In a memorandum that will likely not surprise anyone, the IRS Small Business/Self-Employed Division has issued a memorandum providing guidance that the deduction under §199A will not be included in substitutes for returns (SFRs) prepared under IRC §6020(b).[1]

IRC §6020 grants the IRS authority to prepare substitute tax returns under various conditions. The provision provides:

(a) Preparation of return by Secretary

If any person shall fail to make a return required by this title or by regulations prescribed thereunder, but shall consent to disclose all information necessary for the preparation thereof, then, and in that case, the Secretary may prepare such return, which, being signed by such person, may be received by the Secretary as the return of such person.

(b) Execution of return by Secretary

(1) Authority of Secretary to execute return

If any person fails to make any return required by any internal revenue law or regulation made thereunder at the time prescribed therefor, or makes, willfully or otherwise, a false or fraudulent return, the Secretary shall make such return from his own knowledge and from such information as he can obtain through testimony or otherwise.

(2) Status of returns

Any return so made and subscribed by the Secretary shall be prima facie good and sufficient for all legal purposes.

The qualified business income deduction under IRC §199A provides a 20% deduction related to amounts of qualified business income. The question the memorandum seeks to answer is whether, in preparing such a substitute return, the IRS should include a §199A deduction if the substitute return includes income that appears to be qualified business income.

The memorandum answers that question with a simple no. The memorandum provides the following justification for its position:

Depending on the taxpayer’s taxable income, the QBI deduction is subject to multiple limitations including the type of trade or business, the amount of W-2 wages paid by the trade or business, and the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the trade or business. Additionally, a qualified business loss or qualified publicly traded partnership loss carried forward from prior years must be considered. Therefore, while a taxpayer may be entitled to claim a QBI deduction on a filed return, the Service will not allow the QBI deduction on an SFR prepared under IRC section 6020(b).[2]

The memorandum notes that taxpayers are allowed to file a delinquent return claiming the §199A deduction in response to the substitute return. As the memorandum notes:

If a taxpayer subsequently files a delinquent tax return that includes a QBI deduction, the Service will consider the deduction following the same policies for other items included on the filed return.[3]

When the IRS prepares an SFR, the agency will generally assume all facts that aren’t known for certain by the agency will work to the taxpayer’s detriment. It is not surprising that even though it may be very likely the taxpayer would qualify for a §199A deduction, the agency is not going to place that deduction on the SFR it prepares. It is up to the taxpayer to respond and present the evidence that the taxpayer does qualify for this tax benefit.

[1] SBSE-04-1219-0054, December 9, 2019, https://www.irs.gov/pub/foia/ig/sbse/sbse-04-1219-0054.pdf

[2] SBSE-04-1219-0054, p. 1

[3] SBSE-04-1219-0054, p. 1