IRS Proposes Regulations for Pass-Throughs

August 8, 2018

On August 8, the IRS issued proposed regulations to create a 20 percent deduction on qualified business income for pass-throughs. This proposal is part of the necessary regulations as a result of the Tax Cuts and Jobs Act, and the new provision (Sec. 199A) will be available for tax year 2018 and beyond.

All taxpayers who earn less than $157,500, or $315,000 for a married couple, can now deduct 20 percent of the income they receive via pass-through businesses from their overall taxable income. If taxpayers earn above those amounts and aren’t service professionals, they must meet tests to take the full deduction — the size of their deduction depends on how much they pay in employee wages or how much they’ve invested in capital such as real estate. For “service professionals,” the break fully phases out if they earn more than $207,500 if they’re single, or $415,000 if they’re married.

Among other limits, the rules set minimal standards for businesses that have $25 million or less in gross receipts. The rules disregard specified service income if it totals less than 10 percent of those gross receipts. For businesses with more than $25 million in gross receipts, the rules disregard specified service income if it adds up to less than five percent of those gross receipts.

Specifically, the deduction will be equal to the lesser of 20 percent of their qualified business income plus 20 percent of their qualified real estate investment trust dividends and qualified publicly traded partnership income, or 20 percent of taxable income minus net capital gains.

Qualified business income includes domestic income from a trade or business, however employee wages, capital gains, interest and dividend income are excluded. Given that 83 percent of all small businesses are pass-throughs, this proposal could have a significant impact on the small-business community.

Additionally, in relation to this proposed regulation, IRS released a notice (2018-64) outlining a revenue procedure that provides guidance on methods for calculating W-2 wages for purposes of the new proposed section 199A described above.

The Department of Treasury plans on coming out with additional rules, including some to address a loophole in the tax law under which highly paid professionals, such as investment managers, doctors and lawyers, could form cooperatives to take advantage of the deduction.

Written or electronic comments and requests for a public hearing on this proposed regulation must be received within 45 days of publication in the Federal Register. The notice will appear in Federal Register on Aug. 27, 2018.