On Aug. 16, 2018, the Treasury Department issued proposed regulations under Section 199A of the Internal Revenue Code, which was enacted as part of the 2017 tax legislation and generally allows a 20 percent deduction on income from pass-through entities, subject to certain limitations. The legislation left a lot of uncertainty regarding many issues, and the proposed regulations thankfully provide some clarity. Although the proposed regulations are not effective until they are finalized, taxpayers are permitted to rely on them until then.

Background

On Dec. 22, 2017, P.L. 115-97 (commonly known as the Tax Cuts and Jobs Act) was signed into law, which, among many changes to the Internal Revenue Code, enacted Section 199A. Section 199A allows a deduction to individuals, trusts, and estates of up to 20 percent of certain qualified business income. The deduction can effectively lower the top marginal tax rate on qualified business income from 37 percent to approximately 30 percent. For taxpayers above certain income thresholds, the Section 199A deduction for each trade or business is generally limited to the higher of two amounts: (1) 50 percent of the wages paid by that trade or business to its employees as shown on Form W-2 or (2) 25 percent of such wages plus 2.5 percent of the trade or business’s “unadjusted basis” in its depreciable property. Although the wage and basis limitations must be computed separately for each “trade or business,” the statute did not address how to determine what constitutes a single trade or business.