IRC Section 199A Considerations for Tax Year 2019

Ben Lederman, CPA
Published Date:
Feb 1, 2020

The qualified business income (QBI) deduction under IRC section 199A has been one of the most discussed topics in federal taxation since the passage of the 2017 Tax Cuts and Jobs Act (TCJA). Many articles have followed the release of the new law, proposed regulations, and final regulations to help practitioners to understand the deduction and its impact on their clients.

Practitioners have now had a year to become acquainted with the basic mechanics of the deduction. They have filed returns claiming this deduction on behalf of their clients. Those planning to claim the deduction for tax year 2019, however, should remain cautious; certain aspects of the deduction that didn’t apply for tax year 2018 will begin to be relevant for 2019. Additional consideration and care should be given to businesses with prior-year losses to ensure that QBI is properly calculated for 2019. Practitioners should also be aware of the new Forms 8995 and 8995-A (discussed in more detail later) to report the QBI deduction. Businesses with material charitable contributions should take note of the draft instructions to Form 8995, which may impact tax planning.

Prior-Year QBI Losses

Calculating a taxpayer’s IRC section 199A deduction for tax year 2018 may not have been simple, but it was straightforward in one aspect: only income and loss items from that tax year needed to be considered. This is no longer the case for tax year 2019 and beyond.

To the extent that taxpayers had a net QBI loss in 2018, the loss should be carried forward to 2019. The loss will be treated as a 2019 activity with a QBI loss, and it will be allocated pro-rata to activities with positive QBI, as any other QBI-loss activity would be.

Suppose that in 2018, a taxpayer had three businesses: Moe Co., Larry LLC, and Curly Corp. All were either LLCs or S-corps and were not specified-service trades or businesses. In 2018, Moe Co. had QBI of $100,000; Larry LLC had QBI of $50,000; and Curly Corp had a QBI loss of $300,000. First the taxpayer would need to allocate the QBI loss pro rata to activities with positive QBI. For simplicity, note that the $300,000 QBI loss exceeds the $150,000 of net positive QBI. Therefore, there is no QBI in 2018 on which to take a QBI deduction. The $150,000 net QBI loss is carried forward to 2019.

In 2019, Moe Co. has the same $100,000 of QBI and Larry LLC also has the same $50,000. Curly Corp. has QBI of $0. At first glance, a practitioner might think that the taxpayer is entitled to a QBI deduction because the net QBI is $150,000; however, the prior-year $150,000 QBI loss is carried forward and allocated pro rata to activities with positive QBI. Since two-thirds of the positive QBI comes from Moe Co., two-thirds of the loss is allocated to Moe. Co. The remainder is allocated to Larry LLC. After accounting for the QBI loss from 2018, net 2019 QBI is $0, and no deduction can be taken.

Other Suspended Losses

Prior-year QBI losses are not the only losses that need to be considered in 2019. Suspended losses—whether due to basis, at-risk, or passive activity rules—may also impact a taxpayer’s QBI deduction.

QBI is recognized when its associated income is included in taxable income. If a taxpayer has a suspended loss, the QBI is suspended until the loss is released. This gets particularly complex when a taxpayer has losses that were suspended prior to tax year 2018, the first year under the TCJA: these losses do not carry any QBI with them because QBI was not in the tax code at the time.

Suppose a taxpayer is involved in a partnership formed in 2017. The taxpayer has $100,000 of suspended losses from 2017. In 2018, the taxpayer has $50,000 of suspended losses, and the loss is the same for IRC section 199A purposes. In 2019, the partnership becomes successful and the taxpayer’s share of income is $150,000.

The 2017 and 2018 suspended losses would be released in 2019, fully offsetting the $150,000 of income. For income tax purposes, net partnership income would be $0. A practitioner might therefore think that QBI would also be $0. Since the 2017 loss was incurred before the codification of IRC section 199A, no QBI is associated with it. Only the $50,000 from 2018 has a QBI loss. The taxpayer’s 2019 QBI would be $100,000—the $150,000 of QBI from 2019 minus the $50,000 QBI loss released with the 2018 suspended loss.

For the purposes of IRC section 199A, losses are released on a first-in, first-out basis, meaning that pre-2018 losses may still be relevant in 2019 or may have already been used. Practitioners should remain cautious and confirm that their software properly calculates the IRC section 199A deduction in situations with suspended losses.

New Forms

No forms related to the QBI deduction were released for tax year 2018. Two draft forms have been released for tax year 2019.

The first, Form 8995, is for a simplified QBI calculation. This form will apply for taxpayers with income below the phase-in range who are not aggregating. The form is just one page and includes the calculation of the full deduction, including any publicly traded partnership (PTP) income or real estate investment trust (REIT) dividends.

The second, Form 8995-A, is significantly more complicated. This is for taxpayers with complex QBI calculations, including the imposition of the wage and unadjusted basis immediately after acquisition (UBIA) limitations, the phase-out of QBI from specified service trade or businesses, aggregation, carryforward losses, and income from agricultural cooperatives. While the main form is just two pages, there are as many as four supplementary schedules that may be required depending on the taxpayer’s situation.

Practitioners should make themselves familiar with these new forms, as they will be required for taxpayers with QBI in 2019.

Additional QBI Reductions

The draft instructions for Forms 8995 and 8995-A are generally what a practitioner would expect, with one notable exception. They indicate that charity, business interest expense, and unreimbursed partnership expenses will be considered attributable to the trade or business from which they derive, and therefore should reduce QBI.

The reduction in QBI from these deductions is similar to the reduction in QBI for deductible self-employment tax, self-employed health insurance, and retirement contributions based on income from a trade or business. However, the treatment of deductible self-employment tax, self-employed health insurance, and retirement contributions is explicitly listed in the final regulations released in January 2019. The treatment of charity, business interest expense, and unreimbursed partnership expenses has not previously been defined in the law or the regulations.

While the draft instructions are not a strong authority on their own, they are a good indication of how the IRS intends to treat these deductions. Practitioners should be aware of this treatment because it may have implications for tax planning and compliance for their clients.

Ben Lederman, CPA, is a manager at CohnReznick LLP in New York. He is a member of the Private Client Services group. He specializes in tax planning and compliance for high-net-worth individuals and closely held businesses. He is the vice-chair of the NYSSCPA’s Personal Financial Planning Committee and a member of the Taxation of Individuals Committee.

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