A Planning Introduction to The 2017 Tax Act – The 20% Of Business Income Deduction – Part 1

See “A Planning Introduction to the 2017 Tax Act – The Overview” which briefly discusses this topic and helps put it in an overall perspective within many of the major tax changes enacted in December.

We indicated in that introduction that the new legislation tends to make tax planning more and more mathematical, and while that remark emphasizes alternatives and myriad tax rules, it is particularly true of the new Section 199A that we discuss here.  This new law, this new concept, is effective after 2017.  ((The final bill basically followed the Senate approach, with some rather significant modifications.    See generally, Tax Cuts and Jobs Act, Conference Report to Accompany H.R. 1, 115th Cong., 1st Sess., House Report 115-466, December 15, 2017, which includes the text of the Act, the legislative histories of the House, Senate and Conference.  Hereinafter, the Conf. Rep.  For pagination cites see PDF version:  https://www.congress.gov/congressional-report/115th-congress/house-report/466/1?overview=closed.))

This new tax deduction is scheduled to expire in tax years beginning after 2025.

This major new business deduction provision, which is tantamount to a significant tax rate reduction in some circumstances, is not available to corporations.    The decision to incorporate and access the 21%  tax rate available to C corporations after 2017, a rate reduction which is  not scheduled to expire, means forgoing this new deduction which basically reaches business income of sole proprietors, partners, and shareholders of S corporations.

 

THE BASICS

The details of this new provision can be complicated and there are questions of its interpretation.  However, the basic idea is fairly straightforward: non-corporate taxpayers get a deduction measured by 20% of their business income beginning after December 31, 2017 and before January 1, 2026.   ((See generally Conf. Rep., p. 10-18 for text of new Sec. 199A, and p. 205-224 for the legislative history.))

There are some scenarios where a taxpayer needs wages or wages and capital expenditures to qualify for a deduction unless the taxpayer has lower levels of taxable income, but there are circumstance where the taxpayer may qualify for a very worthwhile deduction without significant wages or capital expenditures.

The deduction can apparently be a million or more in some circumstances.

Certain types of service provider income won’t qualify when the business (or professional) income is significant.    The level of taxable income affects the rules concerning certain types of service providers.

We will at times distinguish the moderate-income taxpayer (whose income isn’t all that small or moderate), the middle-income taxpayer, and the larger-income taxpayer.   The distinctions focus on adjusted taxable income, not gross sales or even business income.    This terminology isn’t found in the law or its legislative history.

The “if less rule” says the deduction cannot exceed 20% of taxable income (before this deduction) as reduced by the sum of net long-term capital gains as reduced by net short-term capital losses and as further reduced by qualified dividends.  ((See 2017 instructions to the Form 1040, p. 23 discussing “qualified dividends.”))

The odd admixture of rules is such that higher levels of taxable income can help or lower levels of taxable income can help.

Itemized deductions, such as charitable donations, as well as business expenses may materially impact the deduction under the “if less rule.”  For example, charitable donations can reduce the 20% of business income deduction by reducing taxable income and increasing the impact of the “if less rule.”   There are certain situations where the rules limit the 20% of business income deduction unless there are  levels of wages or wages and capital but those limitations can be mitigated by reduced taxable income.  In those scenarios, by removing or lessening the wage or wage and capital requirements, charitable donations, for example, may be deductible under the normal rules while also increasing the 20% of business income deduction.  ((Appraisal fees related to charitable donations are mentioned in the legislative history of the repeal of miscellaneous itemized deductions as being not deductible in 2018 to 2025.   Conf. Rep., p. 274. But generally, the upper annual limit on charitable donations was increased from 50% of adjusted gross income to 60%.))

There are portions of the calculations within these rules where increased taxable income helps, and other portions of the calculations where reduced taxable income helps.  The level of taxable income can impact whether certain types of service providers are even included in the benefits of the new 20% of business income concept.

Nonbusiness income may even enhance the 20% of business income deduction by reducing the impact of the “if less rule” but the results may vary depending on whether such income is interest or dividends.

The rules can be quite complex and math here can sometimes be downright surprising.

 

What Qualifies as Business Income for Purposes of the 20% Credit?

The focus is on an active business, not the activity level of the one with the income.

The key definition pertains to “qualified business income” which can arise from a sole proprietorship, partnership or S corporation.    Multi-tiered partnerships or multi-tierd LLCs should work in that the definition of qualifiers is other than a corporation.    ((Sec. 199A(a); See “New Code Section 199A, Pass-through Qualified Business Income Deduction,” Leon C. LaBrecque,  Michigan Association of Certified Public Accountants, MICPA.org, p. 1; http://micpa.org/docs/site/e-news/is-section-199a-of-the-code-a-windfall-for-cpa-firms.pdf?sfvrsn=6.))

Note that characterization can normally change with an S  corporation; i.e., the flow-through might be actively earned at the entity level in an S corporation yet flow  through as a dividend, assuming no salaries are paid to the shareholder by the corporation.   This is the regular income tax rule.   An area of possible dispute with the IRS in an S corporation context is whether payments classified as dividends are in fact compensatory and thus subject to payroll tax.   A partnership is distinguishable; i.e., a partner’s flow-through of income from the entity may well be subject to self-employment tax at the active partner level.

But we note for this purpose, the legislative history treats both partnership and S corporation income as flowing through as business income, if business income by nature, for purposes of this special deduction.   The purpose here is economic stimulus and some outreach to business taxpayers other than C corporations given the major reduction in the corporate tax rate.  ((The corporate tax rate actually increased in so far as the lowest 2017 bracket.))

So business income for purposes of this new provision basically flows through as such regardless of whether the owner of S corporation stock or a partnership interest is personally active in the business.  ((The concept is distinct from that applying, for example, in the self-employment tax area.  See Regs. 1.1402(a)-2(b).))

While an S corporation is generally within the sphere of the new 20% of business income deduction, we note that an S corporation can also incur a built-in gains tax.   We don’t expect the new 20% deduction to grant any relief to that corporate level tax.  An S corporation that was formerly a C corporation, or arose from a taxfree Section 351 transfer of assets of a C corporation, can also incur a corporate-level built-in gains tax for a certain period of years following termination of C corporation status.   ((Sec. 1374.))   The basic idea of the built-in gains tax is to avoid the S election solving the double taxation problem normally inherent with being a C corporation.  The tax may be illustrated by assuming an S corporation sells appreciated realty for a gain of $200,000 and $100,000 of such gain arose during the C corporation period.   The S corporation could incur such tax on the $100,000, even though the shareholders would pay tax on the $200,000.   The tax is imposed on “such corporation.”  ((Sec. 1374(a).))  The Section 199A deduction applies to a “taxpayer other than a corporation…”  ((Sec. 199A(a).  See also Section 199A(f).))

In general, the 20% of business income deduction is based on combined income, and it seems clear that business losses of the year offset business income.  The Conference report indicates it generally follows the Senate version.  The Senate version discusses offsetting business losses against business income before computing the 20% of business income deduction, and if in a year there is a net loss, such loss carries over to potentially reduce any Section 199A deduction in a later year.  ((Conf. Rep. p. 214; see also p. 233 referring to “combined” qualified business income.  See also p. 211 discussing passive losses.))  We discuss later that there can be business-by-business aspects of the computations focused on wages or wage and capital that may limit the deduction.

What is the relationship of the passive activity rules to these new rules?   The passive activity loss rules can defer when items affect taxable income, and it would appear that the Section 199A rules turn on items at the time they enter into “taxable income.”   ((Sec. 199A(c)(3)(A)(ii).  See Conf. Rep., p. 214, which here is the Senate report which with modifications was followed in conference.))

The passive activity rules continue to have their place.   Even though the new Section 199A deduction focuses on business income even if it is by nature not the results of the efforts of a particular partner or S shareholder, the more liberal concept of benefitting the passive participant in an active business doesn’t accelerate the recognition of such items that continue to be subject to the passive activity rules in so far as when they affect taxable income.   These look to be the rules.

But there may well be questions of interpretation and application with respect to the passive loss rules.  For example, we discuss below that middle-income and higher-income taxpayers (our terminology) may be denied access to the 20% of business income deduction unless they can show certain wages or wages and qualified property, and how does one apply such current year limitation concepts in a passive activity context where the income recognized in one year may relate to a multitude of years, and does it matter whether those losses pre-date enactment of this new statute?   The unique information required by this new statute focused on wages and asset additions would obviously never be available, for example, if the passive loss related to an unrelated partnership and the passive loss carries from a year that pre-dated Section 199A.   The likely answer is that, for example, the wages figure in these computations looks only to the wages of the year of computation.  ((See Sec. 199A(b)(4)(A).)) But there could be issues of interpretation and fairness and special circumstances; e.g., what if the activity was winding down and the wages in such year were not representative or it was a short taxable year?  The new statute tells the IRS to provide rules considering short years and major acquisition, major sell-off situations.  ((Sec. 199A(b)(5) whose language includes a focus on what is a “major portion of a trade or business or the major portion of a separate unit of a trade or business…”   See Conf. Rep. p. 223.))

Whether there may be unforeseen complexities or issues of interpretation under Section 199A with respect to passive activities remains to be seen.  ((There is some discussion of the passive activity rules in the Sec. 199A legislative history in the House version.  See Conf. Rep., e.g.,  p. 211 of the legislative history from the House.   Conference followed the Senate version.))

The focus of the statute is on items that affect taxable income, so the authors consider it unlikely that the IRS will interpret Section 199A to remove from the computations passive losses that arise in pre-enactment years and enter into taxable income after 2017.

The potential effect of Section 199A in the various scenarios inclusive of Section 1231 gains and/or losses on the sale of business assets is important and discussed in more detail below in “A Closer Look at What Qualifies as Business Income.”

The topic of disallowed business expenses is beyond our scope, but as an example of such disallowance, we note the following in the legislative history of the 2017 Act.  “Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel.)”  ((Conf. Rep., p. 407.))  In the language of the new Section 199A, we note that in its definition of “qualified business income,” it basically refers to the net figure considering “income, gain, deduction and loss…”  ((Sec. 199A(c)’(1).))  But query whether the IRS will require disallowed business expenses to be subtracted in computing business income subject to the new 20% deduction?

Also included in “qualified business income” are REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income.     Note that a Subchapter S corporation is by definition one with a limited number of shareholders, so in this list we note only publicly traded partnership income.

Toward the goal of some simplification in our discussion of these very complex rules, we won’t include the particulars of REITs and cooperatives, which are basically flow-through entities.

 

Wage Income

The basic definition of a “trade or business” is “any trade or business” with two exceptions: wages of an employee and in certain cases “specified service trade or business.”  ((Sec. 199A(d).))

An employee is considered to be in business, but wage income is expressly excluded from qualifying business income for this purpose.   ((Sec. 199A(c’)(4).))

“Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer.”  ((Conf. Rep., p. 215.))

Planning point:   Earnings as an independent contractor may qualify, so this is one more area of the Code where employee vs. contractor distinctions are important, possibly even placing new strategic emphasis on minimizing employee characterization.

An independent contractor gets some deduction related to the self-employment tax but pays the entire tax versus paying half the payroll tax as an employee, and bearing the incremental self-employment tax  in order to access the new credit is not a persuasive strategy, with the possible exception of high compensation levels that exceed the maximums subject to FICA/FUTA.  So when the employee vs. contractor classification is debatable, borderline, we wouldn’t generally expect employees to be initiating  requests to be reclassified as contractors.

Planning point:  Subchapter S flow-through of business income generally qualifies as being eligible for the 20% of business income deduction but the new context suggests possible disputes with the IRS over whether payouts from the S corporation are nondeductible dividends or wages that should reduce the level of Subchapter S flow-through of business income.    Wage classification is normally a negative because wages don’t qualify as business income, but wages can help in scenarios where a level of wages or wages and capital are necessary to avoid limitations on the 20% deduction.  These limitation rules are discussed below.  Whether payouts from S corporations are dividends or wages triggering payroll taxes and withholding is a traditional area of dispute between the IRS and owners of S corporations, and this issue is still with us.  ((See Rev. Rul. 59-221, 1959-1 C.B. 225, Rev. Rul. 74-44, 1974-1 C.B. 287,  Ding, 200 F. 3d 587 (1999), CA-9, http://caselaw.findlaw.com/us-9th-circuit/1435681.html, PLR 20030026, 3/31/03.))

Following is an excerpt from an IRS site discussing wages in an S corporation context:

“S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly.

The instructions to the Form 1120S, U.S. Income Tax Return for an S Corporation, state “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”

Several court cases support the authority of the IRS to reclassify other forms of payments to a shareholder-employee as a wage expense which are subject to employment taxes.”  ((“S Corporation Compensation and Medical Insurance Issues,”  “Reasonable Compensation,”  https://www.irs.gov/businesses/small-businesses-self-employed/s-corporation-compensation-and-medical-insurance-issues.))

As above, to the extent there is just flow-through income and no payouts to the shareholder-employee, the flow through is a dividend and not wages.

In an S corporation context, to summarize, here are the “wages” issues we see with respect to closely-held shareholders.

To the extent there are payouts in the context of shareholder services and such payments are characterized as dividends, the IRS has traditionally argued, and   will continue to argue, that the “reasonable compensation” element of such payments are really wages subject to payroll tax.

To the extent there are payouts in the context of shareholder services and such payments are characterized as dividends, the IRS will also argue that such payments reduce the business income otherwise eligible for the 20% of business income deduction because such payments are really wages.  The IRS now has a second major incentive to classify S corporation payments to owners as wages.

When there are no payouts of wages and no payouts of dividends which could be challenged as disguised wages, will the IRS argue that for purposes of the new Section 199A, it is entitled to nevertheless characterize the flow-through income as wages to the degree of the value of the shareholder services?     This concept is missing from the legislative history, is contrary to current IRS practice, and we would be very much surprised if the IRS takes such a position.

When there are payouts of wages to shareholder-employees, the taxpayer is conceding (a) payroll taxes; even above the annual FICA/FUTA limits, there is some incremental  tax;   (b) the wages are not subject to the 20% of business income tax; and (c) the wages reduce the S corporation’s business income flowing through to the shareholder-employee, as well as other shareholders if any.   The taxpayer may gain wages classification when a level of wages or wages and capital is necessary to avoid limitations on the 20% business deduction.  But it is difficult to envision it being a net advantage to the IRS to reclassify wages as a dividend.  The more likely scenario is upon exam, the math indicates the wage limitation is already satisfied with other wages or not a factor because of the income level of the taxpayer, and the taxpayer’s representative uncovers arguments as to why wages were overstated; e.g., the taxpayer was ill, getting older and working fewer hours, etc.

Planning point:  Keep in mind that reducing the historic level of wages to shareholder-employees of an S corporation may be justified in some circumstances (age, health, other responsibilities, etc.) and may be particularly advantageous under the new 20% of business income rules.

Guaranteed Payments to a Partner

A partner receiving guaranteed payments from the partnership is not receiving qualifying business income for this purpose.  ((Sec. 199A(c’)(4).))

Planning point:  Reviewing the level of guaranteed payments, which do affect the actual economics in a partnership context, is important because it reduces the flow-through partnership income that may otherwise qualify for the 20% of business income deduction.

The new environment of Section 199A may cause the IRS to argue that payments to partners characterized as distributions are really disguised guaranteed payments.   Such an argument may be even more likely in a family partnership context.

“Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer.   Similarly, qualified business income does not include any guaranteed payment for services rendered with respect to the trade or business, and to the extent provided in regulations, does not include any amount paid or incurred by a partnership to a partner who is acting other than in his or her capacity as a partner for services.”  ((Conf. Rep., p. 215, footnotes omitted..))

There are higher-income areas of the 20% of business income rules that introduce limits that require wages or wages and capital, and we wouldn’t expect the IRS to interpret guaranteed payments of a partnership to qualify as wages for this purpose.

Foreign Income

Qualifying business income must be effectively connected with the conduct of a trade or business within the United States.  ((Sec. 199A(c’)(3)(A).))  Foreign earned income doesn’t qualify for the deduction.    The long-standing but limited exclusion for foreign earned income was not repealed in the new law.

Investment Income

In general, such items as dividends and interest income don’t qualify, albeit it is possible in some circumstances to have interest income qualify if it relates to a business.  ((Sec. 199A(c)’(3)(B).))   Stock market gains, typical capital gains and losses in an investment rather than business context, do not qualify.  ((Conf. Rep., p. 215.))

 

REAL ESTATE INCOME

One doesn’t find “rent” or “rental” in the new Section 199A which is titled “Qualified Business Income.”   It was the Senate version that prevailed, but we note the following comment from the legislative history of the House.

“Unlike a C corporation, partnership, or S corporation, a business conducted as a sole proprietorship is not treated as an entity distinct from its owner for Federal income tax purposes. Rather, the business owner is taxed directly on business income, and files Schedule C (sole proprietorships generally), Schedule E (rental real estate and royalties), or Schedule F (farms) with his or her individual tax return.” ((Conf. Rep. 208 of the House provisions, footnote omitted.  There is also a reference to “rental activities” on p. 211 of the House provisions in the context of passive losses.))   It may be debatable whether these references to rentals were meant to include the activities in business income, although this does seem to say among the filings of the “business owner” is Schedule E with its rental real estate.

There are endless fact patterns but the authors suggest that most tax practitioners wouldn’t consider, say, a “rental house” to be a business activity.   The self-employment tax applies generally to a trade or business but real estate rentals are generally excluded.   They are excluded if the realty is held for investment.  ((Sec. 1402(a)(1); Regs. 1.1402(a)-4.   See also ., Regs. 1.1411-1, 1.1411-5.))

Almost certainly, one would expect, e.g., a housing contractor or hotel/motel operator to be in a trade or business.  ((The following says Section 199A was “clearly intended to apply to commercial real estate,” opines that the rule about 2.5% of basis for qualified property was intended to allow the deduction for rental entities without employees, and queries whether the definition of a trade or business will emphasize Section 162 or Section 1411.  See “New Code Section 199A, Pass-through Qualified Business Income Deduction,” Leon C. LaBrecque,  Michigan Association of Certified Public Accountants, MICPA.org, p. 1; http://micpa.org/docs/site/e-news/is-section-199a-of-the-code-a-windfall-for-cpa-firms.pdf?sfvrsn=6.  See also “Planning for UBTI Changes,” Dennis Walsh, Planned Giving Design Center, 1/16/18; http://www.pgdc.com/pgdc/planning-ubti-changes.))

Note these comments from an IRS site discussing post-construction realty rentals in a self-employment tax context:

“Rents received from the use of or occupancy of hotels, boarding houses, or apartment houses are included in self-employment income IF you provide services to the occupants. Services considered provided to the occupants are services primarily provided for the convenience of the occupants and not normally provided with the rental of rooms or space for occupancy only. Maid service, for example, is a service provided for the convenience of occupants, while heat and light, cleaning of stairways, and the collection of trash are not..  ((“Rents,” https://www.irs.gov/individuals/tax-trails-self-employment-income-6.))

Let’s initially consider a real estate rental fact pattern where it at least may have the appearance of a trade or business.

One might find an office with employees and an integrated operation of real estate operations focused on real estate rentals, occasional projects that involve major improvements or even new construction, owned by two associates or a married couple.   The details of rent collections, calling the plumber, etc., may be with this company, or related company possibly owned by a family member, or such company may be unrelated.  One may argue the real estate rental income is still not subject to self-employment tax, which normally applies to a “trade or business.”  One might argue the realty is held for investment despite a certain recurring level of activities inherent in owning multiple properties.  But does such a position necessarily remove it from being a trade or business for purposes of the 20% of business income deduction?  It is quite possible that the IRS will not consider real estate rentals as subject to Section 199A unless the activities are also subject to self-employment tax.

At the other end of the spectrum is the busy employee or business owner with one real estate rental property, perhaps a former residence, and whether this rises to the level of a trade or business for purposes of the 20% of business income deduction is another question.

It was the Senate version that prevailed albeit with significant modifications in conference.  The legislative history of the Senate and conference discusses qualified business income without mentioning real estate rentals, and investment income without mentioning real estate rentals. ((Conf. Rep., p. 214, 215.))

Had it been the intent to include real estate rentals carte blanche in the definition of a trade or business for purposes of the new Section 199A, one would expect that such intent would have been made patently clear in the statute, or at least the legislative history.

At the other end of the spectrum are real estate “dealers” who are typically considered as being in a trade or business.  ((Regs. 1.1402(a)-4.))    There are many cases focusing on whether the facts indicate realty sales produce ordinary income because the taxpayer was acting as a “dealer,” and the sale of realty, which often involves some level of construction or improvement, was akin to the grocer selling canned goods.  ((Taxpayers sometimes unsuccessfully argue dealer status on a realty sale to avoid the annual limit on capital losses arising from the sale of investment realty.  Conner, T. C. Memo 2018-6.))

Another question in this context is whether or when real estate activities, including rentals, constitute a single trade or business.  Some of the details in the computations look to the income and expense of “each” trade or business.  See the discussion of “Multiple Businesses.”

The real estate industry generally will have considerable focus on the development of the regulations concerning the scope of Section 199A.   ((Section 199, the domestic production activities deduction, was repealed with the enactment of Sec. 199A, and there were aspects of the real estate industry that benefitted in the past from the repealed provision.   Section 199 was  generally repealed for taxable years beginning after 2017.  For corporate taxpayers, it was repealed for taxable years beginning after 2018.  Conf. Rep., p. 400.  See “Domestic Production Activities Deduction – Planning and Practicality,” J. Michael Pusey, Main Street Practitioner, http://mainstreetpractitioner.org/feature/domestic-production-activities-deduction-planning-and-practicality/.))

In general, we are beginning to hear some suggestions that real estate rentals are per se subject to the new 20% of business income deduction, and we have reservations.  For example, if you’re a busy executive planning to buy a rent house and include this 20% of business income in the projections, we would suggest caution.

Hopefully, the IRS will prioritize real estate industry issues in their analysis of this important new legislation.

 

ENTITY ISSUES

Basically, a sole proprietorship, partnership or Subchapter S corporation can generate income that qualifies for the 20% of business income deduction.

An LLC with a single owner may be a disregarded entity, or it may elect to be taxed as a corporation in which case the income would not qualify unless electing S corporation status.  ((See, e.g., Conf. Rep. p. 206.))

A publicly traded partnership is generally treated as a corporation for tax purposes but there are exceptions.  ((See Conf. Rep. p. 206; Sec. 7704(a)(2).))

A sole proprietorship is generally not considered an entity apart from the owner, except for employment tax purposes.   A sole proprietorship, whether just the individual or an LLC not considered an entity apart from its owner, qualifies under the 20% of business income rules if the income is of a nature to qualify.  ((Conf. Rep. 208 reporting the House Report, see Regs. 301.7701-2(c)(2)(iv).))

“While sole proprietorships generally may have no more than one owner, a married couple that files a joint return and jointly owns and operates a business may elect to have that business treated as a sole proprietorship under section 761(f).”  ((Conf. Rep., 208 reporting the House Report.))

In general, a husband and wife in a community property state may disregard their LLC for tax purposes and report results directly on the joint return.  ((See Rev. Proc. 2002-69, 2002 CB 831.))

Whether a partnership or S corporation, the computations focus on the individual taxpayer; i.e., there aren’t computations that begin and end at the partnership or S corporation level for purposes of this new concept.

 

SOME GENERAL RULES AND ISSUES

This deduction is available in arriving at taxable income but not adjusted gross income.   This deduction, for example, won’t affect such areas as medical expense deductions which arise above a percentage of adjusted gross income.   This new deduction is available whether or not the taxpayer itemizes.  ((Conf. Report, p. 224.))

The deduction is available to trusts and estates with provision for apportioning of the deduction between the entity and beneficiaries.  ((Conf. Rep. p. 224.))

This particular deduction doesn’t increase the taxpayer’s net operating loss, so if there is an incremental deduction under the rules of the new Section 199A, the rules seemingly restrict its use to current year’s tax return.    There is no provision to carry over the Section 199A deduction itself.

There is some possibility of carryover within the Section 199A rules for unused business losses.   ((Conf. Rep.  p. 214.  “If the net amount of qualified business income from all qualified trades or businesses during the taxable year is a loss, it is carried forward as a loss from a qualified trade or business in the next year.”))   This carryover is only a negative; i.e., can only lessen future deductions measured by a   percentage of future business income.  Presumably this carryover goes away at the death of the taxpayer.

This deduction isn’t available in computing the self-employment tax.  ((Conf. Rep. p. 220 reporting the Senate Report.))

While the corporate alternative minimum tax was repealed, the individual alternative minimum tax is still with us.  The beginning point in computing such tax is taxable income, and apparently the new 20% of business income deduction is a deduction for AMT purposes.   Seemingly this would be the deduction after applying the 20% and considering the “if less” computation which looks to 20% of taxable income as reduced by the sum of net long-term capital gain in excess of short-term capital loss and qualified dividends, as well as the myriad detailed rules and limitations, such as wage or wage and capital limitations.    The basis for such statement is the absence of anything to the contrary in the new statute and its legislative history and the absence of any amendments in this regard in the AMT statute.

There is a “side note” statutory provision in the new 199A that apparently amends the minimum tax rules in prescribing how this new provision relates to those rules.  It is headed “Coordination with Minimum Tax” and provides, “For purposes of determining alternative minimum taxable income under section 55, qualified business income shall be determined without regard to any adjustments under sections 56 through section 59.”  ((Sec. 199A(f)(2); Conf. Rep., p. 17.  Sections 56 through 59 are within the minimum tax rules.))   The legislative history says, “Qualified business income is determined without regard to any adjustments prescribed under the rules of the alternative minimum tax.”  ((Senate report at Conf. Rep. p. 220.))    The trail here is short and terse but remembering the multitude of items entering into “qualified business income,” the implication seems to be to re-compute the Sec. 199A deduction separately for AMT purposes but when it comes to measuring “qualified business income,”  don’t re-compute its elements when the measure for AMT purposes is different than for regular income tax purposes.   We gather the new Sec. 199A deduction is a potential benefit in so far as the AMT but there may be a regular tax vs. AMT tax difference in measuring the deduction.

The legislative history has some broadly-worded anti-abuse language:

“In the case of property that is sold, for example, the property is no longer available for use in the trade or business and is not taken into account in determining the limitation. The Secretary is required to provide rules for applying the limitation in cases of a short taxable year where the taxpayer acquires, or disposes of, the major portion of a trade or business or the major portion of a separate unit of a trade or business during the year. The Secretary is required to provide guidance applying rules similar to the rules of section 179(d)(2) to address acquisitions of property from a related party, as well as in a sale-leaseback or other transaction as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W–2 wages and capital.  Similarly, the Secretary shall provide guidance prescribing rules for determining the unadjusted basis immediately after acquisition of qualified property acquired in like-kind exchanges or involuntary conversions as needed to carry out the purposes of the provision and to provide anti-abuse rules, including under the limitation based on W–2 wages and capital.”  ((Conf. Rep. p. 223.  See also Sec. 199A(b)(5).))


This article will be continued in upcoming issues of Main Street Practitioner.


About the Authors

Bob Rojas, owner of the firm, has a direct hand in practically everything – accounting, auditing, tax and administration.   As a smaller regional firm with a tendency to hire and retain more heavily experienced professionals, it is common for the staff to also have a broader range of skills and  in-depth insights into both accounting, auditing and tax matters.   At work, Bob does everything but wash the dishes.  He’s been known to mention that he does wash the dishes at home with his wife.   At the office and in the professional community,  if not in the kitchen, Bob’s known as an excellent negotiator.   He has run a regional CPA firm, audit and tax, for some thirty years.  Prior to that, he was an audit manager at a highly respected national firm,and a tax manager at an international CPA firm.   During this time Bob earned his MS in taxation.  It is rare to rise to the manager level in the big national firms in both audit and tax, but it was an excellent background for running his own regional firm.

J. Michael Pusey

J. Michael Pusey, CPA, MSA, is a National Tax Director with Rojas and Associates, CPAs, Los Angeles.  He has over forty years experience in tax and finance.  Mr. Pusey has written or contributed to four tax books, including an AICPA Tax Study, and a finance book.  Mr. Pusey began his career with KPMG before working nine years in “national tax” for Laventhol & Horwath and Grant Thornton. He was V.P., Assistant Tax Director, Manager of Research and Planning for a NYSE financial institution prior to beginning his practice, then joining Rojas and Associates.

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