When President Trump signed into law the Tax Cuts and Jobs Act (TCJA) in Dec. 2017, much was made of the dramatic cut in corporate tax rates. But the TCJA also includes a generous deduction for smaller businesses that operate as pass-through entities, with income that is “passed through” to owners and taxed as individual income.
The IRS issued proposed regulations for the qualified business income (QBI), or Section 199A, deduction in Aug. 2018. Now, it has released final regulations and additional guidance, just before the first tax season in which taxpayers can claim the deduction. Among other things, the guidance provides clarity on who qualifies for the QBI deduction and how to calculate the deduction amount.
QBI Deduction in Action
The QBI deduction generally allows partnerships, limited liability companies, S corporations, and sole proprietorships to deduct up to 20 percent of QBI received. QBI is the net amount of income, gains, deductions and losses (excluding reasonable compensation, certain investment items, and payments to partners) for services rendered. The calculation is performed for each qualified business and aggregated. (If the net amount is below zero, it’s treated as a loss for the following year, reducing that year’s QBI deduction.)
If a taxpayer’s taxable income exceeds $157,500 for single filers or $315,000 for joint filers, a wage limit begins phasing in. Under the limit, the deduction can’t exceed the greater of 1) 50 percent of the business’s W-2 wages or 2) 25 percent of the W-2 wages plus 2.5 percent of the unadjusted basis immediately after acquisition (UBIA) of qualified business property (QBP).
For a partnership or S corporation, each partner or shareholder is treated as having paid W-2 wages for the tax year in an amount equal to his or her allocable share of the W-2 wages paid by the entity for the tax year. The UBIA of qualified property generally is the purchase price of tangible depreciable property held at the end of the tax year.
The application of the limit is phased in for individuals with taxable income exceeding the threshold amount, over the next $100,000 of taxable income for married individuals filing jointly or the next $50,000 for single filers. The limit phases in completely when taxable income exceeds $415,000 for joint filers and $207,500 for single filers.
The amount of the deduction generally can’t exceed 20 percent of the taxable income less any net capital gains. So, for example, let’s say a married couple owns a business. If their QBI with no net capital gains is $400,000 and their taxable income is $300,000, the deduction is limited to 20 percent of $300,000, or $60,000.
The QBI deduction is further limited for specified service trades or businesses (SSTBs). SSTBs include, among others, businesses involving law, financial, health, brokerage, and consulting services, as well as any business (other than engineering and architecture) where the principal asset is the reputation or skill of an employee or owner. The QBI deduction for SSTBs begins to phase out at $315,000 in taxable income for married taxpayers filing jointly and $157,500 for single filers, and phases out completely at $415,000 and $207,500, respectively (the same thresholds at which the wage limit phases in).
The QBI deduction applies to taxable income and doesn’t come into play when computing adjusted gross income (AGI). It’s available to taxpayers who itemize deductions, as well as those who don’t itemize, and to those paying the alternative minimum tax.
Rental Real Estate Owners
One of the lingering questions related to the QBI deduction was whether it was available for owners of rental real estate. The latest guidance (found in IRS Notice 2019-07) includes a proposed safe harbor that allows certain real estate enterprises to qualify as a business for purposes of the deduction. Taxpayers can rely on the safe harbor until a final rule is issued.
Generally, individuals and entities that own rental real estate directly or through disregarded entities (entities that aren’t considered separate from their owners for income tax purposes, such as single-member LLCs) can claim the deduction if:
- Separate books and records are kept for each rental real estate enterprise
- For taxable years through 2022, at least 250 hours of services are performed each year for the enterprise
- For tax years after 2018, the taxpayer maintains contemporaneous records showing the hours of all services performed, the services performed, the dates they were performed and who performed them
The 250 hours of services may be performed by owners, employees, or contractors. Time spent on maintenance, repairs, rent collection, expense payment, provision of services to tenants, and rental efforts counts toward the 250 hours. Investment-related activities, such as arranging financing, procuring property and reviewing financial statements, do not.
Be aware that rental real estate used by a taxpayer as a residence for any part of the year isn’t eligible for the safe harbor.
This safe harbor also isn’t available for property leased under a triple net lease that requires the tenant to pay all or some of the real estate taxes, maintenance, and building insurance and fees, or for property used by the taxpayer as a residence for any part of the year.
Aggregation of Multiple Businesses
It’s not unusual for small business owners to operate more than one business. The proposed regs include rules allowing an individual to aggregate multiple businesses that are owned and operated as part of a larger, integrated business for purposes of the W-2 wages and UBIA of qualified property limitations, thereby maximizing the deduction. The final regs retain these rules with some modifications.
For example, the proposed rules allow a taxpayer to aggregate trades or businesses based on a 50 percent ownership test, which must be maintained for a majority of the taxable year. The final regulations clarify that the majority of the taxable year must include the last day of the taxable year.
The final regs also allow a “relevant pass-through entity” — such as a partnership or S corporation — to aggregate businesses it operates directly or through lower-tier pass-through entities to calculate its QBI deduction, assuming it meets the ownership test and other tests. (The proposed regs allow these entities to aggregate only at the individual-owner level.) Where aggregation is chosen, the entity and its owners must report the combined QBI, wages, and UBIA of qualified property figures.
A taxpayer who doesn’t aggregate in one year can still choose to do so in a future year. Once aggregation is chosen, though, the taxpayer must continue to aggregate in future years unless there’s a significant change in circumstances.
The final regs generally don’t allow an initial aggregation of businesses to be done on an amended return, but the IRS recognizes that many taxpayers may be unaware of the aggregation rules when filing their 2018 tax returns. Therefore, it will permit taxpayers to make initial aggregations on amended returns for 2018.
UBIA in Qualified Property
The final regs also make some changes regarding the determination of UBIA in qualified property. The proposed regs adjust UBIA for non-recognition transactions (where the entity doesn’t recognize a gain or loss on a contribution in exchange for an interest or share), like-kind exchanges and involuntary conversions.
Under the final regs, UBIA of qualified property generally remains unadjusted as a result of these transactions. Property contributed to a partnership or S corporation in a non-recognition transaction usually will retain its UBIA on the date it was first placed in service by the contributing partner or shareholder. The UBIA of property received in a like-kind exchange is generally the same as the UBIA of the relinquished property. The same rule applies for property acquired as part of an involuntary conversion.
SSTB Limitations
Many of the comments the IRS received after publishing the proposed regs sought further guidance on whether specific types of businesses are SSTBs. The IRS, however, found such analysis beyond the scope of the new guidance. It pointed out that the determination of whether a particular business is an SSTB often depends on its individual facts and circumstances.
Nonetheless, the IRS did establish rules regarding certain kinds of businesses. For example, it states that veterinarians provide health services (which means that they’re subject to the SSTB limits), but real estate and insurance agents and brokers don’t provide brokerage services (so they aren’t subject to the limits).
The final regs retain the proposed rule limiting the meaning of the “reputation or skill” clause, also known as the “catch-all.” The clause applies only to cases where an individual or a relevant pass-through entity is engaged in the business of receiving income from endorsements, the licensing of an individual’s likeness or features, or appearance fees.
The IRS also uses the final regs to put a lid on the so-called “crack and pack” strategy, which has been floated as a way to minimize the negative impact of the SSTB limit. The strategy would have allowed entities to split their non-SSTB components into separate entities that charged the SSTBs fees.
The proposed regs generally treat a business that provides more than 80 percent of its property or services to an SSTB as an SSTB if the businesses share more than 50% common ownership. The final regs eliminate the 80 percent rule. As a result, when a business provides property or services to an SSTB with 50 percent or more common ownership, the portion of that business providing property or services to the SSTB will be treated as a separate SSTB.
The final regs also remove the “incidental to an SSTB” rule. The proposed rule requires businesses with at least 50 percent common ownership and shared expenses with an SSTB to be considered part of the same business for purposes of the deduction if the business’s gross receipts represent 5% or less of the total combined receipts of the business and the SSTB.
Note, though, that businesses with some income that qualifies for the deduction and some that doesn’t can still separate the different activities by keeping separate books to claim the deduction on the eligible income. For example, banking activities (taking deposits, making loans) qualify for the deduction, but wealth management and similar advisory services don’t, so a financial services business could separate the bookkeeping for these functions and claim the deduction on the qualifying income.
Real Estate Investment Trusts
The TCJA allows individuals a deduction of up to 20 percent of their combined qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, including dividends and income earned through pass-through entities. The new guidance clarifies that shareholders of mutual funds with REIT investments can apply the deduction. The IRS is still considering whether PTP investments held via mutual funds qualify.
Proceed with Caution
The tax code imposes a penalty for underpayments of income tax that exceed the greater of 10 percent of the correct amount of tax or $5,000. But the TCJA leaves less room for error by taxpayers claiming the QBI deduction: It lowers the threshold for the underpayment penalty for such taxpayers to 5 percent. Our tax advisors can help you avoid such penalties and answer all of your questions regarding the QBI deduction.

Featured Client Testimonials
Barnes Wendling (especially Lena) did a great job with our financials. Everything. It is extremely refreshing and comforting to know that all of our numbers are not only correct, but they are in the right place(s). Your diligence and reporting truly does make me (personally) feel better.
Thomas Adomaitis-Controller, Bialosky Cleveland
Featured Client Testimonials
Larry Friedman is exceptionally thorough and thoughtful.
Greg Mulach, Individual Tax Return

Featured Client Testimonials
I can wholeheartedly tell you that I have yet to work with an audit or tax team that have been more helpful, easy to work with, and committed than the team at Barnes Wendling- I have been through three different firms in the last few years.
Michelle Saylor, Former Controller

Featured Client Testimonials
Floyd Trouten at Barnes Wendling CPAs is an “expert’s expert” when it comes to M & A accounting. Not only does he understand the evolving details of the Tax Code but he also sees the fine points of their application for owners, managers, investors, and financiers.
Mark A. Filippell, Western Reserve Partners

Featured Client Testimonials
Barnes Wendling CPAs has been performing our SOC reports since 2011. They’ve been instrumental in improving the quality of the report by providing recommendations on our description, control objectives, and controls. Their team is collaborative and helpful in working through the process and control changes that impact our report and business.
Ernest Pollak - President, National Enterprise Systems, Inc.

Featured Client Testimonials
The service is amazing at Barnes Wendling CPAs. The benefit is worth more than the cost. Sometimes it’s true that you get what you pay for.
Mark Boucher - Former Owner, Castle Heating & Air, Inc.

Featured Client Testimonials
Floyd and Barnes Wendling CPAs always provide us with peace of mind. Floyd is not only our trusted financial advisor, but we trust him like family. The Barnes Wendling CPAs team is always proactive and meet all of our deadlines. We are very grateful for them.
Trish Gleason, OMCO Holdings & Gleason Family Office

Featured Client Testimonials
Our heartfelt thanks to the Barnes Wendling CPAs team for all you do for us, such as your remarkable responsiveness, timeliness in meeting deadlines, and being such a pleasure to work with!
Karyn Davies Mitchell, Caremetx LLC

Featured Client Testimonials
The quality of your staff on our audit was excellent. I couldn’t ask for a more knowledgeable team with end-result focus.
Brian Spitz, American Tank and Fabricating Company

Featured Client Testimonials
Barnes Wendling takes a holistic, comprehensive approach that helps ensure we are looking ahead to the future. By keeping us up to date on relevant law and regulation changes, we can focus on running our business rather than burying ourselves in tax law. All of this is well communicated, which is the key to any relationship.
Joe Gramc - CFO, Five Star Trucking

Featured Client Testimonials
The valuation team at Barnes Wendling CPAs has provided us with consistently excellent service over the last ten years. We have been impressed with their expertise on business valuations, fairness opinions, and Topic 805 engagements.
Ric Hughes - CFO, AKSM

Featured Client Testimonials
Our auditors from Barnes Wendling CPAs are adept communicators, technically proficient, and patient, reasonable, and very personable. They add value through thoughtful recommendations based on in-depth client knowledge. I respect their opinions and highly recommend them.
Sue Leishman - CFO, Episcopal Diocese of Ohio
Featured Post