Since the 2017 reform of the Tax Code — formally known as the Tax Cuts and Jobs Act (TCJA) — was signed into law, accountants and tax professionals have been working overtime to keep up with the bill’s roughly 500 tax law changes. At the top of the list is one particularly vexing provision: the section 199A qualified business income deduction.
There have been an astounding 47 new clarifications released by the IRS to flesh out the intricacies of the QBI deduction. This April, as the filing deadline loomed, the IRS
The QBI deduction allows eligible taxpayers to deduct up to 20 percent of their QBI, plus 20 percent of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. Income earned through a C corporation, or by providing services as an employee, is not eligible for the deduction. Also, income from certain service businesses is not eligible for 199A if the taxpayer’s taxable income exceeds certain thresholds.
For taxpayers with taxable income below certain threshold amounts, qualifying for the deduction is seemingly simple. All you need to have is income from a qualified trade or business, but therein lies the rub: It’s not always clear what the definition of a “trade” or “business” is.
The dizzying complexities
For starters, nontraditional businesses are incredibly commonplace in today’s business landscape. The gig economy alone, which includes a swath of independent contractors — from Uber and Lyft drivers to eBay and Etsy sellers — presents a fundamental challenge to IRS auditors. Are these activities businesses, as defined by 199A (which borrows the definition from section 162 of the U.S. Code)? It’s not entirely clear.
Real estate can also add to the complexities. Technically owning rental real estate can provide a safe harbor to some types of businesses to qualify under 199A, but that comes with its own pitfalls, particularly in the age of do-it-yourself vacation rental services like Airbnb and HomeAway. The criteria for what type of rental activity qualifies under the IRS’s safe harbor guidelines are very strict. For example, the business must provide at least 250 hours of rental services per year, which requires separate, arduous record keeping on each property from clients.
All the while, high-income filers (for example, joint filers with 2019 taxable income over $321,400) who take the deduction are limited based on the business’s W-2 income and depreciable assets. Things are a little more straightforward for filers below that threshold, but tax pros need more clarity, and they need it soon.
Stuck in the middle
Unfortunately, help may not be forthcoming. That’s because it behooves the IRS to give itself some interpretive wiggle room when it comes to a deduction that can get as complex as this one. Without any existing legal precedent on certain trades or businesses (other than generic section 162 case law), the IRS will be charting new territory once it starts issuing audits on the QBI deduction, so having some room to interpret definitions of what a business is and whether or not it qualifies for the deduction will be an advantage.
That leaves accountants stuck in the middle. If they take a conservative approach and don’t take the deduction for certain business activities, their clients stand to miss out on big tax savings, which in turn could jeopardize their client relationship altogether. But on the flip side, an aggressive approach could land a company in hot water, directly in the crosshairs of an IRS audit with potential accuracy-related penalties for both the business and the preparer.
The road ahead
As the uncertainty around 199A continues, there is sure to be more debate on the matter. Tax Court cases delving into a business’s use of the deduction are a virtual certainty, and — as we approach an election year — the issue being used as a political football isn’t out of the question either.
In the meantime, that’s of little help to preparers who need to help safeguard their clients’ businesses right now, which makes for incredibly tough terrain to navigate. Until the IRS issues clearer guidance, claiming the qualified business income deduction is an exercise in copious fact-finding and careful risk management on the part of accountants and tax professionals. The key for tax pros navigating this period of uncertainty is to stay abreast of technical developments, truly understand the nature of their clients’ business activities, and keep diligent records on why each decision was made.
