A draft version of some of the pages in IRS Publication 535 appeared a few days ago. (See here.) And conveniently the pages provide additional details concerning the Section 199A deduction.
Some of these details will surprise tax accountants, surely. Others may only exasperate.
And one interesting idea to ponder if you’ve followed closely the Section 199A discussion: Do the draft pages for Publication 535 reflect the instructions provided by the proposed regulations published in August 2018… or do they maybe reflect the final regulations which exist but haven’t been published yet.
Note: The final regulations for Section 199A were sent to the Office of Management and Business on December 14, 2018 and will presumably appear sometime in January. (More information about what this means for CPAs here.)
In any case, several really significant details jump out from careful reading of the draft Publication 535 pages and a close look at the worksheets.
Trade or Business Requirement for Rental Investors Changes?
The proposed regulations for Section 199A said that real estate investors may calculate a Section 199A deduction for rental income if the investor shows regularity and continuity in her or his investing and is motivated by profit.
As I’ve discussed in my blog post, Section 199A Rental Property Trade or Business Definition, that set a fairly low bar and applied the Section 162 “trade or business” concept.
Publication 535 stipulates a harsher rule, however, saying,
The ownership and rental of real property doesn’t, as a matter of law, constitute a trade or business, and the issue is ultimately one of fact in which the scope of your activities in connection with the property must be so extensive as to give rise to the stature of a trade or business.
The key thing that jumps out at me? That word, “extensive.”
Apparently, merely showing “regularity,” “continuity” and a “profit motive” means a taxpayer falls short?
Wow. Count me surprised.
Statutory Employees Get Clarity and a Win
More than one tax accountant wondered how Section 199A treats statutory employees. And, really, two specific questions popped up.
First, do the wages paid to statutory employees count as W-2 wages one can plug into the Section 199A formula? (My guess was “no,” as recently explained here: Section 199A Deduction Danger Zones.)
Second, do statutory employees who report their wages and any business expenses on a Schedule C form get to take the Section 199A?
Publication 535 answers these questions, saying you don’t count wages paid to statutory employees as wages. Further, it says statutory employees do get to calculate a Section 199A deduction on their Schedule C’s bottomline profit.
Okay, good to know… good to know.
Real Estate and Insurance Brokers and Agents Lose Deduction
Another interesting “real-estate-related” change that shows up in the draft pages for Publication 535?
The proposed regulations explicitly stated that real estate brokers and agents as well as insurance brokers and agents don’t count as specified service trades or businesses. That meant that even high income real estate and insurance agents and brokers would potentially be eligible to use the Section 199A deduction. These folks weren’t, in other words, treated like doctors and lawyers and investment bankers.
Publication 535 instructions apparently change this, however, saying specified service trades or businesses include,
“Brokerage services, including arranging transactions between a buyer and a seller for a commission or fee such as stock brokers, real estate agents and brokers, insurance agents and brokers, and intellectual property brokers;
So another change from the proposed regulations… And a real bummer for successful real estate and insurance brokers.
Note: If the draft instructions do reflect a change in the regulations, what I wrote here is wrong: Real Estate Broker Section 199A Deductions. Yikes.
“Principal Asset is Reputation or Skill” Label Expanded?
And another interesting change, maybe, in the Section 199A rules…
The Section 199A statute that Congress passed said any trade or business where the principal asset of the firm is the reputation or skill of one or more owners or employees counts as a specified service trade or business.
That matters… Why? Because then these businesses don’t generate qualified business income when the taxpayer’s income is high.
The proposed regulations, elaborating on this issue, said the “principal asset” thing means a situation where some celebrity earns income from appearances, endorsements or licensing their image or name.
Curiously, the draft pages for Publication 535 say all these items do count but the pages also seem to describe them as examples of “principal asset” situations and not the complete list.
Specifically, the draft pages say a specified service trade or business is any,
“…trade or business where the principal asset is the reputation or skill of one or more of its employees, including: – Receiving fees, compensation, or other income for endorsing products or services; – Licensing or receiving fees, compensation or other income for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbols associated with the individual’s identity; or – Receiving fees, compensation, or other income from appearing at an event or on radio, television or another media format.
Am I maybe getting too sensitive to the choice of words the publication uses? Maybe… But have you ever argued with an IRS agent about this sort of language? Yeah, me too. And an agent will read something like that paragraph above from publication the way I worry.
In a nutshell, then, Publication 535 suggests that taxpayers and tax accountants may once more need to worry or wonder about every one (or two?) owner or one (or two?) employee trade or business. That’s a shame. A clear cut rule like the proposed regulations provided would have made the accounting so much easier. Ugh.
Worksheets Clear Up Some Calculation Details
One other interesting thing the draft Publication 535 pages seem to clear up…
Lots of folks wondered whether things like the self-employed health insurance deduction, a sole proprietor’s or partner’s pension plan contributions, and maybe the self-employment taxes deduction counted as business deductions that reduce the qualified business income flowing out of a sole proprietorship or partnership.
The worksheets used to calculate the Section 199A deduction don’t include these deductions in their calculations which indicates, as many guessed, that these items don’t reduce qualified business income.
Note: These items all do indirectly impact the Section 199A deduction, however, because they reduce the taxable income shown on the tax return.
Three Final Comments
We’ll surely get the firm details when the final regulations come out–probably in two or three weeks?
But can I just say what I’m sure we’re all thinking? This is really no way to implement a complex new tax law..
Finally, that picture of the jets gridlocked on the tarmac? That’s what this all feels like to me.
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