by Paul Bishop
Baker Tilly Virchow Krause, LLP is an IMA Member
On Aug. 8, 2018, the Treasury Department issued proposed regulations pertaining to code section 199A (the pass-through deduction), which was added by the Tax Cuts and Jobs Act (TCJA or the Act). In multiple areas, it appears they, along with the Internal Revenue Service, rely upon existing law and guidance. Section 199A provides for a deduction of up to 20 percent of domestic qualified business income (QBI) for trades or businesses operated as a sole proprietorship or through a partnership, S corporation, trust or estate. The proposed regulations provide some clarity on a number of key areas that could impact companies in the food and beverage space.
To recap the pass-through deduction, for taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026, noncorporate taxpayers (individuals, trusts and estates) may take a deduction of up to 20 percent of QBI from sole proprietorships, partnerships, S corporations, trusts and estates. This results in a significant opportunity for taxpayers to minimize their tax liability and consider structuring opportunities to maximize the benefit under section 199A. Below are a few noteworthy areas that should be considered by all taxpayers who may qualify.
One area practitioners and businesses have been waiting for guidance on is in regards to any aggregation rules for purposes of calculating the deduction across multiple trades or businesses. Instead of relying on existing law and guidance under section 469, in this area the proposed regulations create a new set of rules on aggregating qualifying trades or businesses solely for purposes under section 199A. In general, an individual may (but is not required to) aggregate under the proposed regulations, which could create opportunities to maximize their benefit under section 199A. Aggregation will permit taxpayers to combine amounts for purposes of W-2 wage and other limitations that are part of the deduction computation.
The proposed regulations provide four requirements that must be met for taxpayers to aggregate their trades or businesses for purposes of determining their pass-through business deduction:
- As part of the aggregation rules, each trade or business must actually be considered a trade or business, as defined under the proposed regulations
- The same person or group of persons must own a majority interest in each of the businesses for a majority of the year
Note: “Group of persons” is not defined or limited. Therefore, it doesn’t appear that aggregation is limited to a finite number of partners, provided there is common ownership. However, the regulations don’t have any reporting requirement to provide partners information regarding common ownership. Consequently, taxpayers will likely have to obtain such information on their own.
- A specified service trade or business can’t be included in the aggregated group
- The taxpayer must demonstrate at least two of the following:
- The businesses provide products and services that are the same or customarily provided together
- The businesses share facilities or significant centralized business elements, or
- The businesses are operated in coordination with, or reliance on, other businesses in the aggregated group
The proposed regulations fail to provide guidance in regards to the definition of a “trade or business”. Rather, the regulations reference section 162(a) for purposes of defining “trade or business”. Unfortunately, section 162 does not provide a definition and years of case law have not provided clear guidance for a number of industries. Broadly, in this context, a trade or business is an activity a taxpayer engages in with continuity and regularity for the primary purpose of earning a profit. Businesses and individuals will have to look to each separate activity to include rentals and disregarded entities or qualified S corporation subsidiaries to determine which ones meet the definition of “trade or business” for section 199A.
There was uncertainty around taxpayers whether arrangements with third-party payors (such as professional employer organizations) would be able to take into account wages reported on Forms W-2 issued by other parties, provided the wages were paid to employees of the taxpayer for employment by the taxpayer. The proposed regulation allow the taxpayer who has control over the employee to include them in calculation of the W-2 and precludes the employer listed on the W-2 from claiming the wages for purposes of the W-2 limitation.
While this list isn’t inclusive of all the areas covered in the proposed regulations, it highlights a few opportunities for food and beverage processors. As many businesses and owners are looking for ways to minimize tax liability, the proposed regulations provide guidance to start planning. At minimum, taxpayers now have more guidance for purpose of calculating their quarterly estimated taxes and minimizing cash needs after the significant tax law reform.
Overall, even though the provisions are complicated, section 199A provides an opportunity for all companies involved in the food and beverage supply chain to review their structures and current operations to take advantage of this tax deduction.
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