The Tax Cuts and Jobs Act implied that the qualified business income deduction would need to be calculated on an entity by entity basis. However, taxpayers owning more than one business entity may be glad to hear that the recently released IRS proposed regulations allow taxpayers to aggregate those entities eligible for the Section 199A deduction. The IRS reasons that the aggregation rules will allow business owners to maximize their Section 199A deduction without the hassle and potential expense of shifting income, W-2 wages, qualified property, etc. between entities for the sole purpose of the deduction. This could become a great tax savings strategy for many taxpayers.
Who qualifies to aggregate?
First, in order to aggregate, the businesses must be majority owned (50% or more) by the same person or group of persons (directly or indirectly). Because the IRS mentions “group of persons,” this does not exclude non-majority owners from the aggregation benefits, but rather allows them to aggregate so long as the group of persons (who when combined are majority owners) all elect to aggregate. The entities also must be on the same tax year – hence you can’t combine a December 31 year end entity with a June 30 year end entity for the deduction. Also, none of the entities can be a specified service trade or business. See last week’s article to determine if your business could be defined as a specified service trade or business and subject to this limitation as well as others.
Finally, two of the following three factors must be met in order for the businesses to be considered part of a larger, integrated trade or business, and thus able to aggregate:
- The businesses provide products and services that are the same or they provide products and services that are customarily provided together.
- The businesses share facilities or share significant centralized business elements.
- The businesses are operated in coordination with, or reliance on, other businesses in the aggregated group.
What if I lease property to my business?
Another item of importance to note is that regulations allow for aggregation of entities beyond a trade or business, if one of the entities is involved in the rental or licensing of tangible or intangible property to a related trade or business assuming they are under common control. This comes as a welcomed addition to the aggregation rules, benefiting those taxpayers who have separate entities set up from their primary business for the purpose of renting property to that business. Since many of the rental entities commonly do not pay wages or have qualifying property for the 199A deduction, the income from the rental activity would not be eligible and thus the potentially significant deduction would be lost for good. However, considering this piece, the rental income can now be aggregated with the other business income and thus eligible for a potential deduction.
Will an election be necessary?
There are however, rules and requirements set forth that need to be met in order for the entities to be aggregated. First, the IRS states that aggregation is permitted but is not required. Therefore, taxpayers have the option to do so, with the default being that the businesses will be assessed for the deduction individually, unless taxpayers make the specific election to aggregate. Once the election is made, individuals must consistently report the aggregated group in subsequent years.