The final regulations under IRC Section 199A expand the rules for aggregating separate trades or businesses, offering private companies and their owners opportunities to mitigate the impact of the pass-through deduction’s limits.
Section 199A was added by the Tax Cuts and Jobs Act and provides a deduction of up to 20% for qualifying pass-through income. However, the deduction may be limited if the underlying business does not pay sufficient wages or invest in sufficient tangible depreciable property. The ability to aggregate separate trades or businesses can help private companies with tiered structures or those that use separate entities for the purpose of holding property or employing workers.
The final Section 199A regulations (TD 9847) were published in early 2019, and expand on rules in the proposed regulations (REG-107892-18) allowing the aggregation of multiple Qualified Trades or Businesses (QTBs) for purposes of calculating the Section 199A deduction. The most significant change allows the aggregation election to be made at the entity level. Private companies and their owners should evaluate whether aggregation is possible for any separate trades or businesses, and model whether it will be beneficial.
Aggregating activities for the wage and asset test
A taxpayer’s ability to aggregate multiple QTBs for purposes of applying Section 199A can become complicated when a taxpayer conducts business activities through several flow-through entities, such as partnerships or S corporations. The aggregation rules do not incorporate existing law, such as the Section 469 grouping rules. Instead, the IRS developed new aggregation rules specific to Section 199A.
The final regulations confirm that individual taxpayers may aggregate QTBs, subject to certain rules, for purposes of applying the limitations on the Section 199A deduction. They also go one step further than the proposed regulations and permit aggregation of multiple QTBs at the entity level, referred to as a relevant pass-through entity (RPE).
In many situations, the ability to aggregate multiple QTBs is expected to alleviate the negative effects of limitations and increase a taxpayer’s Section 199A deduction. The limitations at issue provide that if certain income thresholds are exceeded, the Section 199A deduction from a QTB cannot exceed the greater of (i) 50% of the W-2 wages paid with respect to the QTB (the W-2 wage limit) or (ii) the sum of 25% of the W-2 wages paid with respect to the QTB plus 2.5% of the unadjusted basis of all qualified property used in the business (the UBIA limit).
The final regulations allow for aggregation at the RPE in contrast with the proposed regulations that required all aggregation decisions to be made at the individual level. An RPE is permitted to aggregate QTBs it operates directly or through lower-tier RPEs. The resulting aggregated QTB classification must be followed and consistently reported by the RPE and all of its owners. The owners of an RPE may also apply the aggregation rules to any QTBs that are reported to them on a separate basis. If an RPE entity chooses to aggregate two or more QTBs, however, then the RPE’s owners may not separate the aggregated QTB. It is possible that different owners of the same QTBs may aggregate in different ways.
Requirements for aggregation
The aggregation rules are optional. An individual or RPE that chooses to aggregate multiple QTBs must demonstrate that the following requirements are satisfied:
- Each aggregated QTB must be a trade or business under Section 162.
- The same person, or group of persons must own a majority interest in each of the businesses; such ownership must exist for the majority of the taxable year in which businesses are to be aggregated.
- For S corporations, a majority interest means 50% or more of the issued and outstanding shares in the corporation (including direct or indirect ownership).
- For partnerships, a majority interest means 50% or more of the capital or profits in the partnership (including direct and indirect ownership).
- All of the items attributable to the aggregated businesses must be reported on returns with the same taxable year.
- None of the aggregated businesses can be an SSTB.
- The aggregated QTB must meet two of the following three factors:
- Provide products and services that are the same, or that are customarily provided together
- Share facilities or centralized business elements (like back office functions)
- Operate in coordination with or reliance on the other businesses
The aggregation rules can apply for all owners if any group owns a majority interest in each of the relevant QTBs. Thus, non-majority owners in the group may benefit from a common ownership. The final regulations incorporate the attribution rules contained in Sections 267(b) and 707(b) for purposes of determining ownership under the aggregation rules, which are broader than the rules in the proposed regulations. This should provide additional opportunities to aggregate QTBs in complex ownership structures.
Grant Thornton Insight:
By allowing RPEs to aggregate QTBs at the entity level, the final regulations potentially reduce the ultimate owner’s burden of demonstrating the aggregation requirements are satisfied. Nevertheless, the aggregation rules could still present a significant compliance burden on the non-majority owners of RPEs that choose not to aggregate at the RPE level. These non-majority owners will need complete ownership information, potentially through tiered structures, to determine whether there is sufficient common ownership to aggregate.
Aggregation reporting and consistency
The final regulations include rules regarding reporting and consistency when taxpayers aggregate. RPEs that directly operate QTBs must compute allocable QBI, W-2 wages, and basis of qualified property for each QTB and provide this information to the RPE’s owners. If an RPE chooses to apply the aggregation rules at the entity level, then this information should be provided with respect to the aggregated QTB. Individual taxpayers must take into account the QBI, W-2 wages, and basis of qualified property for each QTB or aggregated QTB (when aggregation was undertaken by an RPE) in considering whether additional aggregation is permissible or advisable at the individual taxpayer level. If an individual taxpayer aggregates two or more QTBs, then the combined QBI, W-2 wages, and basis of qualified property for that aggregated QTB must be used for purposes of the W-2 Wage Limit and UBIA Limit.
Grant Thornton Insight:
Aggregation is expected in many circumstances to maximize an individual’s Section 199A deduction because aggregation is performed for the purpose of applying the W-2 Wage Limit and the UBIA Limit. However, the aggregation election will not be favorable in all circumstances, particularly when one business may have significant UBIA but little wages while the other has significant wages and little UBIA.
After an RPE or individual taxpayer chooses to aggregate two or more QTBs, the taxpayer must consistently report the aggregated QTBs in all subsequent taxable years. The final regulations clarify that not aggregating in one year does not preclude a taxpayer from aggregating in a future year. The ultimate owner of an RPE that chooses to aggregate two or more QTBs at the RPE level must also consistently report the aggregated QTB (in other words, an individual taxpayer must follow an RPE aggregation decision in a given year and consistently apply the decision in future years).
A taxpayer is permitted, however, to add a newly created or newly acquired QTB to an existing QTB or aggregated QTB if the new QTB meets all requirements for aggregation. In addition, if there is a change in circumstances such that an aggregated QTBs no longer qualifies for aggregation, then the aggregation rules must be reapplied.
Grant Thornton Insight:
The decision to aggregate QTBs does not have to be formally made until a return reflecting the new Section 199A deduction is filed. For the 2018 taxable year only, initial aggregation may be made on an amended tax return. Although the final regulations clarify that declining to aggregate QTBs in one year does not foreclose the possibility of choosing to aggregate in a future year (assuming all requirements are satisfied), most RPEs and individual taxpayers could benefit from evaluating the possibility of aggregating their QTBs at the first opportunity.
Individuals and RPEs that choose to aggregate two or more QTBs must provide certain information to the IRS, including:
- The employer identification number of each RPE in which a QTB is operated
- A description of each QTB
- Information identifying any QTB that was formed, ceased operations, was acquired, or was disposed of during the taxable year
- Information identifying any aggregated QTB of an RPE in which the filer owns an interest
The regulations provide that the IRS may disaggregate two or more QTBs if the owner fails to make the required aggregation disclosure.
Next steps
Taxpayers should assess how the aggregation rules affect their Section 199A computations. This is true for both RPEs and individual taxpayers. In particular, sufficient information should be gathered well in advance of filing deadlines to determine whether aggregation is permissible, and if so, whether it is beneficial to the taxpayer.
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