed Regulations, the IRS has provided definitions and examples illustrating the meaning of an SSTB. While these rules are helpful, taxpayers will need to carefully review these definitions in the context of their particular trade or business to ensure compliance with the rules. Additionally, the Proposed Regulations contain a de minimis rule and rules regarding activities incidental to an SSTB. The ultimate determination of an SSTB will continue to require careful analysis.
  • Reporting Obligations of an SSTB: Because the QBI generated from an SSTB may not be subject to exclusion at the individual level, all SSTBs will be required to determine and report to each owner their share of QBI, W-2 wages, and UBIA of qualified property. Consequently, even passthrough entities that operate an SSTB will be faced with similar reporting obligations as non-SSTB passthrough businesses.
  • Other Reporting Rules: The Proposed Regulations provide detailed reporting rules that must be followed by certain passthrough entities. These rules will require reporting entities to maintain specific details and ensure the necessary information is accurately reported to its owners.
  • Electing Small Business Trusts: The Proposed Regulations clarify that an electing small business trust (ESBT) is entitled to the QBI Deduction.  The “S portion” of the ESBT may take into account only items from any S corporation owned by the ESBT properly allocated to the S portion.  Thus, an ESBT may also take into account items relevant to the QBI Deduction in a grantor portion or a non-S portion.
  • Fiscal-Year Passthrough Entities: The Proposed Regulations clarify that for purposes of determining QBI, W-2 wages, and UBIA of qualified property, if an individual receives any of these items from a passthrough entity having a fiscal year beginning in 2016 and ending before December 31, 2017, such items are treated as having been incurred by the individual during the individual's 2017 taxable year,  Conversely, if an individual receives any of these items from a passthrough entity having a fiscal year beginning in 2017 and ending in 2018, such items are treated as having been incurred by the individual during the individual’s 2018 taxable year and may be taken into account in determining the individual’s QBI Deduction.
                                                                                       

The Proposed Regulations in Detail

General computational rules
As a threshold matter, taxpayers will need to determine each separate trade or business. The Proposed Regulations rely on the general definition of a trade or business determined under Section 162. However, rental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a Section 162 trade or business is nevertheless treated as a trade or business for purposes of Section 199A, if the property is rented or licensed to a commonly-controlled trade or business.

Special computational rules apply in situations where a taxpayer’s taxable income does not exceed the Threshold Amount and the taxpayer generates negative QBI or negative qualified REIT dividends plus qualified publicly traded partnership (PTP) income. Under these rules, if the total QBI amount is less than zero, the portion of the individual's Section 199A deduction related to QBI is zero for the taxable year. The negative total QBI amount is treated as negative QBI from a separate trade or business in the succeeding taxable year of the individual for purposes of Section 199A. This carryover rule does not affect the deductibility of the loss for other purposes.[2] Further, if the combined amount of REIT dividends and qualified PTP income is less than zero, the portion of the individual's Section 199A deduction related to qualified REIT dividends and qualified PTP income is zero for the taxable year. The negative combined amount must be carried forward and used to offset the combined amount of REIT dividends and qualified PTP income in the succeeding taxable year of the individual for purposes of Section 199A. This carryover rule does not affect the deductibility of the loss for purposes of other provisions of the Code.[3]

Additionally, an individual with taxable income that exceeds the Threshold Amount for the taxable year determines the QBI component of the QBI Deduction using the following computational rules, which are to be applied in the order they appear:[4]
  1. If the individual's taxable income is within the phase-in range, then only the applicable percentage of QBI, W-2 wages, and UBIA of qualified property for each SSTB is taken into account for purposes of determining the individual's QBI Deduction. If the individual's taxable income exceeds the phase-in range, then none of the individual's share of QBI, W-2 wages, or UBIA of qualified property attributable to an SSTB may be taken into account for purposes of determining the individual's QBI Deduction.[5]
  2. If an individual chooses to aggregate trades or businesses, the individual must combine the QBI, W-2 wages, and UBIA of qualified property of each trade or business within an aggregated trade or business prior to applying the Wages & Capital Limitation.[6]
  3. If an individual's QBI from at least one trade or business is less than zero, the individual must offset the QBI attributable to each trade or business that produced net positive QBI with the QBI from each trade or business that produced net negative QBI in proportion to the relative amounts of net QBI in the trades or businesses with positive QBI. The W-2 wages and UBIA of qualified property from the trades or businesses which produced net negative QBI are not taken into account and are not carried over to the subsequent year.[7]
  4. If an individual's QBI from all trades or businesses combined is less than zero, the QBI component is zero for the taxable year. This negative amount is treated as negative QBI from a separate trade or business in the succeeding taxable year of the individual. This carryover rule does not affect the deductibility of the loss for other tax purposes. The W-2 wages and UBIA of qualified property from the trades or businesses which produced net negative QBI are not taken into account and are not carried over to the subsequent year.[8]
  5. If the individual’s taxable income is within the phase-in range and the Wages & Capital Limitation amount is less than the individual’s QBI amount for the trade or business, a proportionate reduction will apply to the individual’s QBI component. Specifically, that reduction will be equal to the amount by which QBI exceeds the Wages & Capital Limitation multiplied by a fraction, the numerator of which is the amount by which the individual’s taxable income exceeds the Threshold Amount and the denominator of which is $100,000 for married filing joint filers and $50,000 for all other filers.[9]
 
Determination of wages allocable to QBI[10]
The Proposed Regulations generally follow the W-2 wage rules under former Section 199. As a result, in order for wages to be included in the W-2 wages of a taxpayer for purposes of the QBI Deduction, wages must be reported on a Form W-2 and must be for employment by the taxpayer. Additionally, taxpayers may take into account wages reported on Forms W-2 issued by other parties provided that the wages reported on the Forms W-2 were paid to employees of the taxpayer for employment by the taxpayer.

The proposed regulations provide that, in determining W-2 wages, a person may take into account any W-2 wages paid by another person and reported by the other person on Forms W-2 with the other person as the employer listed in Box c of the Forms W-2, provided that the W-2 wages were paid to common law employees or officers of the person for employment by the person.

Persons that pay and report W-2 wages on behalf of, or with respect to, others can include certified professional employer organizations, statutory employers, and agents. Under this rule, persons who otherwise qualify for the QBI Deduction are not limited in applying the deduction merely because they use a third party payor to pay and report wages to their employees. However, with respect to individuals who taxpayers assert are their common law employees for purposes of Section 199A, taxpayers have a duty to file returns and apply the tax law on a consistent basis.

The W-2 wage limitation in Section 199A applies separately for each trade or business. Accordingly, in the case of W-2 wages that are allocable to more than one trade or business, the portion of the W-2 wages allocable to each trade or business is determined to be in the same proportion to total W-2 wages as the deductions associated with those wages are allocated among the particular trades or businesses. The statute also requires that to be taken into account, W-2 wages must be properly allocable to QBI. W-2 wages are properly allocable to QBI if the associated wage expense is taken into account in computing QBI.
 
Determination of the UBIA of qualified property[11]
In general, qualified property means, with respect to any trade or business of an individual or an RPE for a taxable year, tangible property of a character subject to the allowance for deprecation under Section 167(a), which is held by, and available for use in, the trade or business at the close of the taxable year, which is used at any point during the taxable year in the trade or business’ production of QBI, and the depreciable period[12] for which has not ended before the close of the individual’s or RPE’s taxable year. For purchased or produced qualified property, UBIA generally will be its cost basis as of the date the property is placed in service. For qualified property contributed to a partnership in a Section 721 transaction and immediately placed in service, UBIA generally will be its basis under Section 723. For qualified property contributed to an S corporation in a Section 351 transaction and immediately placed in service, UBIA generally will be its basis under Section 362. Further, for property inherited from a decedent and immediately placed in service by the heir, the UBIA generally will be its fair market value at the time of the decedent’s death under Section 1014. UBIA is not reduced for additional first-year (bonus) depreciation or any Section 179 expense claimed by the taxpayer. However, UBIA must be reduced for the percentage of the taxpayer’s use of property for the taxable year other than in the taxpayer’s trade or business.

In the case of qualified property held by an RPE, each partner’s or shareholder’s share of the UBIA of qualified property is an amount that bears the same proportion to the total UBIA of qualified property as the partner’s or shareholder’s share of tax depreciation bears to the entity’s total tax depreciation attributable to the property for the year. In the case of qualified property of a partnership that does not produce tax depreciation during the year (for example, property that has been held for less than 10 years but whose recovery period has ended), each partner’s share of the UBIA of qualified property is based on how gain would be allocated to the partners pursuant to Sections 704(b) and 704(c) if the qualified property was sold in a hypothetical transaction for cash equal to the fair market value of the qualified property. In the case of qualified property of an S corporation that does not produce tax depreciation during the year, each shareholder’s share of the UBIA of the qualified property is a share of the UBIA proportionate to the ratio of shares in the S corporation held by the shareholder over the total shares of the S corporation.[13]

In the case of any addition to or improvement of qualified property that has already been placed in service, such addition or improvement is treated as separate qualified property as of the date such addition or improvement is placed in service.[14] Section 743(b) and 734(b) basis adjustments are not treated as separate qualified property.[15] Additionally, property is not qualified property if the property is acquired within 60 days of the end of the taxable year and disposed of within 120 days without having been used in a trade or business for at least 45 days prior to disposition, unless the taxpayer demonstrates that the principal purpose of the acquisition and disposition was a purpose other than increasing the Section 199A deduction.[16]

Definition and determination of QBI
In general, QBI includes the net amount of domestic items of income, gain, deduction, and loss[17] with respect to any qualified trade or business of taxpayer, subject to certain exclusions. Specifically, the statute provides that QBI does not include the following items of income, gain, deduction, or loss: (1) income such as dividends, investment interest income, short-term and long-term capital gains or losses (including gains or losses under Section 1231 which are treated as capital gains or losses), commodities gains or losses, foreign currency gains or losses, and similar items; (2) any Section 707(c) guaranteed payments paid in compensation for services performed by the partner to the partnership; (3) Section 707(a) payments for services rendered with respect to the trade or business; or (4) qualified REIT dividends or qualified PTP income.

The Proposed Regulations provide clarity around the inclusion of certain amounts within the definition of QBI. The Proposed Regulations clarify that:
  • Section 751 ordinary income is taken into account for purposes of computing QBI.[18]
  • Income attributable to guaranteed payments for the use of capital is not taken into account for purposes of computing QBI. However, the partnership’s deduction associated with the guaranteed payment is taken into account for purposes of computing QBI if the deduction is properly allocable to the trade or business and is otherwise deductible for Federal income tax purposes.[19]
  • Section 481 adjustments (whether positive or negative) are generally included in QBI but only if the adjustment arises in taxable years ending after December 31, 2017.[20]
  • Previously disallowed losses or deductions allowed in the taxable year are taken into account for purposes of computing QBI unless the losses or deductions were from taxable years ending before January 1, 2018.[21]
  • A deduction for a net operating loss is not taken into account in computing QBI. However, to the extent that the net operating loss is disallowed under Section 461(l), the net operating loss is taken into account for purposes of computing QBI.[22]
  • QBI does not include any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss, including any item treated as one of such items, such as gains or losses under Section 1231 which are treated as capital gains or losses.[23]
  • QBI does not include any interest income other than interest income which is properly allocable to a trade or business. However, interest income attributable to an investment of working capital, reserves, or similar accounts is not properly allocable to a trade or business.[24]
  • For purposes of determining QBI, W-2 wages, and UBIA of qualified property, if an individual receives any of these items from an RPE with a taxable year that begins before January 1, 2018, and ends after December 31, 2017, such items are treated as having been incurred by the individual during the individual's taxable year in which or with which such RPE taxable year ends.[25]
 
Allocation of items of directly-conducted trades or businesses
If an individual or RPE directly conducts multiple trades or businesses, and has items of QBI which are properly attributable to more than one trade or business, the individual or RPE must allocate those items among the several trades or businesses to which they are attributable using a reasonable method based on all the facts and circumstances. The individual or RPE may use a different reasonable method for different items of income, gain, deduction, and loss. The chosen reasonable method for each item must be consistently applied from one taxable year to another and must clearly reflect the income and expenses of each trade or business. The overall combination of methods must also be reasonable based on all facts and circumstances. The books and records maintained for a trade or business must be consistent with any allocations applied by the taxpayer.[26]
 
Aggregation of trades or businesses
An individual or passthrough entity may be engaged in more than one trade or business. Under the general rules, each trade or business is treated as a separate trade or business for purposes of determining the QBI Deduction, including application of the Wages & Capital Limitation and SSTB Exclusion. The Proposed Regulations provide that individuals may, for purposes of the Wages & Capital Limitation, aggregate certain trades or businesses. Aggregation of multiple trades or businesses by an individual will be allowed only if:[27]
  1. Each activity to be aggregated must be considered a trade or business and reported on returns with the same taxable year.
  2. The same person, or group of persons, directly or indirectly, owns 50 percent or more of each of the trades or businesses to be aggregated for the majority of the taxable year in which the items attributable to each trade or business are included in income.
  3. None of the aggregated trades or businesses are an SSTB.
  4. The trades or businesses meet at least two of three factors, which demonstrate that the businesses are in fact part of a larger, integrated trade or business:
    1. The trades or businesses provide products and services that are the same (for example, a restaurant and a food truck) or they provide products and services that are customarily provided together (for example, a gas station and a car wash).
    2. The trades or businesses share facilities or share significant centralized business elements (for example, common personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources).
    3. The trades or businesses are operated in coordination with, or reliance on, other businesses in the aggregated group (for example, supply chain interdependencies).
An individual may aggregate trades or businesses operated directly and the individual's share of QBI, W-2 wages, and UBIA of qualified property from trades or businesses operated through RPEs. Multiple owners of an RPE do not need to aggregate in the same manner. For those trades or businesses directly operated by the individual, the individual computes QBI, W-2 wages, and UBIA of qualified property for each trade or business before applying the aggregation rules. Following aggregation of multiple trades or businesses, the individual then combines the QBI, W-2 wages, and UBIA of qualified property for all aggregated trades or businesses for purposes of applying the Wages & Capital Limitation.[28]

Once an individual chooses to aggregate two or more trades or businesses, the individual must consistently report the aggregated trades or businesses in all subsequent taxable years. However, an individual may add newly created or newly acquired trades or businesses to an existing aggregated trade or business if the requirements described above are satisfied. In a subsequent year, if there is a change in facts and circumstances such that an individual's prior aggregation of trades or businesses no longer qualifies for aggregation under the rules of this section, then the trades or businesses will no longer be aggregated and the individual must determine a new permissible aggregation (if any).[29]

For each taxable year, individuals must attach a statement to their returns identifying each aggregated trade or business. The statement must contain (A) a description of each trade or business; (B) the name and EIN of each entity in which a trade or business is operated; (C) information identifying any trade or business that was formed, ceased operations, was acquired, or was disposed of during the taxable year; and (D) such other information as the Commissioner may require in forms, instructions, or other published guidance. If an individual fails to attach the required statement, the Commissioner may disaggregate the individual's trades or businesses.[30]
 
Definition of SSTB[31]
An SSTB means any trade or business involving the performance of services in the fields of health, law, accounting, actuarial sciences, 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, or which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.

The Proposed Regulations provide much-needed clarity around the meaning of the term SSTB, separately addressing each of the listed services as follows:

Health: Medical services provided by individuals such as physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists and other similar healthcare professionals performing services in their capacity as such who provide medical services directly to a patient (service recipient). The performance of services in the field of health does not include the provision of services not directly related to a medical services field, even though the services provided may purportedly relate to the health of the service recipient. For example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers, payment processing, or the research, testing, and manufacture and/or sales of pharmaceuticals or medical devices.

Law: Performance of services by individuals such as lawyers, paralegals, legal arbitrators, mediators, and similar professionals performing services in their capacity as such. The performance of services in the field of law does not include the provision of services that do not require skills unique to the field of law such as services performed by printers, delivery services, or stenography services.

Accounting: Performance of services by individuals such as accountants, enrolled agents, return preparers, financial auditors, and similar professionals performing services in their capacity as such.

Actuarial Science: Performance of services by individuals such as actuaries and similar professionals performing services in their capacity as such.

Performing Arts: Performance of services by individuals who participate in the creation of performing arts, such as actors, singers, musicians, entertainers, directors, and similar professionals performing services in their capacity as such. The performance of services in the field of performing arts does not include the provision of services that do not require skills unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities for use in the performing arts. Similarly, the performance of services in the field of the performing arts does not include the provision of services by persons who broadcast or otherwise disseminate video or audio of performing arts to the public.

Consulting: The provision of professional advice and counsel to clients to assist the client in achieving goals and solving problems. Consulting includes providing advice and counsel regarding advocacy with the intention of influencing decisions made by a government or governmental agency and all attempts to influence legislators and other government officials on behalf of a client by lobbyists and other similar professionals performing services in their capacity as such. The performance of services in the field of consulting does not include sales or economically similar services or the provision of training and educational courses. The determination of whether a person’s services are sales or economically similar services is based on all the facts and circumstances of that person’s business which may include, for example, the manner in which the taxpayer is compensated for the services provided. Performance of services in the field of consulting does not include the performance of consulting services embedded in, or ancillary to, the sale of goods or performance of services on behalf of a trade or business that is otherwise not an SSTB (such as typical services provided by a building contractor) if there is no separate payment for the consulting services.

Athletics: Performance of services by individuals who participate in athletic competition such as athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing. The performance of services in the field of athletics does not include the provision of services that do not require skills unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events. Similarly, the performance of services in the field of athletics does not include the provision of services by persons who broadcast or otherwise disseminate video or audio of athletic events to the public.

Financial Services: Provision of financial services to clients including managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in title 11 or similar cases), and raising financial capital by underwriting, or acting as a client’s agent in the issuance of securities and similar services. This includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals performing services in their capacity as such.

Brokerage: Services in which a person arranges transactions between a buyer and a seller with respect to securities for a commission or fee. This includes services provided by stock brokers and other similar professionals, but does not include services provided by real estate agents and brokers, or insurance agents and brokers.

Investment Management: Services related to a trade or business involving the receipt of fees for providing investing, asset management, or investment management services, including providing advice with respect to buying and selling investments. The performance of services of investing and investment management does not include directly managing real property.

Trading: Services related to a trade or business of trading in securities, commodities, or partnership interests based on relevant facts and circumstances, including the source and type of profit that is associated with engaging in the activity regardless of whether that person trades for the person’s own account, for the account of others, or any combination thereof. A taxpayer, such as a manufacturer or a farmer, who engages in hedging transactions as part of their trade or business of manufacturing or farming is not considered to be engaged in the trade or business of trading commodities.

Dealing in Securities, Commodities, or Partnership Interests: Regularly purchasing securities, commodities, or partnership interests from and selling securities, commodities, or partnership interests to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. However, a taxpayer that regularly originates loans in the ordinary course of a trade or business of making loans but engages in no more than negligible sales of the loans is not dealing in securities.

Reputation or Skill: The term “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” means any trade or business that consists of any of the following (or any combination thereof):
  1. A trade or business in which a person receives fees, compensation, or other income for endorsing products or services,
  2. A trade or business in which a person licenses or receives fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity, or
  3. Receiving fees, compensation, or other income for appearing at an event or on radio, television, or another media format.
For purposes of foregoing, the term fees, compensation, or other income includes the receipt of a partnership interest and the corresponding distributive share of income, deduction, gain or loss from the partnership, or the receipt of stock of an S corporation and the corresponding income, deduction, gain or loss from the S corporation stock.

De Minimis Rule: A trade or business (determined before the application of the aggregation rules) is not an SSTB if the trade or business has gross receipts of $25 million or less in a taxable year and less than 10 percent of the gross receipts of the trade or business is attributable to the performance of services in an SSTB. For trades or business with gross receipts greater than $25 million in a taxable year, a trade or business is not an SSTB if less than five percent of the gross receipts of the trade or business are attributable to the performance of services in an SSTB.

Related Services Provided to an SSTB: An SSTB includes any trade or business that provides 80 percent or more of its property or services to an SSTB if there is 50 percent or more common ownership of the trades or businesses. However, if a trade or business provides less than 80 percent of its property or services to an SSTB within the meaning of this section and there is 50 percent or more common ownership of the trades or businesses, that portion of the trade or business of providing property or services to the 50 percent or more commonly-owned SSTB is treated as a part of the SSTB. 

Trade or Business Incidental to an SSTB: If a trade or business (that would not otherwise be treated as an SSTB) has 50 percent or more common ownership with an SSTB, including related parties, and has shared expenses with the SSTB, including shared wage or overhead expenses, then such trade or business is treated as incidental to and, therefore, part of the SSTB within the meaning of this section if the gross receipts of the trade or business represents no more than five percent of the total combined gross receipts of the trade or business and the SSTB in a taxable year.
 
Reporting obligations of an SSTB
Individuals with taxable income below the Threshold Amount are not subject to a restriction with respect to SSTBs. Therefore, if an individual or trust has taxable income below the Threshold Amount, the individual or trust is eligible to claim the QBI Deduction notwithstanding that a trade or business is an SSTB.

Further, the exclusion of QBI, W-2 wages, and UBIA of qualified property from the computation of the Section 199A deduction is subject to a phase-in for individuals with taxable income within the phase-in range. The application of this phase-in is determined at the individual, trust, or estate level, which may not be where the trade or business is operated.

Therefore, if a partnership or an S corporation operates an SSTB, the application of the threshold does not depend on the partnership or S corporation’s taxable income but rather, the taxable income of the individual partner or shareholder claiming the Section 199A deduction. For example, if the partnership’s taxable income is less than the Threshold Amount, but each of the partnership's individual partners have income that exceeds the Threshold Amount plus $50,000 ($100,000 in the case of a joint return), then none of the partners may claim a Section 199A deduction with respect to any income from the partnership’s SSTB.

An RPE conducting an SSTB may not know whether the taxable income of any of its equity owners is below the Threshold Amount. However, the RPE is best positioned to make the determination as to whether its trade or business is an SSTB. Therefore, the Proposed Regulations require each RPE to determine whether it conducts an SSTB and disclose that information to its partners, shareholders, or owners. With respect to each trade or business, once it is determined that a trade or business is an SSTB, it remains an SSTB and cannot be aggregated with other trades or business.[32]
 
Other reporting requirements[33]
An RPE must determine and report information attributable to any trades or businesses it is engaged in necessary for its owners to determine their QBI Deduction. Under the Proposed Regulations, the RPE is required to follow four rules:
  1. The RPE must determine if it is engaged in one or more trades or businesses. The RPE must also determine whether any of its trades or businesses is an SSTB.
  2. The RPE must determine the QBI for each trade or business engaged in directly.
  3. The RPE must determine the W-2 wages and UBIA of qualified property for each trade or business engaged in directly.
  4. The RPE must determine whether it has any qualified REIT dividends or qualified PTP income earned either directly or indirectly.
An RPE must separately identify and report the following information on the Schedule K-1 issued to its owners for any trade or business engaged in directly by the RPE:
  1. Each owner's allocable share of QBI, W-2 wages, and UBIA of qualified property attributable to each such trade or business.
  2.  Whether any of the trades or businesses is an SSTB.
  3. Any QBI, W-2 wages, UBIA of qualified property, or SSTB determinations, reported to it by any RPE in which the RPE owns a direct or indirect interest.
  4. Each owner's allocated share of any qualified REIT dividends or qualified PTP income or loss received by the RPE (including through another RPE).
If an RPE fails to separately identify or report on the Schedule K-1 (or any attachments thereto) issued to an owner the required items described above, the owner's share (and the share of any upper-tier indirect owner) of positive QBI, W-2 wages, and UBIA of qualified property attributable to trades or businesses engaged in by that RPE will be presumed to be zero.
 

CONTACT:
 
Jeffrey Bilsky
National Tax Office Partner
Technical Practice Leader, Partnerships
  John Nuckolls
National Tax Office Managing Director
Technical Practice Leader, Private Client Services

 
Kevin Anderson
National Tax Office Partner
  Traci Kratish Pumo
National Tax Office Managing Director

   
Tommy Orr
National Tax Office Senior Manager
   
 
[1] The Threshold Amount is equal to $315,000 for joint filing taxpayers and $157,500 for all other taxpayers. The limitations and exclusions subject to these Threshold Amounts are subject to a phase-in over the $100,000 and $50,000 of taxable income generated by joint filing and other taxpayers, respectively, earned above the Threshold Amounts. Therefore, for joint filing taxpayers, the phase-in occurs between $315,000 and $415,000 and for other taxpayers the phase-in occurs between $157,500 and $207,500. The Threshold Amount is subject to future cost-of-living adjustments.
 
[2] Prop. Treas. Reg. § 1.199A-1(c)(2)(i).
[3] Prop. Treas. Reg. § 1.199A-1(c)(2)(ii).
[4] Prop. Treas. Reg. § 1.199A-1(d)(2).
[5] Prop. Treas. Reg. § 1.199A-1(d)(2)(i).
[6] Prop. Treas. Reg. § 1.199A-1(d)(2)(ii).
[7] Prop. Treas. Reg. § 1.199A-1(d)(2)(iii)(A).
[8] Prop. Treas. Reg. § 1.199A-1(d)(2)(iii)(B).
[9] Prop. Treas. Reg. § 1.199A-1(d)(2)(iv)(B).
[10] Prop. Treas. Reg. § 1.199A-2.
[11] Prop. Treas. Reg. § 1.199A-2(c).
[12] The term depreciable period means, generally, the period beginning on the date the property was first placed in service by the individual or RPE and ending on the later of (A) the date that is 10 years after such date, or (B) the last day of the last full year in the applicable recovery period that would apply to the property under Section 168(c). Any available bonus depreciation deduction does not affect the applicable recovery period.
Additionally, qualified property that is acquired in a Section 1031 like-kind exchange or a Section 1033 involuntary conversion is treated as placed in service by the individual or RPE under the following rules:

    A. The date the exchanged basis in the replacement Modified Accelerated Cost Recovery System (MACRS) property was first placed in service by the trade or business is the date on which the relinquished property was first placed in service by the individual or RPE; and
    B. The date any excess basis in the replacement MACRS property was first placed in service by the individual or RPE is the date on which the replacement MACRS property was first placed in service by the individual or RPE; or
    C. If the individual or RPE makes an election under Treas. Reg. §1.168(i)-6(i)(1) (the election not to apply Treas. Reg. § 1.168(i)-6)), the date the exchanged basis and any excess basis in the replacement MACRS property was first placed in service by the trade or business is the date on which the replacement MACRS property was first placed in service by the individual or RPE.

If an individual or RPE acquires qualified property in certain nonrecognition transactions, the individual or RPE must determine the date on which the qualified property was first placed in service as follows:
    A. For the portion of the transferee's unadjusted basis in the qualified property that does not exceed the transferor's unadjusted basis in such property, the date such portion was first placed in service by the transferee is the date on which the transferor first placed the qualified property in service; and
    B. For the portion of the transferee's unadjusted basis in the qualified property that exceeds the transferor's unadjusted basis in such property, such portion is treated as separate qualified property that the transferee first placed in service on the date of the transfer.
 
[13] Prop. Treas. Reg. § 1.199A-2(a)(3).
[14] Prop. Treas. Reg. § 1.199A-2(c)(1)(ii).
[15] Prop. Treas. Reg. § 1.199A-2(c)(1)(iii).
[16] Prop. Treas. Reg. § 1.199A-2(c)(1)(iv).
[17] For purposes of the QBI Deduction, domestic items of income, gain, deduction, and loss include those items that are effectively connected with the conduct of US trade or business within the meaning of Section 864(c).
[18] Prop. Treas. Reg. § 1.199A-3(b)(1)(i).
[19] Prop. Treas. Reg. § 1.199A-3(b)(1)(ii).
[20] Prop. Treas. Reg. § 1.199A-3(b)(1)(iii).
[21] Prop. Treas. Reg. § 1.199A-3(b)(1)(iv).
[22] Prop. Treas. Reg. § 1.199A-3(b)(1)(v).
[23] Prop. Treas. Reg. § 1.199A-3(b)(2)(ii)(A).
[24] Prop. Treas. Reg. § 1.199A-3(b)(2)(ii)(C).
[25] Prop. Treas. Reg. § 1.199A-3(d)(1)(ii) and 1.199A-5(e)(2).
[26] Prop. Treas. Reg. § 1.199A-3(b)(5).
[27] Prop. Treas. Reg. § 1.199A-4(b)(1).
[28] Prop. Treas. Reg. § 1.199A-4(b)(2).
[29] Prop. Treas. Reg. § 1.199A-4(c)(1).
[30] Prop. Treas. Reg. § 1.199A-4(c)(2).
[31] Prop. Treas. Reg. § 1.199A-5(b).
[32] Prop. Treas. Reg. § 1.199A-6(b)(3)(B).
[33] Prop. Treas. Reg. § 1.199A-6(b).