Section 199A passthrough deductions: What law firms need to know

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In late January, final Section 199A regulations were released clarifying a number of issues that were outstanding from the proposed regulations. Notable for law firms, is the removal of the ‘incidental rule’ that had eliminated any benefit of separate trades that were incidental to (i.e., less than 5% of combined revenues) the specified services trade or business.

Background

Section 199A provides individual taxpayers and some trusts and estates a deduction for combined qualified businesses from a partnership, S corporation, sole proprietorship, trust, or estate. The deduction applies to tax years beginning after December 31, 2017 and before January 1, 2026. 

The Section 199A deduction is limited to the lesser of (1) up to 20% of the qualified business income (“QBI”) from an individual taxpayer’s trade or business or (2) 20% of the excess of taxable income over net capital gain. 

Not all businesses are considered a qualified trade or business for purposes of the Section 199A deduction. Any trade or business involving the performance of services in the field of law, consulting and accounting, amongst other services, is considered a specified service trades or business (“SSTB”), and therefore does not qualify for Section 199A deduction unless the individual taxpayer of an SSTB has a taxable income below certain threshold.

199A passthrough deductions

Aggregation of trades or business

Under the proposed regulations, only an individual owner of multiple trades or businesses could aggregate them, if eligible, for purposes of the Section 199A deduction limitation computation. Now the final regulations provide relevant guidance to law firms on the Section 199A passthrough deductions final regulations provide that an RPE may aggregate multiple trades or businesses it conducts and report the information to the owners on an aggregate basis. 

Under the final regulations, if the RPE aggregates trades or businesses, then the RPE also must attach a statement to each Schedule K-1 that contains the following additional information on the aggregated trade or business: 

  • A description of each trade or business,
  • The name and FEIN of each entity in which a trade or business is operated,
  • Information identifying any trade or business that was formed, ceased operations, was acquired, or was disposed of during the tax year,
  • Information identifying any aggregated trade or business in which the RPE holds an ownership interest, and
  • Other information the IRS may require in forms, instructions, or other published guidance.

Removal of Incidental Rule

The proposed regulations had required if a trade or business (not otherwise an SSTB) had (1) 50% or more common ownership with an SSTB and (2) shared expenses with an SSTB (including shared wage or overhead expenses), the trade or business was incidental to and, therefore, part of the SSTB if gross receipts of the trade or business were less than 5% of the total combined gross receipts of the trade or business and the SSTB. The final regulations remove this incidental rule, which opens the possibility for law firms that operate a separate trade or business that does not itself qualify as a SSTB to provide some level of Section 199A deduction to the partners, subject to the taxable income, W-2 wage and UBIA limitations as discussed above.

The final regulations did provide clarifications and changes which are favorable to taxpayers, but may result in additional reporting complexity.

199A tax reporting

Contact us

Carole Symonds

Partner, Law Firm Services Tax Leader, PwC US

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