Freeman Law advises domestic and international ventures with corporate and tax compliance. Clients with flow-through entity structures may need to consider the impact of section 199A. Planning for section 199A may significantly impact a client’s bottom line and investor returns. This resource provides additional background on the concept of Qualified Business Income (“QBI”) for section 199A purposes.
Section 199A was enacted as part of the Tax Cuts and Jobs Acts of 2017, P.L. 115-97 (the “TCJA”). Its rules are currently effective for tax years beginning after 2017 and before 2026. Qualified Business Income (“QBI”) is a central concept in the calculation of a taxpayer’s section 199A deduction. For a more in-depth Insight on section 199A, see our other resources, such as A Practical Roadmap Through Section 199A and Advising Domestic Business Ventures: Section 199A and Flow-Through Structures.
QBI is defined as the net amount of qualified items of income, gain, deduction, and loss with respect to any trade or business of the taxpayer. QBI specifically excludes (that is, does not include) certain items. We can start with those items. QBI does not include:
- capital gain or loss,
- interest income other than interest income properly allocable to a trade or business,
- amounts received from an annuity other than in connection with a trade or business,
- certain items described in section 954, and
- items of deduction or loss properly allocable to these items.
Moreover, QBI does not include reasonable compensation paid to the taxpayer by any qualified trade or business for services provided, nor any guaranteed payment described in section 707(c) paid to a partner for services provided to a trade or business. QBI also does not include—to the extent provided in regulations—any payment described in section 707(a) to a partner for services provided to the trade or business. Finally, QBI does not include any qualified REIT dividends or qualified PTP income.
Now, what items are specifically included in QBI? QBI includes all other items of gross income, gain, deduction, and loss to the extent such items are:
- effectively connected with the conduct of a trade or business within the United States (within the meaning of section 864(c), and
- included or allowed in determining taxable income for the taxable year.
There are also a number of special rules.
Section 751(a) or (b). For partnerships, if section 751(a) or (b) applies, then gain or loss attributable to assets of the partnership giving rise to ordinary income under section 751(a) or (b) is considered attributable to the trades or businesses conducted by the partnership, and is taken into account for purposes of computing QBI.
Guaranteed Payments. Income attributable to a guaranteed payment for the use of capital is not considered to be attributable to a trade or business, and is therefore not taken into account for purposes of computing QBI; however, the partnership’s deduction associated with the guaranteed payment is taken into account for purposes of computing QBI if the deduction is properly allocable to the trade or business and is otherwise deductible for Federal income tax purposes.
Section 481 Adjustments. Section 481 adjustments (whether positive or negative) are taken into account for purposes of computing QBI to the extent that the requirements of the regulations and section 199A are satisfied—but only if the adjustment arises in taxable years ending after December 31, 2017.
Previously Disallowed Losses. Generally, previously disallowed losses or deductions (including under sections 465, 469, 704(d), and 1366(d)) allowed in the tax year are taken into account for purposes of computing QBI. However, under the proposed regulations losses or deductions that were disallowed, suspended, limited, or carried over from taxable years ending before January 1, 2018 (including under sections 465, 469, 704(d), and 1366(d)), are not taken into account in a later tax year for purposes of computing QBI.
Net Operating Losses. Generally, a deduction under section 172 for a net operating loss is not considered with respect to a trade or business and therefore, is not taken into account in computing QBI. However, to the extent that the net operating loss is disallowed under section 461(l), the net operating loss is taken into account for purposes of computing QBI.
Guaranteed payments for the provision of services are addressed above.