On Jan. 18, 2019, the Treasury Department and the IRS issued final regulations and three pieces of guidance around the new qualified business income (QBI) deduction. The Tax Cuts and Jobs Act established a 20 percent QBI deduction for sole proprietorships, partners in partnerships, S corporation shareholders, trusts and estates. Qualified real estate investment trust (REIT) dividends and publicly traded partnership (PTP) income are also eligible for the deduction. This deduction is claimed on the individual tax return and takes effect beginning in tax year 2018. The QBI deduction is subject to limitations when taxable income is above $315,000 for joint filers and $157,500 for other filers.
The following article summarizes high-impact areas of the latest guidance covering these areas.
- Safe harbor for certain real estate enterprises that may be treated as a trade or business for QBI purposes (Notice 2019-07).
- Regulations proposed on Aug. 8, 2018, become finalized (Final Regulations).
- Determining W-2 wages for QBI (Revenue Procedure 2019-11).
- New set of proposed regulations (Proposed Regulations).
New Safe Harbor for Real Estate Activities
Individuals and entities owning rental real estate can treat a rental real estate enterprise as a trade or business for QBI purposes if they meet certain requirements. A rental real estate enterprise is an interest (owned directly or through an entity) in real property held for the production of rental income and may consist of an interest in multiple properties. If an enterprise fails to meet the safe harbor, it may still qualify for QBI as long as trade or business standards are met.
Safe harbor requirements:
- Maintenance of separate books and records to report income and expenses of each rental real estate enterprise.
- For tax years beginning before Jan. 1, 2023, 250 or more hours of rental services must be performed each year.
- Beginning on Jan. 1, 2019, the taxpayer must maintain records with details about the services, including hours, description, dates and who performed the services.
Rental services include advertising, negotiating and executing leases, verifying tenant applications, collecting rent, daily operation, maintenance and repairs, property management, purchasing materials, and supervising workers. Rental services may be performed by owners, employees, agents or independent contractors. The taxpayer must sign and attach a statement to the tax return showing the requirements have been met.
Rental scenarios that are not eligible for the safe harbor include IRC Sec. 280A (personal use of a dwelling including vacation homes) and triple net leases (tenant pays taxes, fees, insurance and maintenance).
- Key takeaway: This safe harbor gives taxpayers much needed clarity in determining which rental activities qualify and which ones don’t qualify for the QBI deduction.
Finalizing Proposed Regulations
The Treasury issued final Sec. 199A regulations that adopt many of the rules described in the proposed regulations that were issued on Aug. 8, 2018, with certain revisions. The following rule is one of the higher impact items in the final regulations.
In general, deductions attributable to a trade or business are taken into account in computing QBI. One clarification in the final regulations is that the one-half self-employment tax deduction, the self-employed health insurance deduction and the deduction for contributions to a qualified retirement plan should also reduce QBI.
Determining W-2 Wages for QBI
The revenue procedure provides three methods for calculating W-2 wages for purposes of computing the W-2 wage limit associated with the QBI deduction. For taxpayers above certain thresholds of taxable income, the QBI deduction is limited to the lesser of 20 percent of QBI or the greater of 50 percent of W-2 wages from the qualified trade or business or the sum of 25 percent of W-2 wages from the qualified trade or business, plus 2.5 percent of the unadjusted basis of qualified property immediately after acquisition.
- Unmodified box method: Lesser of total Box 1 amounts (Wages) or total Box 5 amounts (Medicare Wages and Tips).
- Modified Box 1 method: Total Box 1 amounts 1) excluding amounts not treated as wages for federal income tax withholding purposes, such as supplemental unemployment benefits, 2) plus Box 12 amounts for certain elective deferrals and salary reductions.
- Tracking wages method: Total wages subject to federal income tax withholding plus Box 12 amounts for certain elective deferrals and salary reductions.
- Key takeaway: The first method allows for a simplified calculation, while the second and third methods allow for greater accuracy.
New Proposed Regulations
The new proposed regulations provide guidance on previously suspended losses and some lower impact areas, such as regulated investment companies, charitable remainder trusts and split-interest trusts.
The final regulations (cited earlier) indicate that previously disallowed losses or deductions (at-risk, passive, partner basis and shareholder basis) that are allowed or freed up in the current year need to be taken into account when computing QBI (except to the extent the losses or deductions were disallowed, suspended, limited or carried over from a tax year prior to 2018). The final regulations also establish a first-in, first-out ordering rule for these losses. Under the new proposed regulations, previously disallowed losses need to be treated as losses from a separate trade or business.
- IR-2019-04, Jan. 18, 2019
- IRS Deduction for Qualified Business Income FAQs
- Intuit® ProConnect™ Tax Reform Resource Center