The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

General welfare and disaster relief payments

If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the COVID 19 pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. Payments from the following states fall in this category and the IRS will not challenge the treatment of these payments as excludable for federal income tax purposes in 2022:

• California,

• Colorado,

• Connecticut,

• Delaware,

• Florida,

• Hawaii,

• Idaho,

• Illinois,

• Indiana,

• Maine,

• New Jersey,

• New Mexico,

• New York,

• Oregon,

• Pennsylvania, and

• Rhode Island.

Alaska is in this group only for the supplemental Energy Relief Payment received in addition to the annual Permanent Fund Dividend. Illinois and New York issued multiple payments and in each case one of the payments was a refund of taxes to which the above treatment applies, and one of the payments is in the category of disaster relief payment. A list of payments to which the above treatment applies is available on the IRS website.

Refund of state taxes paid

If the payment is a refund of state taxes paid and recipients either claimed the standard deduction or itemized their deductions but did not receive a tax benefit (for example, because the $10,000 tax deduction limit applied) the payment is not included in income for federal tax purposes. Payments from the following states in 2022 fall in this category and will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted.

• Georgia,

• Massachusetts,

• South Carolina, and

• Virginia

Other Payments

Other payments that may have been made by states are generally includable in income for federal income tax purposes. This includes the annual payment of Alaska’s Permanent Fund Dividend and any payments from states provided as compensation to workers.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

Clean Vehicle Classification Changes

For a vehicle to qualify for the new clean vehicle credit, its manufacturer’s suggested retail price (MSRP) cannot exceed:

• $80,000 for a van, SUV or pickup truck; or

• $55,000 for any other vehicle.

In December, the IRS announced that proposed regulations would define these vehicle types by reference to the general definitions provided in Environmental Protection Agency (EPA) regulations in 40 CFR 600.002 (Notice 2023-1).

However, the IRS has now determined that these vehicles should be defined by reference to the fuel economy labeling rules in 40 CFR 600.315-08. This change means that some vehicles that were formerly classified as “other vehicles” subject to the $55,000 price cap are now classified as SUVs subject to the $80,000 price cap.

Until the IRS releases proposed regulations for the new clean vehicle credit, taxpayers may rely on the definitions provided in Notice 2023-1, as modified by today’s guidance. These modified definitions are reflected in the Clean Vehicle Qualified Manufacturer Requirements page on the IRS website, which lists makes and models that may be eligible for the clean vehicle credits.

Expected Definitions of Vans, SUVs, Pickup Trucks and Other Vehicles

The EPA fuel economy standards establish a large category of nonpassenger vehicles called “light trucks.” Within this category, vehicles are defined largely by their gross vehicle weight ratings (GVWR) as follows:

• Vans, including minivans

• Pickup trucks, including small pickups with a GVWR below 6,000 pounds, and standard pickups with a GVWR between 6,000 and 8,500 pounds

• SUVs, including small SUVs with a GVWR below 6.000 pounds, and standard SUVs with a GVWR between 6,000 and 10,000 pounds

• Other vehicles (passenger automobiles) that, based on seating capacity of interior volume, are classified as two-seaters; mini-compact, subcompact, compact, midsize, or large cars; and small, midsize, or large station wagons.

However, the EPA may determine that a particular vehicle is more appropriately placed in a different category. In particular, the EPA may determine that automobiles with GVWR of up to 8,500 pounds and medium-duty passenger vehicles that possess special features are more appropriately classified as “special purpose vehicles.” These special features may include advanced technologies, such as battery electric vehicles, fuel cell vehicles, plug-in hybrid electric vehicles and vehicles equipped with hydrogen internal combustion engines.

FAQ Updates

The IRS also updated its frequently asked questions (FAQs) page for the Code Sec. 30D new clean vehicle credit, the Code Sec. 25E previously owned vehicle credit and the Code Sec. 45W qualified commercial clean vehicles credit. In addition to incorporating the new definitions discussed above, these updates:

• Define “original use” and "MSRP;"

• Describe the information a seller must provide to the taxpayer and the IRS;

• Clarify that the MSRP caps apply to a vehicle placed in service (delivered to the taxpayer) in 2023, even if the taxpayer purchased it in 2022; and

• Explain what constitutes a lease.

Effect on Other Documents

Notice 2023-1 is modified. Taxpayers may rely on the definitions provided in Notice 2023-1, as modified by Notice 2023-16, until the IRS releases proposed regulations for the new clean vehicle credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit. The IRS also provided:

• initial guidance regarding the overall program design ,

• the application process, and

• additional criteria that will be considered in making the allocations.

After the 2023 allocation process begins, the Treasury Department and IRS will monitor and assess whether to implement any modifications to the Low-Income Communities Bonus Credit Program for calendar year 2024 allocations of Capacity Limitation.

Facility Categories, Capacity Limits, and Application Dates

The program establishes four facilities categories and the capacity limitation for each:

The IRS anticipates applications will be accepted for Category 3 and Category 4 facilities in the third quarter of 2023. Applications for Category 1 and Category 2 facilities will be accepted thereafter. The IRS will issue additional guidance regarding the application process and facility eligibility.

The program will also incorporate additional criteria in determining how to allocate the Capacity Limitation reserved for each facility category among eligible applicants. These may include a focus on facilities that are owned or developed by community-based organizations and mission-driven entities, have an impact on encouraging new market participants, provide substantial benefits to low-income communities and individuals marginalized from economic opportunities, and have a higher degree of commercial readiness.

Finally, only the owner of a facility may apply for an allocation of Capacity Limitation. Facilities placed in service prior to being awarded an allocation of Capacity Limitation are not eligible to receive an allocation. The Department of Energy (DOE) will provide administration services for the Low-Income Communities Bonus Credit Program. An allocation of an amount of capacity limitation is not a determination that the facility will qualify for the energy investment credit or the increase in the credit under the Low-Income Communities Bonus Credit Program.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The guidance announcing the program also:

• defines key terms, including qualifying advanced energy project, specified advanced energy property, eligible property, the placed in service date, industrial facility, manufacturing facilities, and recycling facility;

• describes the prevailing wage and apprenticeship requirements, along with remediation options; and

• sets forth the program timeline and the steps the taxpayer must follow.

Application and Certification Process

For Round 1 of the Section 48C(e) program, the application period begins on May 31, 2023. The IRS expects to allocate $4 billion in credit in this round, including $1.6 billion to projects in energy communities.

The taxpayer must submit a concept paper detailing the project by July 31, 2023. The taxpayer must also certify under penalties of perjury that it did not claim a credit under several other Code Sections for the same investment.

Within two years after the IRS accepts an allocation application, the taxpayer must submit evidence to the DOE to establish that it has met all requirements necessary to commence construction of the project. DOE then notifies the IRS, and the IRS certifies the project.

Taxpayers generally submit their papers through the Department of Energy (DOE) eXHANGE portal at https://infrastructure-exchange.energy.gov/. The DOE must recommend and rank the project to the IRS, and have a reasonable expectation of its commercial viability.

Energy Communities and Progress Expenditures

The guidance also provides additional procedures for energy communities and the credit for progress expenditures.

For purposes of the minimum $4 billion allocation for projects in energy communities, the DOE will determine which projects are in energy community census tracts. Additional guidance is expected to provide a mapping tool that applicants for allocations may use to determine if their projects are in energy communities.

Finally, the guidance explains how taxpayers may elect to claim the credit for progress expenditures paid or incurred during the tax year for construction of a qualifying advanced energy project. The taxpayer cannot make the election before receiving its certification letter.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

Background

Under Code Sec. 461, developers cannot add common improvement costs to the basis of benefitted units until the costs are incurred under the Code Sec. 461(h) economic performance requirements. Thus, common improvement costs that have not been incurred under Code Sec. 461(h) when the units are sold cannot be included in the units' basis in determining the gain or loss resulting from the sales. Rev. Proc. 92-29, provided procedures under which the IRS would consent to developers including the estimated cost of common improvements in the basis of units sold without meeting the economic performance requirements of Code Sec. 461(h). In order to use the alternative cost method, the taxpayer had to meet certain conditions, provide an estimated completion date, and file an annual statement.

Rev. Proc. 2023-9 Alterative Cost Method

In releasing Rev. Proc. 2023-9, the IRS and Treasury stated that they recognized certain aspects of Rev. Proc. 92-29 are outdated, place additional administrative burdens on developers and the IRS, and that application of the method to contracts accounted for under the long-term contract method of Code Sec. 460 may be unclear.

The alternative cost method must be applied to all projects in a trade or business that meet the definition of a qualifying project. However, the alternative cost limitation of this revenue procedure is calculated on a project-by-project basis. Thus, common improvement costs incurred for one qualifying project may not be included in the alternative cost method calculations of a separate qualifying project.

The revenue procedure provides definitions including definitions of "qualifying project,""reasonable method," and "CCM contract" (related to the completed contract method). It provides rules for application of the alternative cost method for developers using the accrual method of accounting and the completed contract method of accounting, rules for allocating estimated common improvement costs, and a method for determining the alternative costs limitation. The revenue procedure also provides examples of how its rules are applied.

Accounting Method Change Required

Under Rev. Proc. 2023-9, the alternative cost method is a method of accounting. A change to this alternative cost method is a change in method of accounting to which Code Secs. 446(e) and 481 apply. An eligible taxpayer that wants to change to the Rev. Proc. 2023-9 alternative cost method or that wants to change from the Rev. Proc. 92-29 alternative cost method, must use the automatic change procedures in Rev. Proc. 2015-13 or its successor. In certain cases, taxpayers may use short Form 3115 in lieu of the standard Form 3115 to make the change.

Effective Date

This revenue procedure is effective for tax years beginning after December 31, 2022.

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. 

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. Previously, taxpayers had to wait for a paper check for any refund, a step that added time onto the amended return process. Following IRS system updates, taxpayers filing amended returns can now enjoy the same speed and security of direct deposit as those filing an original Form 1040 tax return. Taxpayers filing an original tax return using tax preparation software can file an electronic Form 1040-X if the software manufacturer offers that service. This is the latest step the IRS is taking to improve service this tax filing season.

Further, as part of funding for the Inflation Reduction Act, the IRS has hired over 5,000 new telephone assistors and is adding staff to IRS Taxpayer Assistance Centers (TACs). The IRS also plans special service hours at dozens of TACs across the country on four Saturdays between February and May. No matter how a taxpayer files the amended return, they can still use the "Where's My Amended Return?" online tool to check the status. Taxpayers still have the option to submit a paper version of Form 1040-X and receive a paper check. Direct deposit is not available on amended returns submitted on paper. Current processing time is more than 20 weeks for both paper and electronically filed amended returns.

"This is a big win for taxpayers and another achievement as we transform the IRS to improve taxpayer experiences," said IRS Acting Commissioner Doug O’Donnell. "This important update will cut refund time and reduce inconvenience for people who file amended returns. We always encourage directdeposit whenever possible. Getting tax refunds into taxpayers’ hands quickly without worry of a lost or stolen paper check just makes sense."

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. 

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. Pillar Two provides for a global minimum tax on the earnings of large multinational businesses, leveling the playing field for U.S. businesses and ending the race to the bottom in corporate income tax rates. This package follows the release of the Model Rules in December 2021, Commentary in March 2022 and rules for a transitional safe harbor in December 2022. The guidance will be incorporated into a revised version of the Commentary that will replace the prior version.

Additionally, the package includes guidance on over two dozen topics, addressing those issues that Inclusive Framework members identified are most pressing. This includes topics relating to the scope of companies that will be subject to the Global Anti-Base Erosion (GloBE) Rules and transition rules that will apply in the initial years that the global minimum tax applies. Additionally, it includes guidance on Qualified Domestic Minimum Top-up Taxes (QDMTTs) that countries may choose to adopt.

"The continued progress in implementing the globalminimum tax represents another step in leveling the playing field for U.S. businesses, while also protecting U.S. workers and middle-class families by ending the race to the bottom in corporate tax rates," said Assistant Secretary of the Treasury for Tax Policy Lily Batchelder. "We welcome this agreed guidance on key technical questions, which will deliver certainty for green energy tax incentives, support coordinated outcomes and provide additional clarity that stakeholders have asked for."

New IRS guidance aiming to curb certain state and local tax (SALT) deduction cap "workarounds" is the latest "hot topic" tax debate on Capitol Hill. The IRS released proposed amendments to regulations, REG-112176-18, on August 23. The proposed rules would prevent taxpayers, effective August 27, 2018, from using certain charitable contributions to work around the new cap on SALT deductions.

New IRS guidance aiming to curb certain state and local tax (SALT) deduction cap "workarounds" is the latest "hot topic" tax debate on Capitol Hill. The IRS released proposed amendments to regulations, REG-112176-18, on August 23. The proposed rules would prevent taxpayers, effective August 27, 2018, from using certain charitable contributions to work around the new cap on SALT deductions.

SALT Deduction

The SALT deduction limit is one of the most controversial temporarily enacted provisions of the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) signed into law last December. Under the TCJA, beginning in 2018 and running through 2025, taxpayers may not claim more than $10,000 ($5,000 if married filing separately) for all state and local sales, income and property taxes.

After the tax code overhaul, New York, New Jersey, and Connecticut (considered high-tax states) passed legislation that essentially allows taxpayers to circumvent the SALT deduction cap by making charitable contributions to state-run charitable organizations. Indeed, similar workarounds for private-school tuition already exists in other states.

"Congress limited the deduction for state and local taxes that predominantly benefited high-income earners to help pay for major tax cuts for American families,"Treasury Secretary Steven Mnuchin said in a statement. "The proposed rule will uphold that limitation by preventing attempts to convert tax payments into charitable contributions."

Congressional Republicans and Democrats, as with the TCJA, are mostly divided on the topic. House Ways and Means Committee Chair Kevin Brady, R-Tex., praised the IRS proposal for aiming to prevent tax evasion. "These Treasury regulations rightly close the door on improper tax evasion schemes conjured up by state and local politicians who insist on brutally taxing local families and businesses," Brady said in a statement.

Meanwhile, Democratic lawmakers are criticizing the regulations. "The Trump administration doubled down on its attack on the middle class," Ways and Means ranking member Richard Neal, D-Mass., said in a statement. "The administration’s new regulations block affected states’ attempts to cope with this significant change and protect residents."

Tax Policy Experts Weigh-In

Several tax policy experts have criticized states’ efforts to circumvent the SALT deduction cap. Carl Davis, research director at the Democratic-leaning Institute on Taxation and Economic Policy, has called the workarounds an "abuse" of the charitable giving deduction. "Anyone who wants a fair and transparent tax system should be cautiously optimistic that these rules will put an end…to the workaround provisions enacted by states more recently," Davis wrote in a recent op-ed about the proposed IRS guidance.

Jared Walczak, senior policy analyst at the conservative-leaning Tax Foundation, has said that states’ strategies to re-characterize SALT payments were pursued to primarily help high-income taxpayers. Additionally, the top one percent of the wealthiest households would reap more than half of the benefit if the SALT cap were eliminated, according to an estimate from the Democratic-leaning Tax Policy Center.

Last year’s Tax Reform created a new 20-percent deduction of qualified business income for passthrough entities, subject to certain limitations. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) created the new Code Sec. 199A passthrough deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, the provision was enacted only temporarily through 2025. The controversial deduction has remained a buzzing topic of debate among lawmakers, tax policy experts, and stakeholders. In addition to its impermanence, the new passthrough deduction’s ambiguous statutory language has created many questions for taxpayers and practitioners.

Last year’s Tax Reform created a new 20-percent deduction of qualified business income for passthrough entities, subject to certain limitations. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) created the new Code Sec. 199A passthrough deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, the provision was enacted only temporarily through 2025. The controversial deduction has remained a buzzing topic of debate among lawmakers, tax policy experts, and stakeholders. In addition to its impermanence, the new passthrough deduction’s ambiguous statutory language has created many questions for taxpayers and practitioners.

The IRS released the much-anticipated proposed regulations on the new passthrough deduction, REG-107892-18, on August 8. The guidance has generated a mixed reaction on Capitol Hill, and while significant questions may have been answered, it appears that many remain. Indeed, an IRS spokesperson told Wolters Kluwer Tax & Accounting before the regulations were released that the IRS’s goal was to issue complete regulations but that the guidance "would not cover every question that taxpayers have."

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new passthrough deduction and proposed regulations. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

I. Qualified Business Income and Activities

Wolters Kluwer: What is the effect of the proposed regulations requiring that qualified business activities meet the Code Sec. 162 trade or business standard? And for what industries might this be problematic?

Joshua Wu: The positive aspect of incorporating the Section 162 trade or business standard is that there is an established body of case law and administrative guidance with respect to what activities qualify as a trade or business. However, the test under Section 162 is factually-specific and requires an analysis of each situation. Sometimes courts reach different results with respect to activities constituting a trade or business. For example, gamblers have been denied trade or business status in numerous cases. In Groetzinger, 87-1 ustc ¶9191, 480 U.S. 23 (1987), the Court held that whether professional gambling is a trade or business depends on whether the taxpayer can show he pursued gambling full-time, in good faith, regularly and continuously, and possessed a sincere profit motive. Some courts have held that the gambling activity must be full-time, from 60 to 80 hours per week, while others have questioned whether the full-time inquiry is a mandatory prerequisite or permissive factor to determine whether the taxpayer’s gambling activity is a trade or business. See e.g., Tschetschot , 93 TCM 914, Dec. 56,840(M)(2007). Although Section 162 provides a built-in body of law, plenty of questions remain.

Aside from the gambling industry, the real estate industry will continue to face some uncertainty over what constitutes a trade or business under Code Secs. 162 and 199A. The proposed regulations provide a helpful rule, where the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business if the rental or licensing and the other trade or business are commonly controlled. But, that rule does not help taxpayers in the rental industry with no ties to another trade or business. The question remains whether a taxpayer renting out a single-family home or a small group of apartments is engaged in a trade or business for purposes of Code Secs. 162 and 199A. Some case law indicates that just receiving rent with nothing more may not constitute a trade or business. On the other hand, numerous cases have found that managing property and collecting rent can constitute a trade or business. Given the potential tax savings at issue, I suspect there will be additional cases in the real estate industry regarding the level of activity required for the leasing of property to be considered a trade or business.

Qualified Business Income

Wolters Kluwer: How does the IRS define qualified business income (QBI)?

Joshua Wu: QBI is the net amount of effectively connected qualified items of income, gain, deduction, and loss from any qualified trade or business. Certain items are excluded from QBI, such as capital gains/losses, certain dividends, and interest income. Proposed Reg. §1.199A-3(b) provides further clarity on QBI. Most importantly, they provide that a passthrough with multiple trades or businesses must allocate items of QBI to such trades or businesses based on a reasonable and consistent method that clearly reflects income and expenses. The passthrough may use a different reasonable method for different items of income, gain, deduction, and loss, but the overall combination of methods must also be reasonable based on all facts and circumstances. Further, the books and records must be consistent with allocations under the method chosen. The proposed regulations provide no specific guidance or examples of what a reasonable allocation looks like. Thus, taxpayers are left to determine what constitutes a reasonable allocation.

Unadjusted Basis Immediately after Acquisition

Wolters Kluwer: What effect does the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to a trade or business have on determining QBI?

Joshua Wu: For taxpayers above the taxable income threshold amounts, $157,500 (single or married filing separate) or $315,000 (married filing jointly), the Code limits the taxpayer’s 199A deduction based on (i) the amount of W-2 wages paid with respect to the trade or business, and/or (ii) the unadjusted basis immediately after acquisition (UBIA) of qualified property held for use in the trade or business.

Where a business pays little or no wages, and the taxpayer is above the income thresholds, the best way to maximize the deduction is to look to the UBIA of qualified property. Rather than the 50 percent of W-2 wages limitation, Section 199A provides an alternative limit based on 25 percent of W-2 wages and 2.5 percent of UBIA qualified property. The Code and proposed regulations define UBIA qualified property as tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year. The proposed regulations helpfully clarify that UBIA is not reduced for taxpayers who take advantage of the expanded bonus depreciation allowance or any Section 179expensing.

De Minimis Exception

Wolters Kluwer: How is the specified service trade or business (SSTB) limitation clarified under the proposed regulations? And how does the de minimis exception apply?

Joshua Wu: The proposed regulations provide helpful guidance on the definition of a SSTB and avoid what some practitioners feared would be an expansive and amorphous area of section 199A. Under the statute, if a trade or business is an SSTB, its items are not taken into account for the 199A computation. Thus, the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial and brokerage services, investment management, trading, dealing in securities, and any trade or business where the principal asset of such is the reputation or skill of one or more of its employees or owners, do not result in a 199A deduction.

There is a de minimis exception to the general rule for taxpayers with taxable income of less than $157,500 (single or married filing separate) or $315,000 (married filing jointly). Once those thresholds are hit, the 199A deduction phases-out until it is fully eliminated at $207,500 (single) or $415,000 (joint).

The proposed regulations provide guidance for each of the SSTB fields. Importantly, they also limit the "reputation or skill" category. The proposed regulations state that the "reputation or skill" clause was intended to describe a "narrow set of trades or businesses, not otherwise covered by the enumerated specified services." Thus, the proposed regulations limit this definition to cases where the business receives income from endorsing products or services, licensing or receiving income for use of an individual’s image, likeness, name, signature, voice, trademark, etc., or receiving appearance fees. This narrow definition is unlikely to impact most taxpayers.

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new Code Sec. 199A passthrough deduction and its recently-released proposed regulations, REG-107892-18. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new Code Sec. 199A passthrough deduction and its recently-released proposed regulations, REG-107892-18. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

II. Aggregation, Winners & Losers

Wolters Kluwer: How do the proposed regulations provide both limitations and flexibility regarding the available election to aggregate trades or businesses?

Joshua Wu: Treasury agreed with various comments that some level of aggregation should be permitted to account for the legal, economic and other non-tax reasons that taxpayers operate a single business across multiple entities. Permissive aggregation allows taxpayers the benefit of combining trades or businesses for applying the W-2 wage limitation, potentially resulting in a higher limit. Under Proposed Reg. §1.199A-4, aggregation is allowed but not required. To use this method, the business must (1) qualify as a trade or business, (2) have common ownership, (3) not be a SSTB, and (4) demonstrate that the businesses are part of a larger, integrated trade or business (for individuals and trusts). The proposed regulations give businesses the benefits of electing aggregation without having to restructure the businesses from a legal standpoint. Businesses failing to qualify under the above test will have to consider whether a legal restructuring would be possible.

Wolters Kluwer: How does Notice 2018-64 Methods for Calculating W-2 Wages for Purposes of Section 199A, which accompanied the release of the proposed regulations, coordinate with aggregation?

Joshua Wu: Notice 2018-64 contains a proposed revenue procedure with guidance on three methods for calculating W-2 wages for purposes of section 199A. The Unmodified Box method uses the lesser of totals in Box 1 of Forms W-2 or Box 5 (Medicare wages). The Modified Box 1 method takes the total amounts in Box 1 of Forms W-2 minus amounts not wages for income withholding purposes, and adding total amounts in Box 12 (deferrals). The Tracking wages method is the most complex and tracks total wages subject to income tax withholding. The calculation method is dependent on the group of Forms W-2 included in the computation and, thus, will vary depending upon whether businesses are aggregated under §1.199A-4 or not. Taxpayers with businesses generating little or no Medicare wages may consider aggregating with businesses that report significant wages in Box 1 that are still subject to income tax withholding. Under the Modified Box 1 method, that may result in a higher wage limitation.

Crack & Pack

Wolters Kluwer: What noteworthy anti-abuse safeguards did the proposed regulations seek to establish? How do the rules address "cracking" or "crack and pack" strategies?

Joshua Wu: Treasury included some anti-abuse provisions in the proposed regulations. One area that Treasury noted was the use of multiple non-grantor trusts to avoid the income threshold limitations on the 199A deduction. Taxpayers could theoretically use multiple non-grantor trusts to increase the 199A deduction by taking advantage of each trust’s separate threshold amount. The proposed regulations, under the authority of 643(f), provide that two or more trusts will be aggregated and treated as a single trust if such trusts have substantially the same grantor(s) and substantially the same primary beneficiary or beneficiaries, and if a principal purpose is to avoid tax. The proposed regulations have a presumption of a principal purpose of avoiding tax if the structure results in a significant tax benefit, unless there is a significant non-tax purpose that could not have been achieved without the creation of the trusts.

Another anti-abuse issue relates to the "crack and pack" strategies. These strategies involve a business that is limited in its 199A deduction because it is an SSTB spinning off some of its business or assets to an entity that is not an SSTB and could claim the 199A deduction. For example, a law firm that owns its building could transfer the building to a separate entity and lease it back. The law firm is an SSTB and, thus, is subject to the 199A limitations. However, the real estate entity is not an SSTB and can generate a 199A deduction (based on the rental income) for the law partners. The proposed regulations provide that a SSTB includes any business with 50 percent common ownership (direct or indirect) that provides 80 percent or more of its property or services to an excluded trade or business. Also, if a trade or business shares 50 percent or more common ownership with an SSTB, to the extent that trade or business provides property or services to the commonly-owned SSTB, the portion of the property or services provided to the SSTB will be treated as an SSTB. The proposed regulations provide an example of a dentist who owns a dental practice and also owns an office building. The dentist rents half the building to the dental practice and half to unrelated persons. Under [Proposed Reg.] §1.199A-5(c)(2), the renting of half of the building to the dental practice will be treated as an SSTB.

Winners & Losers

Wolters Kluwer: Generally, what industries can be seen as "winners" and "losers" in light of the proposed regulations?

Joshua Wu: The most obvious "losers" in the proposed regulations are the specified services businesses (e.g., lawyers, accountants, doctors, etc.) who are further limited by the anti-abuse provisions in arranging their affairs to try and benefit from 199A. On the other hand, certain specific service providers benefit from the proposed regulations. For example, health clubs or spas are exempt from the SSTB limitation. Additionally, broadcasters of performing arts, real estate agents, real estate brokers, loan officers, ticket brokers, and art brokers are all exempt from the SSTB limitation.

Wolters Kluwer: What areas of the Code Sec. 199A provision stand out as most complex when calculating the deduction, and how does this complexity vary among taxpayers?

Joshua Wu: With respect to calculating the deduction, one complex area is planning to maximize the W-2 wages limitation. Because compensation as W-2 wages can reduce QBI, and potentially the 199A deduction, determining the efficient equilibrium point between having enough W-2 wages to limit the impact of the wage limitation, while preserving QBI, will be a fact-driven complex planning issue that must be determined by each taxpayer. Another area of complexity will be how taxpayers track losses which may reduce future QBI and, thus, the 199A deduction. The proposed regulations provide that losses disallowed for taxable years beginning before January 1, 2018, are not taken into account for purposes of computing QBI in a later taxable year. Taxpayers will be left to track pre-2018 and post-2018 losses and determine if a loss in a particular tax year reduces QBI or not.

III. Looking Ahead

Questions Remain

Wolters Kluwer: An IRS spokesperson told Wolters Kluwer that the IRS did not expect the proposed regulations to answer all questions surrounding the deduction. Indeed, Acting IRS Commissioner David Kautter has said that stakeholder feedback would help finalize the regulations. What significant questions remain unanswered for taxpayers and tax practitioners, and has additional uncertainty been created with the release of the IRS guidance?

Joshua Wu: On the whole, the proposed regulations did a good job addressing the most important areas of Section 199A. However, there are many areas where additional guidance would be helpful. Such guidance may be in the form of additional regulations or other administrative pathways. For example, the proposed regulations did not address the differing treatment between a taxpayer operating as a sole proprietor versus an S corporation. Wages paid to an S corporation shareholder boosts the W-2 limitation but are not considered QBI. Thus, with the same underlying facts, the 199Adeduction may vary between taxpayers operating as a sole proprietor versus those operating as an S corporation.

Possible Changes to Proposed Regulations

Wolters Kluwer: In what ways do you see the passthrough deduction rules changing when the final regulations are released?

Joshua Wu: I suspect that the core components of the proposed regulations will not change significantly. However, I would not be surprised if Treasury were to include more specific examples with respect to real estate and whether certain types of activity constitute a trade or business. Additionally, the proposed regulations will likely generate comments and questions from various industry groups related to the SSTB definitions and specific types of services (e.g., do trustees and executors fall under the legal services definition). Treasury may change the definitions of SSTBs in response to comments and clarify definitions for industry groups.

Tax Reform 2.0

Wolters Kluwer: The White House and congressional Republicans are currently moving forward on legislative efforts known as "Tax Reform 2.0." The legislative package proposes making permanent the passthrough deduction. How does the impermanence of this deduction currently impact taxpayers? (Note: On September 13, the House Ways and Means Committee marked up a three-bill Tax Reform 2.0 package. The measure is expected to reach the House floor for a full chamber vote by the end of September.)

Joshua Wu: The 199A deduction has a significant impact on the choice of entity question for businesses. With the 21 percent corporate rate, we have seen many taxpayers considering restructuring away from passthrough entities to a C corporation structure. The 199A deduction is a large consideration in whether to restructure or not, but its limited effective time does raise questions about the cost effectiveness of planning to obtain the 199A deduction where the benefit will sunset in eight years.

Key Takeways

Wolters Kluwer: Aside from advice on specific taxpayer situations, what key takeaways should tax practitioners generally alert clients to ahead of the 2019 tax filing season?

Wolters Kluwer: Aside from advice on specific taxpayer situations, what key takeaways should tax practitioners generally alert clients to ahead of the 2019 tax filing season?

Joshua Wu: Practitioners should remind clients who may benefit from the 199A deduction to keep detailed records of any losses for each line of business, as this may impact the calculation of QBI in the future. Practitioners should also help clients examine the whole of their activity to define their "trades or businesses." This will be essential to calculating the 199A deduction and planning to maximize any such deduction. Finally, practitioners should remember that some of the information that may be necessary to determine a 199A deduction may not be in their client’s possession. Practitioners need to plan in advance with their clients regarding how information about each trade or business will be obtained (e.g., how will a limited partner in a partnership obtain information regarding the partnership’s W-2 wages and/or UBIA of qualified property).

Wolters Kluwer: Any closing thoughts or comments?

Joshua Wu: Practitioners and taxpayers should remember that the regulations are only proposed and may change before they become final. Any planning undertaken this year should carefully weigh the economic costs and be rooted in the statutory language of 199A. It will be some time before case law helps clarify the nuances of Section 199A, and claiming the deduction allows the IRS to more easily impose the substantial understatement penalty if a taxpayer gets it wrong.

Wolters Kluwer has projected annual inflation-adjusted amounts for tax year 2019. The projected amounts include 2019 tax brackets, the standard deduction, and alternative minimum tax amounts, among others. The projected amounts are based on Consumer Price Index figures released by the U.S. Department of Labor on September 12, 2018.

Wolters Kluwer has projected annual inflation-adjusted amounts for tax year 2019. The projected amounts include 2019 tax brackets, the standard deduction, and alternative minimum tax amounts, among others. The projected amounts are based on Consumer Price Index figures released by the U.S. Department of Labor on September 12, 2018.

The Tax Cuts and Jobs Act of 2017 (TCJA) ( P.L. 115-97) mandated a change from the Consumer Price Index for All Urban Consumers (CPI-U) to the Chained Consumer Price Index for All Urban Consumers (C-CPI-U). Official amounts for 2019 should be released by the IRS later in 2018.

Individual Tax Brackets

The projected bracket ranges for individuals in 2019 are as follows.

For married taxpayers filing jointly:

The 10 percent bracket applies to taxable incomes up to $19,400
The 12 percent bracket applies to taxable incomes over $19,400 and up to $78,900
The 22 percent bracket applies to taxable incomes over $78,900 and up to $168,400
The 24 percent bracket applies to taxable incomes over $168,400 and up to $321,450
The 32 percent bracket applies to taxable incomes over $321,450 and up to $408,200
The 35 percent bracket applies to taxable incomes over $408,200 and up to $612,350
The 37 percent bracket applies to taxable incomes over $612,350

For heads of households:

The 10 percent bracket applies to taxable incomes up to $13,850
The 12 percent bracket applies to taxable incomes over $13,850 and up to $52,850
The 22 percent bracket applies to taxable incomes over $52,850 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,700
The 32 percent bracket applies to taxable incomes over $160,700 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $510,300
The 37 percent bracket applies to taxable incomes over $510,300

For unmarried taxpayers:

The 10 percent bracket applies to taxable incomes up to $9,700
The 12 percent bracket applies to taxable incomes over $9,700 and up to $39,450
The 22 percent bracket applies to taxable incomes over $39,450 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,700
The 32 percent bracket applies to taxable incomes over $160,700 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $510,300
The 37 percent bracket applies to taxable incomes over $510,300

For married taxpayers filing separately:

The 10 percent bracket applies to taxable incomes up to $9,700
The 12 percent bracket applies to taxable incomes over $9,700 and up to $39,450
The 22 percent bracket applies to taxable incomes over $39,450 and up to $84,200
The 24 percent bracket applies to taxable incomes over $84,200 and up to $160,725
The 32 percent bracket applies to taxable incomes over $160,725 and up to $204,100
The 35 percent bracket applies to taxable incomes over $204,100 and up to $306,175
The 37 percent bracket applies to taxable incomes over $306,175

For estates and trusts:

The 10 percent bracket applies to taxable incomes up to $2,600
The 24 percent bracket applies to taxable incomes over $2,600 and up to $9,300
The 35 percent bracket applies to taxable incomes over $9,300 and up to $12,750
The 37 percent bracket applies to taxable incomes over $12,750

Standard Deduction

TCJA also roughly doubled the amount of the standard deduction. For 2019, the following standard deduction amounts are projected:

For married taxpayers filing jointly, $24,400
For heads of households, $18,350
For unmarried taxpayers and well as married taxpayers filing separately, $12,200

AMT Exemptions

TCJA eliminated the AMT for corporations, and increased the exemption amounts, and the exemption phaseouts, for individuals. For 2019, the AMT exemption amounts are projected to be:

For married taxpayers filing jointly, $111,700
For unmarried individuals and heads of households, $71,700
For married taxpayers filing separately, $55,850

Estate and Gift Tax

The following amounts related to transfer taxes (estate, generation-skipping, and gift taxes) are projected for 2019:

The gift tax annual exemption is projected to be $15,000 in 2019

The estate and gift tax applicable exclusion (increased under TCJA) is projected to be $11,400,000 for decedents dying in 2019

The exclusion for gifts made in 2019 to a spouse who is not a U.S. citizen is projected to be $155,000 for 2019

Other Amounts

The following other amounts are also projected for 2019:

The adoption credit for 2019 is projected to be $14,080 for 2019.

For 2019, the allowed Roth IRA contribution amount is projected to phase out for married taxpayers filing jointly with income between $193,000 and $203,000 For heads of household and unmarried filers, the projected phaseout range is between $122,000 to $137,000.

The maximum amount of deductible contributions that can be made to an IRA is projected to be $6,000 for 2019. The increased contribution amount for taxpayers age 50 and over will, therefore, be $7,000.

The deduction for traditional IRA contributions is projected to begin to phase out for married joint filers whose income is greater than $103,000 if both spouses are covered by a retirement plan at work. If only one spouse is covered by a retirement plan at work, the phaseout is projected to begin when modified adjusted gross income reaches $193,000. For heads of household and unmarried filers who are covered by a retirement plan at work, the 2019 income phaseout range for deductible IRA contributions is projected to begin at $64,000.

For 2019, the $2,500 student loan interest deduction is projected to begin to phase out for married joint filers with modified adjusted gross income (MAGI) above $140,000. For single taxpayers, the 2019 deduction is projected to begin to phase out at a MAGI level of over $70,000.

The amount of the 2019 foreign earned income exclusion under Code Sec. 911 is projected to be $105,900.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97).

In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity.

Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

• each trade or business is itself a trade or business;
• the same person or group owns a majority interest in each business to be aggregated;
• none of the aggregated trades or businesses can be a specified service trade or business; and
• the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers.

A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

• gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
• gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

• endorsing products or services;
• licensing the use of an individual’s image, name, trademark, etc.; or
• receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

• W-2 wages that are allocable to QBI; and
• unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.

The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, "immediately after acquisition" is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

• definitions;
• basic computations;
• loss carryovers;
• Puerto Rico businesses;
• coordination with other Code Sections;
• penalties;
• special basis rules;
• previously suspended losses and net operating losses;
• other exclusions from qualified business income;
• allocations of items that are not attributable to a single trade or business;
• anti-abuse rules;
• application to trusts and estates; and
• special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

• several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
• anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
• if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018.

The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.