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Proposed regulations issued for pass-through deduction

On Aug. 8, 2018, the Treasury Department issued proposed regulations pertaining to code section 199A (the pass-through deduction), which was added by the Tax Cuts and Jobs Act (TCJA or the Act). In multiple areas, it appears the department, along with the Internal Revenue Service, relies upon existing law and guidance. Section 199A provides for a deduction of up to 20 percent of domestic qualified business income (QBI) operated as a sole proprietorship or through a partnership, S corporation, trust or estate. The deduction does not apply to specified services businesses, except in the case of a taxpayer whose taxable income is below the threshold amount ($157,500, or $315,000 for joint returns).

The following is a high-level outline of certain provisions included in the newly released guidance.

Broad overview

For taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026, noncorporate taxpayers (individuals, trusts and estates) may take a deduction of up to 20 percent of QBI from sole proprietorships, partnerships, S corporations, trusts and estates. Qualified dividends from cooperatives and REITs, as well as qualified income from publicly traded partnerships, may also qualify for the deduction (for the sake of simplicity, we will not focus on these items in this alert).

In general, qualified items of income, gain, deduction and loss with respect to each qualified trade or business are eligible for the deduction. Qualifying income must come from U.S. sources and excludes various investment-related items such as capital gains and losses, dividends and nonbusiness interest income. Reasonable compensation paid to the taxpayer and guaranteed payments for services rendered to a partnership are additionally excluded from QBI. Each business will pass through the allocable share of income or loss to the taxpayer, who will calculate the deduction separately for each trade or business.

If the net amount of QBI is less than zero, the loss will be carried to the next taxable year and will be included in the calculation of QBI for that year. For example, if the combined loss from all trades or businesses in 2018 is $100,000 and the qualifying income from all businesses in 2019 is $300,000, the $100,000 loss from 2018 must be carried to 2019 and reduce the qualifying income in 2019 to $200,000. Thus, a deduction of $40,000 (20 percent of $200,000) may be allowed in 2019, subject to the limitations discussed below.

If a taxpayer with multiple qualifying trades or businesses has a net amount of QBI greater than zero, but the QBI from one of the businesses is a loss, the loss will offset the positive QBI from the other businesses pro rata, rather than carry forward. This offset will occur prior to applying the limitations discussed below.

The deduction is not allowed in computing adjusted gross income; instead, it is a deduction that reduces taxable income. Therefore, the deduction does not affect limitations based on adjusted gross income. Further, the deduction does not reduce net investment income or self-employment income; however, the deduction is allowed for alternative minimum tax. In addition, the deduction is allowed regardless of whether a taxpayer itemizes his or her deductions.


This alert focuses on three major issues addressed by the proposed regulations:

  1. What is a trade or business for section 199A purposes?
  2. What are the key definitions related to specified services?
  3. Do wages paid by other entities count for purposes of the W-2 wage limitation?

Trade or business for section 199A purposes

These regulations rely on a large body of existing case law and administrative guidance in interpreting the meaning of a trade or business for purposes of the section 199A deduction. Broadly, in this context, a trade or business is an activity a taxpayer engages in with continuity and regularity for the primary purpose of engaging in a profit. The definition of a trade or business is extended for certain property that is rented to a trade or business that is commonly controlled. Provided certain tests are met, separate trades or businesses may be aggregated, treating the aggregate as a single trade or business for purposes of applying the limitations.

Limitations on types of qualifying income – service businesses

Congress specifically excluded certain “specified service trade or business” income from qualifying for the deduction. For purposes of the 20 percent deduction, specified service trades or businesses are businesses that involve the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services and any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. The proposed regulations considerably restrict the application of the aforementioned “reputation or skill.” In what appears to be a taxpayer-friendly definition, “reputation or skill” is generally limited to income from a taxpayer’s endorsements, use of personal likeness, voice, or other identity-related symbols or appearance fees.

While specified service trade or business income generally does not qualify for the deduction, there is an exception based on taxable income. For example, for joint filers with taxable income below $315,000 (before factoring in this deduction) would be eligible for the deduction. If taxable income is between $315,000 and $415,000, only a percentage of specified service income is eligible. If taxable income is more than $415,000, specified service trade or business income does not qualify. The table below summarizes these limits as well as the W-2 wage/basis limits.

Wage and basis limitations

Once the 20 percent of the qualifying income from the trade or business (including the specified service trade or business restriction) figure is determined, a further limitation arises. The deduction cannot exceed the greater of (a) 50 percent of the W-2 wages from the trade or business or (b) 25 percent of the wages from the trade or business, plus 2.5 percent of the unadjusted basis of depreciable assets from the trade or business. Each owner of the business will use the owner’s allocable share of wages and basis of depreciable assets from the business to calculate this limitation. These limits are phased in based on taxable income.

Specified service income and W-2 wage/basis limitations


Trade or business is not a specified service

Trade or business is a specified service

Taxable income less than or equal to $157,500 (single), $315,000 (joint)

W-2 wage/basis limitations do not apply

W-2 wage/basis limitations do not apply; specified service income is eligible

Taxable income greater than $157,500 (single), $315,000 (joint) but less than $207,500 (single), $415,000 (joint)

W-2 wage/basis limitations are phased in over the $50,000 to $100,000 range

“Applicable percentage” of specified service income is eligible; AND W-2 wage/basis limitations are phased in over the $50,000 to $100,000 range

Taxable income greater than $207,500 (single), $415,000 (joint)

W-2 wage/basis limitations apply in full

Specified service income not eligible

Again, using previously existing guidance, the proposed regulations allow taxpayers to include W-2 wages paid by a third party, such as a professional employer organization. The W-2 wage limitation is applied separately for each trade or business. The IRS, in a concurrently released notice, provided three methods for calculating the W-2 wage limitation, allowing a simplified method as well as two methods that would provide greater accuracy.

The depreciable asset basis limitations start with cost on the date the property is placed in service. Restrictions are placed on property acquired specifically to increase the section 199A deduction. In addition, the proposed regulations discuss basis determinations of transferred property, basis adjustments and qualified asset improvements.

As noted above, further communications detailing the content of these regulations will be forthcoming. If you have questions regarding how this may affect your tax situation, we encourage you to reach out to your Baker Tilly tax professional.

For related insights and in-depth analysis, see our Tax Reform Resource Center.

For more information on these topics, or to learn how Baker Tilly tax specialists can help, contact our team.

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