Treasury Releases Final Guidance on Section 199A Deduction

• January 19, 2019
• Amanda Garnett

Quite to our surprise, on Friday the Treasury released final guidance regarding the Section 199A deduction. Based on our preliminary analysis of the provisions, there appears to be some good news for financial institutions, but not the wholesale qualification of all income that many bankers were hoping for.

Background

Under the Tax Cuts and Jobs Act (“TCJA”), beginning in 2018 individual taxpayers and some trusts and estates may be entitled to a deduction of up to 20% of their qualified business income (“QBI”) from a trade or business including income from a pass-through entity such as an S Corporation under Section 199A. The deduction is subject to multiple limitations including the type of trade or business, the taxpayer’s taxable income, the amount of business wages paid, and the amount of qualified property owned by the business.

Specified Service Trade or Business Limitation

Shareholders of a specified service trade or business (“SSTB”) generally are not eligible for a Section 199A deduction unless certain exceptions are met.

First, their taxable income isn’t more than $157,500 if single or $315,000 if married filing jointly. With taxable income below these thresholds, shareholders are entitled to a Section 199A deduction on their business income regardless of whether the business is a SSTB.

Or, their taxable income is between $157,500 and $207,500 single or $315,000 and $415,000 married filing jointly. With taxable income within these ranges, shareholders would be entitled to a reduced Section 199A deduction if the business is a SSTB.

The preliminary 199A guidance released in August 2018 appeared to include several types of services that banks routinely perform under the definition of SSTB including:

• Financial services such as wealth management and financial planning
• Investment management services such as the sale of mutual funds and other products
• Brokerage services
• In certain circumstances, the sale of loans

Thankfully, the final guidance released this week appears to indicate that sales of loans that a bank originates will not be considered SSTB income though the manner by which the Treasury addressed this issue is complex and continues to be analyzed.

Unfortunately, the final guidance indicates that investment services, financial services, and brokerage services are SSTBs. This could include certain services performed by a bank’s trust department.

The De Minimis Threshold

The final guidance on Section 199A retains the proposed de minimis threshold. For businesses with annual gross receipts of $25 million or less, the threshold is 10%. For businesses over $25 million in gross receipts, the threshold is 5%.

The final guidance released this week clarifies that if a trade or business is over the de minimis threshold they are considered to be a SSTB. As a result, their shareholders who are over the personal income thresholds would not be eligible for a Section 199A deduction.

However, the regulations do offer a possible alternative. The guidance clearly indicates that a single legal entity may operate more than one trade or business and that when it does operate multiple businesses the de minimis rule is applied to each business independently. This suggests that it may be possible, in some cases, to bi-furcate the legal entity into multiple businesses thereby allowing for a Section 199A deduction on a portion of the corporation’s taxable earnings.

Multiple Trade or Businesses

Determining whether one legal entity has more than one trade or business activity is challenging. Little IRS guidance or case law currently exists on this matter. Where the operations of one business are very different from another business and are conducted at a separate facility and with separate staff than the operations of the second business, there may be a strong argument for separate treatment.

When the businesses are inter-mixed in anyway, be it location, personnel, operations, or customer base, the distinction is less clear. One very important consideration is whether each business has separate books and records reporting their operations.

There is no clear guidance on what a “separable set of books and records” constitutes in the tax code, but it appears that the taxpayer must arrive at a profit and loss statement for each separate business and allocate all expenses between the businesses.

Next Steps

With calendar year S Corporation returns due in less than 60 days, there is a lot of work still to be done to understand the full scope of the 247 pages of new regulations before the deadline.

CLA is here to help you analyze how these new provisions may impact your institution. Please contact us.

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