The Treasury recently finalized regulations on the 20% 199A passthrough deduction. While some questions remain unanswered, the new regulations address several areas omitted from the proposed regulations released this past August, alter rules on others, and clarify yet more. Most of these changes were nuances that only nerds who read tax code and regulations (insert author’s name here) would want to read. However, a few are of note to the tax savvy layman.
One of those changes was self-employment tax, self-employed health insurance, and deductions for qualified retirement contributions should be taken into account when calculating the passthrough deduction. This eliminated a preference in the draft regulations where sole proprietors and partners in partnerships were placed in better position than S corporation owners. Under the draft regulations the passthrough deduction was calculated for these business owners as 20% of income before these deductions were applied, artificially increasing the deduction.
Most of the other significant changes were in definitions of qualified service businesses, businesses that are disqualified from the deduction if the taxpayer is over an income threshold. The definition of the field of health was expanded, but pharmacists who only sell pharmaceuticals, as opposed to those who consult with physicians thereon, were exclude from the category. The businesses of performing arts and athletics were clarified to apply the businesses thereof, not just the artists and athletes themselves, pulling team owners and the owners of production and recording companies into the category. Also, brokerage services were defined to only include the sale of securities, removing concerns that insurance and real estate brokers would be included in the category.
Also, the Treasury simultaneously released a proposed Revenue Procedure with a safe harbor for rental activities to determine if they rise to the level of a trade or business. If they rise to this status, they can qualify for the deduction. Qualifying for the safe harbor requires separate books and records to be maintained, 250 hours of rental services to be performed, and the taxpayer to maintain contemporaneous records regarding those services. Services include advertising, leasing, tenant background checks, collecting rent, daily operation, maintenance, repairs, and oversight of employees. The services may be provided by owners, employees, or contractors. Time spent on financing, acquisition, strategic planning, management, traveling between real estate activities, and construction of long-term improvements is specifically excluded.
If you would like to discuss how the final regulations on the 199A passthrough deductions apply to your situation, please feel free to reach out to us for a consultation.
Written by Damien Falato, CPA, MST, CGMA, Tax Director