Proposed vs. Final Regulations

[MH]

The preamble to the Section 199A final regs gives the option of using the proposed regs for 2018 tax returns (all final or all proposed, no cherry-picking).  The proposed regs did not contain the provisions about reducing QBI by one-half of SE tax, SE health insurance, and SE retirement plan contribtions.  Ror 2018 returns, is it legitimate to use the proposed regs and not make those reductions to QBI?

[itonewbie]

I'm not sure I will take the position that none of those apply. If you read the explanation in the final regs carefully, you'll see that northing changed in relation to those items. The Treasury and the IRS clarify that they did not adopt recommendations from various commenters to bifurcate on how some or all of those items should or should not be treated as QBI items because they are attributable to a trade or business and determination of whether any item is treated as attributable to a trade or business is addressed within the existing code sections and regs that govern those items, which they explain is the reason why they will not specifically address other questions raised by other commenters such as those related to unreimbursed partner expenses.

[MH]

Thank you for your comment, and I see your point.  However, prior to the final regs being issued, I didn't see any commentary that suggested that those items would reduce QBI as trade or business expenses.  More importantly, the examples in the proposed regulations did not reduce QBI by those items when there are clearly examples where at least the one-half of self-employment tax deduction would have been in play.  That seems like a distinct difference between the proposed and final regs.

[itonewbie]

Perhaps I have missed the examples you cited.  I just checked §1.199A-0 Table of Contents in the Prop. Regs but didn't see any related to QBI items attributable to a trade or business.  The only emphasis that was placed on SE-tax at that time was that the QBI deduction does not reduce net earnings from SE for the purpose of SE-tax.

Could you clarify where in the Prop. Regs I can find the example so that I can take a second look for my own understanding?

[MH]

Example 1 at proposed 1.199A-1(c)(3) makes a calcluation based on a business's "net taxable income from operations."  That does not seem to contemplate a deduction for one-half of self-employment tax or health insurance premiums (what if the spouse covered the business owner through her employer's plan but paid with after-tax dollars, for example).  Example 3 addresses the QBI of an LLC (classified as a partnership) member and when comparing the taxpayer's QBI to the taxable income limit amount, there is no discussion of reducing the QBI from the LLC by any additional deductions on the taxpayer's individual return.  To the contrary, the taxpayer's QBI is shown as exactly the amount reported out by the LLC.  Sure, the LLC coudl be a real estate LLC not allocating out any SE income, but that seems unlikely with $3,000,000 of QBI, $1,000,000 of W-2 wages, and only $100,000 of UBIA. 

[itonewbie]

I wouldn't read too much into that example, which is under the subsection that deals with QBI of taxpayer's whose taxable income is below the threshold amounts and it refers to"net" business income (which although is not a term defined in the code, does highlight that it is after reduction of relevant amounts, whatever those may be), which only serves to simply the concept. If you take a look at the same example in the final regs, you'd see that northing in that example has changed despite the clarification.

Not everything in the code and the regs need to be spelled out in order for an existing principle to apply. Often times, it's only exceptions that get codified and regulations. promulgated to specify which among various related sections may govern the operation (e.g. related person for purposes of QBI).

One of the key emphasis of the Treasury and IRS is the structure and design of §199A, which is to mirror the tax treatment of C Corp and these items would all be deducted to arrive at the corporation's taxable income. On what basis should these not be under §199A?

For these reasons, personally, I do not believe that there is technical merit or a reasonable basis to take that position. I'm not sure how well you can defend the position relying solely on the preamble and Prop. Regs. being silent on the exact tax treatment and when the example remains the same even after clarifications are made with the promulgation of the Final Regs. But, again, that's just my personal opinion.

[MH]

I agree with your opinion if a client wants to take the safest and most  conservative position - and many do.  I disagree, however, with your opinion that there is no technical merit or a reasonable basis to take the position.  But I appreciate your thoughts and your taking the time to correspond on the matter.  Thank you.

[Stephen L Nelson CPA]

I agree with itnewbie here. Just because the proposed regulations were vague about how that accounting worked? Gosh, that doesn't really seem to give one a license to fill in the details.

BTW in a sense, all the final regs did was say the treatment of pension fund contributions, SE health insurance, employer half of payroll taxes works the same way for sole props and partnerships as it does for S corporations.

[Stephen L Nelson CPA]

The proposed regs used an effectively connected phrasing I think... (I read the proposed regs maybe a dozen times...) And lots of folks, me included, thought that signaled a "Section 162" standard made sense. I.e., if the deduction appeared on Schedule C, the 1065, etc., it reduced QBI.

I realize I've done a blog post on this subject:

https://evergreensmallbusiness.com/section-199a-qualified-business-income-adjustments/

[itonewbie]

It may be too broad a statement to say that "if the deduction appeared on Schedule C, the 1065, etc., it reduced QBI."  We had a recent discussion about this (see link below).  Feel free to pitch in and further the discussion.

https://accountants-community.intuit.com/questions/1797405-shouldn-t-qbi-be-reduced-by-sec-179-depre...

[Stephen L Nelson CPA]

I didn't mean to suggestion a "forms" based rule... only pointed to that concept as a way to get a handle.

The final regs provide a great and workable instruction, I think,

"...for purposes of section 199A, deductions such as the deductible portion of the tax on self-employment income under section 164(f), the self-employed health insurance deduction under section 162(l), and the deduction for contributions to qualified retirement plans under section 404 are considered attributable to a trade or business to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis."

I think the above language, which appears a couple of places in final regs makes it pretty easy to pick and choose what we need to watch for...

[Intuit_Devin]

This is an interesting discussion, and I haven't kept up with everything the IRS has published on this particular issue, but I can tell you that verbally the IRS has indicated to industry that they emphatically do NOT consider it reasonable to treat silence on SE deductions in the proposed regs as an affirmative statement not to include them.

[itonewbie]

Good to know. Thanks, Devin!