On August 8, the Treasury Department and Internal Revenue Service released long-awaited regulations on the 20% deduction for pass-through businesses whose income flows through to individuals or certain trusts and estates. The release totaled over 180 pages of explanations and technical guidance. At the same time, the IRS released Notice 2018-64, which provides guidance on calculating eligible wages used in the overall calculation.
As a refresher, the Tax Cuts and Jobs Act created the deduction when the Act was signed into law in December 2017 and the deduction is first available to reduce income on 2018 tax returns. The deduction is available to all taxpayers making less than $157,500 as individuals or $315,000 as joint filers. For those taxpayers above the limits, specified service trade or businesses are not eligible for the deduction. These businesses include law, accounting, consulting, performing arts, athletics, financial services, health, and brokerage services, as well as “any trade or business where the principal asset” is the “reputation or skill” of at least one employee. The proposed regulations provide additional clarity into the definitions of these specified services. Note that architects and engineers continue to be specifically excluded from the list of service businesses ineligible for the deduction.
For those businesses that qualify for the deduction, an initial impression is that the IRS appears to have provided favorable interpretations of the rules. Banks, insurance businesses, and real estate brokers received favorable news while others, such as veterinarians, were not as fortunate. Initial takeaways include:
- The proposed regulations include several anti-abuse measures including rules aimed at preventing non-eligible businesses from splitting potentially eligible businesses from ineligible businesses and employees from being labeled as independent contractors.
- The proposed regulations contain favorable rules for businesses with minor amounts of potentially unfavorable service revenue.
- Favorable aggregation rules are proposed, permitting taxpayers to combine business entities to help them satisfy wage limitations in the tax law.
Over the next few weeks, the proposed rules will be analyzed more thoroughly, and additional planning ideas and compliance guidance will be provided. In the meantime, if you have questions, please contact your Schneider Downs tax consultant.