©flySnow/ISTOCK/THINKSTOCK
In mid-August, the Treasury Department and Internal Revenue Service (IRS) issued a notice of proposed rulemaking that outlines how the TCJA’s qualified business income (QBI) deduction for pass-through businesses under Section 199A of Internal Revenue Code will be implemented. Financial Executives International (FEI) submitted a comment letter offering recommendations on how the proposed regulations could be modified to reduce compliance burdens on private companies and their owners and requested clarification on certain aspects of the proposed rules. Comment letters were submitted by 333 organizations and individuals.
This week’s public hearing, which included testimony from 24 witnesses, allowed interested parties to provide additional feedback to senior Treasury Department and IRS officials who are writing the final regulations.
Two members of FEI’s Committee on Private Companies (CPC) participated in a Treasury Department and IRS public hearing earlier this week in Washington, DC. on proposed regulations to implement the new deduction for some pass-through business income established by last year’s Tax Cuts and Jobs Act (TCJA). CPC Chair Arlene Schwartz and committee member Todd Horsager travelled to the nation’s capital to provide feedback on the proposal on behalf of FEI’s private company members.
Computation of the Deduction
On behalf of FEI’s private company members, Schwartz and Horsager called on Treasury to simplify and streamline the computation that relevant passthrough entities (RPEs) must make to calculate the deduction. As proposed by Treasury and the IRS, the tax deduction is taken at the individual owner level, on his Form 1040. The process to compute the deduction requires many items of information that are only available to the RPE. Not only is it difficult for individual shareholders or partners to obtain the data needed to compute their deductions, the calculation is quite complex and requires an in-depth understanding of many new definitions, rules and concepts. Many individuals do not have the knowledge nor the resources to compute the deduction.
CPC recommended instead that Treasury permit an option for an RPE to complete the computation of the QBI deduction at the entity level and to report each owner’s allocable share of the QBI deduction. This information could be reported on Form K-1 to each individual, so that individuals could decide whether to take the amount reported to them, or to perform their own calculations. Such pre-determined computation of the QBI deduction at the RPE level to take into account statutory limitations required, such as W-2 wages, unadjusted basis of qualified property immediately after acquisition (UBIA), and Specified Service Trade or Business (SSTB). This would provide a much simpler option for the small business owner. Under this approach, the aggregation of other trades or businesses owned by the RPE would also be performed at the RPE level, thereby providing both individuals and the Service a more straightforward and less cumbersome option to compute and determine the deduction by individual owners of small businesses.
Aggregation
While FEI’s CPC agreed with rulemakers’ decision to allow taxpayers to group multiple trades or businesses together when determining their QBI deduction under section 199A, Ms. Schwartz and Horsager noted that, based on feedback from FEI private company members, many business owners would be unable to aggregate their multiple businesses under the proposed rules because the requirements are too restrictive and the necessary information required may not be available to the individual. To address these concerns, CPC recommended that the final regulations relax or eliminate some or all of the requirements that must be met, including deletion of the 50 percent ownership test, which requires that the taxpayer own, directly or indirectly 50 percent or more of each trade or business to be aggregated. There are many situations where a partner or shareholder may have a minority stake, in which they are paying W-2 wages and/or investing in qualified business assets and should be able to aggregate. For example, one may own 25 percent of four different businesses, or businesses with multiple locations, and while they may have a 100 percent interest in total, they would be precluded from aggregated under the proposed rule.
Schwartz and Horsager also suggested that the final regulations permit aggregation at either the individual level or entity level on an annual basis, which is also aligned with old Section 199 rules and regulations. This solution would reduce the complexity of a consolidated QBI determination by individual taxpayers and would help the IRS in their audit process, allowing the Service to focus at the business entity level for the calculation versus possibly a significant number of partners or investors in larger pass-through organizations
Classification of the QBI Deduction
Finally, on behalf of FEI’s private company members, Schwartz and Horsager recommended that final regulations clarify that the QBI deduction allowed for purposes of Section 199A is not a deduction that is paid or incurred for purposes of §162 or a deduction for any other purposes of the Code. To be treated as a trade or business expense under §162, ordinary and necessary expenses must be paid or incurred during the taxable year in carrying on any trade or business. This is also true under 461(h) of the Code in meeting the economic performance standard. The §199A “deduction” is not generated by the payment of cash or the incurring of a liability nor does it reflect an item of a specific business expense. Rather it is computed based on the QBI of a business including elements of both income and expense netted together and applying a statutorily determined computation of 20 percent; it does not reflect an actual expense that has been paid or incurred. Given these factors, 199A is not intended to be a deduction for an item paid or accrued under §162(a) or for any other purposes of the Code. Instead, FEI believes §199A is an essential component of the statutory rate structure and the computation of tax for qualified pass-through entities and requests that final regulations reflect this.
The CPC will continue to provide feedback and recommendations to the Treasury Department and IRS has they draft the final Section 199A deduction rules. It is widely expected the final regulation will be issued by year-end.