For tax years beginning after December 31, 2017, pass-through businesses and sole proprietors are eligible for the pass-through deduction of up to 20% of qualified business income. This new deduction is thanks to the Tax Cuts and Jobs Act (TCJA) that was passed into law on December 22, 2017. There have been quite a few outstanding issues regarding the pass-through deduction, and the IRS is finally attempting to clear up some of these issues with the proposed regulations released on August 8, 2018.
Aggregation of businesses
The proposed regulations clarify when taxpayers are required or permitted to aggregate multiple businesses in calculating the pass-through deduction. Guidance is provided as to when wages and property of similar business can be aggregated for purposes of calculating the deduction. Many Tax Practitioners suspected that the aggregation rules would be like the existing passive activity “grouping” rules; however, Prop. Regs. Sec. 1.199A-4 provides guidelines for aggregation under section 199A.
Prop. Regs. Sec. 1.199A-1 provides guidance to determine if there are multiple trades or businesses. This is the first step in determining potential aggregation. Luckily, the proposed regulations look to section 162 to determine whether a trade or business exists for 199A purposes, so this should not be a new feat. Also, if a company is renting or licensing tangible or intangible property to a commonly controlled entity, this will also be considered a trade or business for 199A purposes even if it would not otherwise be considered a trade or business separately.
In general, whether to aggregate businesses for the 199A deduction is elective. Two of the three following requirements must be satisfied.
- Each business must be owned by the same person or group of persons.
- None of the businesses can be specified service trades or businesses other than minor exceptions.
- Each business must meet two of the three tests below:
- The businesses provide products and/or services that are normally provided together.
- The businesses share facilities or centralized business elements.
- The businesses are operated in coordination or reliant upon other businesses in the group.
Computation when losses are generated
Another important item addressed in the proposed regulations is what happens when a qualified business generates losses. The regulations contain taxpayer friendly rules for current year “netting” of losses of one business with the income of another business. This means that if a taxpayer has three qualified businesses, and one of those businesses has a loss, the loss will be proportionally applied to the other two businesses’ income.
These proposed regulations appear to provide some favorable results for taxpayers. However, the complexity of these rules requires full attention to make sure there are no hidden traps. Reach out to your SDK team member for more information. We will help you make sure you are taking the proper deduction based on these proposed regulations and your business needs.