One of the most talked about provisions of the 2017 Tax Cuts and Jobs Act is the new qualified business income (QBI) deduction under Section 199A where eligible taxpayers may be entitled to a deduction of up to 20% of QBI.
The QBI is a boon for qualifying individuals operating a domestic business as a sole proprietorship or through a partnership, LLC, S corporation, trust, or estate. But there’s also a downside. The deduction is subject to complicated rules and limitations, and it requires extensive additional record-keeping and reporting.
Taxpayers that aggregate businesses and relevant pass-through entities (RPEs) are hit hard by the reporting and disclosure requirements. For taxpayers engaged in more than one trade or business, each trade or business is generally treated separately for purposes of applying the limitations on calculation of QBI. However, recent proposed reliance regulations would allow individuals to aggregate trades or businesses, and treat the aggregate as a single trade or business for QBI purposes. This is good news. Unfortunately, the benefits of aggregating businesses are somewhat diminished by the burden of additional record-keeping made necessary by the reporting and disclosure requirements.
For each tax year, individuals must attach a statement to their returns identifying each aggregated trade or business. The statement must disclose detailed information required by the proposed reliance regulations, as well as other information that may be required by the IRS. Failure to comply could result in the IRS disaggregating the individual’s trades or businesses.
Practitioners working with RPEs (basically, certain partnerships, S corporations, trusts, or estates) can also expect an additional record-keeping burden under the proposed reliance regulations. For example, the RPE must separately identify and report several additional items on the Schedule K-1 issued to its owners for any trade or business that is engaged in directly by the RPE, and it must disclose allocable shares of QBI and other items of income and basis. The allowable deduction amount could be reduced if the RPE fails to comply with the new requirements.
These reporting and disclosure rules require maintenance of extensive records for taxpayers with aggregated businesses or RPEs. Owners considering the aggregation option face an increased tax compliance burden. For 2018, the first year of the deduction, a new grouping of records for the newly-aggregated businesses must be established and maintained. After that, the aggregation must be reported annually.
For RPEs, extensive additional disclosures must be made on K-1s, and the RPE will also need to keep records of new information relevant to the calculation of its owners’ QBI deduction.
And there’s still more. Because there is an alternative deduction limitation involving unadjusted basis immediately after acquisition (UBIA) of qualified property (Section 199A(b)(2)), practitioners need to undertake onerous research regarding business assets. This will require identification of qualifying assets, correct basis and depreciation periods, and allocation among owners.
The Section 199A is a complicated deduction with many reporting and record-keeping obligations. This warrants a fresh look at how we approach and serve clients that wish to use it. Practitioners will find coverage of the QBI deduction and the comprehensive proposed reliance regulations that provide guidance regarding its operation and calculation in the Tax Advisors Planning System (Title 1, Choice of Entity, Ƥ13.11 et seq.).
To read more about the impact of Section 199A Qualified Business Income Deduction, please check out the following blog posts: