Section 199A Expected to Increase Compliance Costs for Pass-through Entities

The Tax Cuts and Jobs Act contains a provision under IRC Section 199A that provides a 20 percent Qualified Business Income Deduction to individuals (subject to limitations). But what does this mean at the entity level?

On August 8, 2018, the IRS issued much-anticipated Proposed Regulations 1.199A-1 through 1.199A-6, clarifying some of the murkier issues in IRC Section 199A. Much of the guidance is meant for individuals subject to the deduction. However, Proposed Regulation 1.199A-6 also contains the provision that Relevant Passthrough Entities (RPEs) must report pertinent Section 199A information to owners on or within Schedule K-1. This information includes each owner’s share of items, such as Specified Service Trade or Business (SSTB) status, Qualified Business Income (QBI), W-2 Wages, and the Unadjusted Basis Immediately after Acquisition (UBIA) of qualified property. Let’s look at each of the required items separately for a few of the issues that can arise.

SSTB Status

For individuals with income above a threshold amount, the ability to utilize the deduction depends on the type of trade or business in which the RPE is involved, with income from SSTBs limited or excluded. (RPE is defined in the Proposed Regs as both pass-through entities that directly operate the trade or business, and those that pass through trade or business’ items of income, gain, loss or deduction from lower tier RPEs to the individual.) The definition of an SSTB for purposes of Section 199A is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade of business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, and, any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities. Because the terms could be considered ambiguous, Proposed Reg 1.199A-5 clarified the meaning of each listed field. As one example, the services of physical therapists are considered an SSTB under the Regs, but the operation of a health spa that provides physical exercise or conditioning is not. As another example, the “reputation and skill” clause was narrowed to describe trade or business activities using an individual’s image, receiving appearance or endorsement fees, or certain other activities. Because consulting is a common component of many trades or businesses, the Proposed Regs provide a de minimis rule that consulting services will not be considered an SSTB if they comprise less than 10% of gross receipts (5% in some cases) or are provided ancillary to the sale of goods. Careful analysis by each RPE will be required to determine if their trade or business is considered an SSTB.


QBI is defined as the net amount of items of income, gain, deduction and loss effectively connected with conducting a U.S. trade or business. Capital gains and losses, dividends and interest income not allocable to a trade or business are excluded. Although this seems straightforward, there can be complexities associated with the calculation. For example, the Proposed Regs state that interest income from reserves or working capital is not included in QBI, but interest income from notes receivable is included. Section 1231 gain or loss is included if considered ordinary, but excluded if considered capital. In this case, although the RPE is required to determine QBI for the owner, the ultimate treatment of 1231 gain or loss is not determined at the entity level, but at the individual level, after netting all such gains and losses together.

W-2 Wages

W-2 wages are total wages subject to wage withholding, elective deferrals and deferred compensation paid during the tax year that are subject to QBI. To qualify, wages must be reported on a return filed with the Social Security Administration on or before the 60th day after the due date. Wages are to be allocated in the same manner as wage expense. Common paymasters are allowed but must then be allocated among the various trades or businesses before being allocated to the owners. The rules concerning what qualifies as wages are so complex that, the same date the Proposed Regs were issued, the IRS issued Notice 2018-64 containing a Proposed Revenue Procedure, the express purpose of which is to provide methods for calculating W-2 wages for purposes of Section 199A.


Unadjusted Basis Immediately after Acquisition will arguably be the most time consuming of the components to track. Qualified property must be in use by the trade or business during the tax year, still held at the end of the year, and still in its depreciable period at the end of the year. Depreciable period is defined as the period starting on the placed-in-service date and ending on the later of the last entire year of the MACRS depreciable life of the asset (regardless of the actual life used, example ADS), or 10 years from the placed-in-service date. The Proposed Regs provide guidance on property contributed by an owner to a partnership or S Corporation in a non-taxable transaction, on inherited property, and on partnership basis adjustments. To prevent anticipated abuse, the Proposed Regs contain a limitation on property 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. Such assets are excluded unless it can be demonstrated by the taxpayer that the principal purpose of acquisition and disposition was other than increasing the Section 199A deduction. Of course, at the end of the year the RPE may not know if an asset will be disposed of in the next year. If an asset is still producing tax depreciation, allocation to the owners is based on allocation of depreciation expense. If not, a partnership is to use a hypothetical sale of the asset, while an S Corporation is to use a ratio of shares owned over total shares.

The IRS has acknowledged that this reporting burden will be costly to RPEs, projecting an additional 2.75 hours of work annually per owner. While this article explored only a few of the complexities that could arise from Section 199A compliance, many more exist. Pass-through entities should start now to develop processes and procedures to comply with the new law, and expect additional time and associated cost. Contact your CSH advisor if you have questions about Section 199A or the proposed regulations.


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