The IRS released long-awaited guidance on new Code Sec 199A, commonly known as the “pass-through deduction” or the “qualified business income deduction.” Taxpayers can rely on these proposed regulations and a proposed revenue procedure until they are issued as final (NPRM REG-107892-18; Notice 2018-4).

Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act of 2017.


The proposed regulations apply to:

  • individuals, which includes individuals, trusts, estates, and other persons who are eligible for the deduction; and
  • relevant pass-through entities (RPEs), which are pass-through entities that directly operate a qualified trade or business or pass through the items of QBI from lower-tier RPEs to an individual.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. However, a rental activity that does not meet the Code Sec. 162 requirements also qualifies as a business if it rents or licenses tangible or intangible property to a commonly controlled business. Businesses are commonly controlled if the same person or persons own at least 50 percent of each business.

A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity. Taxpayers cannot use the passive activity rules to group multiple activities into a single business.

However, an individual may aggregate businesses if:

  • each one is itself a trade or business;
  • the same person or group owns a majority interest in each;
  • all items attributable to them are reported on returns using the same tax year;
  • none is a specified service trade or business; and
  • they are actually part of a larger, integrated trade or business.

RPEs cannot aggregate businesses. Specified Service Trade or Business Income from a specified service trade or business (SSTB) generally cannot be qualified business income, though this exclusion is phased in for lower-income taxpayers. A new de minimis exception allows a service business to escape the SSTB designation if less than 10 percent of its gross receipts is attributable to services (or less than 5 percent if the business has more than $25 million in gross receipts).

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/ owner’s reputation or skill only when the business is engaged in:

endorsing products or services; licensing the use of an individual’s image, name, trademark, etc.; or receiving appearance fees.

The regulations also define “financial services” to exclude banking, and provide detailed rules for the trade or business of being an employee. In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50 percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’:

  • W-2 wages that are allocable to QBI; and
  • unadjusted basis in qualified property immediately after acquisition (UBIA).

The proposed regulations and Notice 2018-64 provide detailed rules for determining W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.


However, the Code Sec. 199 rules applied to the taxpayer’s aggregate wages, while the QBI rules apply separately to each business. If wages are allocable to multiple businesses, they are allocated to each business in accordance with wage expense.

In defining UBIA, the proposed regulations largely adopt existing capitalization rules for determining basis. However, “immediately after acquisition” is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

In addition, the proposed UBIA regulations:

  • clarify that additional first-year depreciation does not affect the recovery period;
  • provide anti-abuse rules for end-of-year acquisitions;
  • generally adopt existing MACRs rules for improvements, additions, and nonrecognition transactions;
  • exclude most partnership basis adjustments; and
  • allocate basis when a pass-through entity owns the property.

Other Rules

Finally, the proposed regulations address several other issues, including:

  • definitions;
  • basic computations;
  • loss carryovers;
  • Puerto Rico businesses;
  • coordination with other Code Sections;
  • penalties;
  • previously suspended losses and net operating losses;
  • other exclusions from qualified business income;
  • allocations of items among multiple businesses; and
  • application to trusts and estates.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. However:

  • several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
  • anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
  • if a qualified business’ tax year begins before January 1, 2018, and ends after December 31, 2017, an individual’s items are treated as having been incurred in the individual’s tax year during which business’s tax year ends.

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