The IRS has issued proposed regulations that further clarify which business owners can deduct 20 percent of their qualified business income (QBI). 

This long-awaited regulation could mean clearer instructions and big tax news—good and bad—for some high-net-worth clients.

The new Section 199A deduction was created by the Tax Cuts and Jobs Act and is available for tax years beginning after Dec. 31, 2017. (Though the rules are still in proposal, you can use them to guide clients while the IRS gathers comments on the proposed rules this year up until fall.)

“The proposed regs provide some welcome clarity on some of the questions we had on the QBI deduction,” said Mike Crabtree, a CPA and partner with Boulay in Minneapolis. “They will add some confidence in our ability to claim the deduction for some high-net-worth clients who were uncertain if they’d qualify.”

According to the IRS, the deduction is for up to 20 percent of QBI from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust or estate. For taxpayers with taxable income that exceeds $315,000 for a married couple filing a joint return ($157,500 for all other taxpayers), the deduction is subject to limitations such as the type of trade or business, the taxpayer’s taxable income, the amount of W-2 wages paid by the qualified trade or business and the unadjusted basis immediately after acquisition of qualified property held by the trade or business.

Income earned through a C corporation or by providing services as an employee is not eligible. The deduction is equal to the lesser of 20 percent of QBI plus 20 percent of qualified real estate investment trust dividends and qualified publicly traded partnership income or 20 percent of taxable income minus net capital gains. Deductions for taxpayers above the taxable income thresholds may be limited; employee wages, capital gain, interest and dividend income are excluded.

Crabtree echoes many tax preparers in saying that the proposed rules importantly narrow the definition of what trades or businesses qualify for the deduction. “Some businesses got a pleasant surprise,” he said. “Many real estate brokers and insurance brokers assumed they would be excluded from the QBI deduction because it specifically excludes brokerage services, [but] the proposed regs limit the definition of ‘brokerage’ to securities brokers.”

“Many high-net-worth individuals will be hit hard by the specified service trade or business (SSTB) definitions,” said Bill Smith, Bethesda, Md.-based managing director for the CBIZ MHM national tax office, “including lawyers, accountants, performers, athletes, financial advisors, investment bankers, investment managers, asset and wealth managers, M&A advisors, retirement advisors, securities brokers and lobbyists.”

Groups that escaped under new regs include architects and engineers, real estate management, bankers and other groups that feared the catch-all of businesses where the principal asset is the “reputation or skill of one or more of the owners or employees,” the latter being wording in the regulations that many deemed too ambiguous and wide-ranging.

“The big area of ambiguity left is consulting,” Smith said.

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