IRS Proposes New Rules Regarding Pass-Through Entities

In early August the Trump Administration proposed regulations that would implement and interpret the new rules governing pass-through entities pursuant to the comprehensive tax reform law that was enacted last year. As a general matter, section 199A of the tax reform law provides a deduction against taxable income (not against gross income or adjusted gross income) for individuals, trusts, or estates of up to 20 percent of income from a domestic trade or business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. This deduction is designed to bridge the uneven reduction in income tax rates on C corporations (much larger reduction) and on owners of businesses conducted as S corporations, partnerships, and sole proprietorships (much smaller reduction).

Under Section 199A of the tax reform law, the deduction is limited to the greater of (1) 50 percent of the W-2 wages with respect to the trade or business, or (2) the sum of 25 percent of the W-2 wages, plus 2.5 percent of the unadjusted basis immediately after the acquisition of all qualified property.  Qualified trades and businesses include everything except the trade or business of performing services as an employee and "specified service" trades or businesses (e.g., law, accounting, etc.) or where the business's principal asset is the reputation or skill of one or more of its owners or employees. 
 
The tax reform law included many yet-unclear points, such as its application to rental property, the netting of qualified business income and loss for taxpayers with multiple qualified trades or businesses, allocating W-2 wages among businesses, and whether compensation paid to an S corporation shareholder is included in W-2 wages for purposes of that limitation.
 
The proposed rule that the IRS released in August was designed to clarify and obtain public comment some of these unclear issues. 
 
More information from the IRS is available here. NATSO members are advised to consult their tax professional to discuss their specific situations and how the IRS proposal will impact their businesses.  For additional questions or further guidance, please feel free to contact NATSO's Legislative and Regulatory Counsel David Fialkov (dfialkov@natso.com). 

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