Troy Lewis, CPA, CGMA, chair of the American Institute of CPAs’ (AICPA) Task Force on Qualified Business Income (QBI), testified on behalf of the AICPA at a U.S. Department of the Treasury and Internal Revenue Service (IRS) at an October 16 hearing concerning the proposed regulations to implement the deduction, mandated by the Tax Cuts and Jobs Act, for QBI under section 199A of the Internal Revenue Code.
Lewis focused his testimony on five of the 11 key areas raised by the AICPA in its written comments that were submitted to the Treasury Department and IRS on October 1 about the proposed regulations (REG-107892-18).
First, he addressed the qualification of rental real estate as a trade or business for purposes of the qualified business income deduction. Lewis said that, while the preamble to the proposed regulations defines a trade or business according to Internal Revenue Code section 162(a), no uniform definition exists. “Taxpayers are left to determine trade or business status on a case-by-case basis, sometimes with discrepancies even within the same industry. The courts have also struggled for a long time with drawing definitive lines on what constitutes a trade or business. This lack of clarity on the qualification of rental real estate will undoubtedly lead to inconsistent treatment,” he said. To promote clarity and certainty in the rules, Lewis said, “We recommend that a rental real estate activity is considered a trade or business.”
He discussed the anti-abuse rules from Prop. Reg. §1.199A-5(c) (2), which are designed to prevent the splitting of revenue, between related businesses, to qualify some of the group’s income for the deduction. “We agree with the need for anti-abuse rules and having to separate out the specified service trade or business (SSTB) income from non-SSTB income,” Lewis stated. “However, income from a non-SSTB should not be unfairly recharacterized. The 80 percent or more rule that automatically recharacterizes all of the income limits the effectiveness of the QBI deduction. In the final regulations, we recommend removing the 80 percent threshold cliff rule and allowing the pro-ration rule to cover these transactions,” he said.
When businesses have both SSTB and non-SSTB lines of business, Lewis said, the regulations should allow businesses to separate their net income between qualified and SSTB activities. “Applying a cliff effect to taxpayers who exceed the threshold would be unfair. It would also discourage natural business growth,” he stated. Instead, Lewis said, “We could easily apply the section 199 Small Business Simplified Overall Method.” He explained that practitioners already use this method and that it would enable taxpayers to “ratably apportion their costs and deductions between the different types of activities.”
Regarding aggregation rules for when taxpayers may treat multiple businesses as a single business, Lewis highlighted two issues. The first issue concerns siblings. He recommended that businesses use existing attribution rules under Internal Revenue Code sections 267 and 707 rather than creating a new family attribution rule. “Congress intended section 199A to benefit businesses that are not organized as C corporations. Many of these businesses are family owned. There is no reason to adopt a new family attribution standard and arbitrarily disadvantage businesses that are owned by siblings,” Lewis stated. The second issue involves multi-tiered passthroughs or Relevant Passthrough Entities (RPEs). He said, “We recommend that aggregation be available at the RPE level. Allowing for RPEs to aggregate all the lower-tier businesses together would simplify its reporting process and result in a reduction in compliance costs.”
Lewis concluded his testimony by stressing the importance of the details of how to calculate QBI. He said, “The IRS should confirm that certain deductions do not reduce a taxpayer’s QBI, including the self-employed health insurance deduction, the 50 percent deductible portion of the self-employment tax, and a self-employed taxpayer’s qualified retirement plan contributions. These are details CPAs care about and need in order to properly calculate QBI.”