Although many have forgotten about it by now, the IRS had not yet finalized all of the regulations under IRC §199A.  In TD 9899[1] the IRS has now issued additional final regulations dealing with the qualified business income deduction under IRC §199A.

The new regulations deal with the following issues:

• Treatment of previously suspended losses included in QBI;

• Registered investment companies (RICs) with interests in publicly traded partnerships (PTPs) and real estate investment trusts (REITs); and

• Special rules for trusts and estates related to separate shares and charitable remainder trusts.

While the regulations will generally be effective first for calendar year 2021 year tax returns, taxpayers are allowed to rely upon these regulations for preparing returns for earlier years so long as the rules are applied consistently.

Treatment of Previously Suspended Losses – General Rules

While the IRS had dealt with the issue of previously suspended losses in the original final regulations at Reg. §1.199A-3(b)(1)(iv), the IRS proposed to expand the guidance as discussed below in the preamble to the final regulations:

Section 1.199A-3(b)(1)(iv) of the February 2019 Final Regulations provides that previously disallowed losses or deductions (including under sections 465, 469, 704(d), and 1366(d)) allowed in the taxable year are generally taken into account for purposes of computing QBI, except to the extent the losses or deductions were disallowed, suspended, limited, or carried over from taxable years ending before January 1, 2018. These losses are used, for purposes of section 199A, in order from the oldest to the most recent on a first-in, first-out (FIFO) basis. The February 2019 Proposed Regulations expanded this rule to provide that previously disallowed losses or deductions are treated as losses from a separate trade or business in the year they are taken into account in determining taxable income. Further, the attributes of the previously disallowed losses or deductions, including whether they are attributable to a trade or business and whether they would otherwise be included in QBI, are determined in the year the loss or deduction is incurred.[2]

The IRS notes that some individuals had expressed concern that §461(l) was not listed in the original final regulations.  In these new final regulations, the IRS expands the list and clarifies that the list is not all inclusive:

Previously disallowed losses or deductions allowed in the taxable year generally are taken into account for purposes of computing QBI to the extent the disallowed loss or deduction is otherwise allowed by section 199A. These previously disallowed losses include, but are not limited to losses disallowed under sections 461(l), 465, 469, 704(d), and 1366(d). These losses are used for purposes of section 199A and this section in order from the oldest to the most recent on a first-in, first-out (FIFO) basis and are treated as losses from a separate trade or business. To the extent such losses relate to a PTP, they must be treated as a loss from a separate PTP in the taxable year the losses are taken into account. However, losses or deductions that were disallowed, suspended, limited, or carried over from taxable years ending before January 1, 2018 (including under sections 465, 469, 704(d), and 1366(d)), are not taken into account in a subsequent taxable year for purposes of computing QBI.[3]

The regulations also clarify the treatment of a partial disallowance of a deduction that relates to QBI:

If a loss or deduction attributable to a trade or business is only partially allowed during the taxable year in which incurred, only the portion of the allowed loss or deduction that is attributable to QBI will be considered in determining QBI from the trade or business in the year the loss or deduction is incurred. The portion of the allowed loss or deduction attributable to QBI is determined by multiplying the total amount of the allowed loss by a fraction, the numerator of which is the portion of the total loss incurred during the taxable year that is attributable to QBI and the denominator of which is the amount of the total loss incurred during the taxable year.[4]

Example 1, Reg. §1.199A-3(b)(1)(iv)(D)

A is an unmarried individual and a 50% owner of LLC, an entity classified as a partnership for Federal income tax purposes. In 2018, A’s allocable share of loss from LLC is $100,000 of which $80,000 is negative QBI. Under section 465, $60,000 of the allocable loss is allowed in determining A’s taxable income. A has no other previously disallowed losses under section 465 or any other provision of the Code for 2018 or prior years. Because 80% of A’s allocable loss is attributable to QBI ($80,000/$100,000), A will reduce the amount A takes into account in determining QBI proportionately. Thus, A will include $48,000 of the allowed loss in negative QBI (80% of $60,000) in determining A’s section 199A deduction in 2018. The remaining $32,000 of negative QBI is treated as negative QBI from a separate trade or business for purposes of computing the section 199A deduction in the year the loss is taken into account in determining taxable income as described in §1.199A-1(d)(2)(iii).

The regulations on disallowed losses are effective for tax years beginning after August 24, 2020, based on the scheduled publication date in the Federal Register.[5]

Disallowed Losses from a Specified Service Trade or Business (SSTB)

The regulations also deal with the issue of how to handle a disallowed loss from a specified service trade or business (SSTB).  The regulation provides that, in general, “[w]hether a disallowed loss or deduction is attributable to a trade or business, and otherwise meets the requirements of this section, is determined in the year the loss is incurred.”[6]

The IRS uses this rule to decide that the impact of the limitations on inclusion of QBI items from an SSTB has to be determined in the year the loss is incurred.  The regulations provide:

If a disallowed loss or deduction is attributable to a specified service trade or business (SSTB), whether an individual has taxable income at or below the threshold amount as defined in §1.199A-1(b)(12), within the phase-in range as defined in §1.199A-1(b)(4), or in excess of the phase-in range is determined in the year the loss or deduction is incurred. If the individual’s taxable income is at or below the threshold amount in the year the loss or deduction is incurred, the entire disallowed loss or deduction must be taken into account when applying paragraph (b)(1)(iv)(A) of this section. If the individual’s taxable income is within the phase-in range, then only the applicable percentage, as defined in §1.199A-1(b)(2), of the disallowed loss or deduction is taken into account when applying paragraph (b)(1)(iv)(A) of this section. If the individual’s taxable income exceeds the phase-in range, none of the disallowed loss or deduction will be taken into account in applying paragraph (b)(1)(iv)(A) of this section.[7]

Example 2, Reg. §1.199A-3(b)(1)(iv)(D)

B is an unmarried individual and a 50% owner of LLC, an entity classified as a partnership for Federal income tax purposes. After allowable deductions other than the section 199A deduction, B’s taxable income for 2018 is $177,500. In 2018, LLC has a single trade or business that is an SSTB. B’s allocable share of loss is $100,000, all of which is suspended under section 465. B’s allocable share of negative QBI is also $100,000. B has no other previously disallowed losses under section 465 or any other provision of the Code for 2018 or prior years. Because the entire loss is suspended, none of the negative QBI is taken into account in determining B’s section 199A deduction for 2018. Further, because the negative QBI is from an SSTB and B’s taxable income before the section 199A deduction is within the phase-in range, B must determine the applicable percentage of the negative QBI that must be taken into account in the year that the loss is taken into account in determining taxable income. B’s applicable percentage is 100% reduced by 40% (the percentage equal to the amount that B’s taxable income for the taxable year exceeds B’s threshold amount ($20,000=$177,500-$157,500) over $50,000). Thus, B’s applicable percentage is 60%. Therefore, B will have $60,000 (60% of $100,000) of negative QBI from a separate trade or business to be applied proportionately to QBI in the year(s) the loss is taken into account in determining taxable income, regardless of the amount of taxable income and how rules under §1.199A-5 apply in the year the loss is taken into account in determining taxable income.

These regulations impacting SSTB disallowed losses are effective for tax years beginning after August 24, 2020, based on the scheduled publication date in the Federal Register. [8]

Dividends Paid by a Registered Investment Company (RIC)

The regulations also give details on the treatment of dividends paid by a regulated investment company (RIC), more commonly referred to as a mutual fund.

In addition to giving detailed rules the mutual fund will use to compute the amount of the §199A dividends reported to shareholders[9] that will primarily be of interest to those who handle tax reporting for such funds (and is beyond the scope of this article’s more general audience), the regulations give details on reporting of such dividends by shareholders that will be of more general interest.

The final regulations note that a shareholder of the fund who receives a §199A dividend from the fund treats the dividend as a qualified REIT dividend under the rules for §199A.[10]  However, the regulations note that in the following cases the shareholder is not allowed to treat the dividend as a §199A REIT dividend:

• The RIC stock is held by the shareholder for 45 days or less (taking into account the principles of section 246(c)(3) and (4)) during the 91-day period beginning on the date which is 45 days before the date on which the share becomes ex-dividend with respect to such dividend; or

• To the extent that the shareholder is under an obligation (whether pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.[11]

The regulations impacting RICs are effective for tax years beginning after August 24, 2020, based on the scheduled publication date in the Federal Register. [12]

Separate Shares in Trusts or Estates

The regulations clarify the treatment of a trust or estate if the trust or estate has separate shares for tax purposes as defined at IRC §663(c).  The new regulations provide:

In the case of a trust or estate described in section 663(c) with substantially separate and independent shares for multiple beneficiaries, such trust or estate will be treated as a single trust or estate for purposes of determining whether the taxable income of the trust or estate exceeds the threshold amount; determining taxable income, net capital gain, net QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income for each trade or business of the trust and estate; and computing the W-2 wage and UBIA of qualified property limitations. The allocation of these items to the separate shares of a trust or estate will be governed by the rules under §§1.663(c)-1 through 1.663(c)-5, as they may be adjusted or clarified by publication in the Internal Revenue Bulletin (see §601.601(d)(2)(ii)(b) of this chapter).[13]

The regulations impacting separate shares are effective for tax years beginning after August 24, 2020, based on the scheduled publication date in the Federal Register.[14]

Charitable Remainder Trusts

While the charitable remainder trust does not itself qualify to claim a deduction under §199A, the regulations provide that a taxable recipient of a unitrust or annuity amount may qualify for a deduction.

The regulations provide:

A charitable remainder trust described in section 664 is not entitled to and does not calculate a section 199A deduction, and the threshold amount described in section 199A(e)(2) does not apply to the trust. However, any taxable recipient of a unitrust or annuity amount from the trust must determine and apply the recipient’s own threshold amount for purposes of section 199A taking into account any annuity or unitrust amounts received from the trust. A recipient of a unitrust or annuity amount from a trust may take into account QBI, qualified REIT dividends, or qualified PTP income for purposes of determining the recipient’s section 199A deduction for the taxable year to the extent that the unitrust or annuity amount distributed to such recipient consists of such section 199A items under §1.664-1(d).[15]

The regulation illustrates the application of this provision as follows:

For example, if a charitable remainder trust has investment income of $500, qualified dividend income of $200, and qualified REIT dividends of $1,000, and distributes $1,000 to the recipient, the trust would be treated as having income in two classes within the category of income, described in §1.664-1(d)(1)(i)(a)(1), for purposes of §1.664- 1(d)(1)(ii)(b). Because the annuity amount first carries out income in the class subject to the highest income tax rate, the entire annuity payment comes from the class with the investment income and qualified REIT dividends. Thus, the charitable remainder trust would be treated as distributing a proportionate amount of the investment income ($500/(1,000+500)*1,000 = $333) and qualified REIT dividends ($1000/(1,000+500)*1000 = $667) because the investment income and qualified REIT dividends are taxed at the same rate and within the same class, which is higher than the rate of tax for the qualified dividend income in a separate class. The charitable remainder trust in this example would not be treated as distributing any of the qualified dividend income until it distributed all the investment income and qualified REIT dividends (more than $1,500 in total) to the recipient.[16]

If more than one individual receives such a distribution during the year, there is a proportionate allocation of affected amounts:

To the extent that a trust is treated as distributing QBI, qualified REIT dividends, or qualified PTP income to more than one unitrust or annuity recipient in the taxable year, the distribution of such income will be treated as made to the recipients proportionately, based on their respective shares of total QBI, qualified REIT dividends, or qualified PTP income distributed for that year. The trust allocates and reports any W-2 wages or UBIA of qualified property to the taxable recipient of the annuity or unitrust interest based on each recipient’s share of the trust’s total QBI (whether or not distributed) for that taxable year.[17]

Again, the regulation provides an illustration of such an allocation:

Accordingly, if 10 percent of the QBI of a charitable remainder trust is distributed to the recipient and 90 percent of the QBI is retained by the trust, 10 percent of the W-2 wages and UBIA of qualified property is allocated and reported to the recipient and 90 percent of the W-2 wages and UBIA of qualified property is treated as retained by the trust. However, any W-2 wages retained by the trust cannot be used to compute W-2 wages in a subsequent taxable year for section 199A purposes.[18]

The regulation also notes that such a trust with QBI may also run into issues with unrelated business taxable income:

Any QBI, qualified REIT dividends, or qualified PTP income of the trust that is unrelated business taxable income is subject to excise tax and that tax must be allocated to the corpus of the trust under §1.664-1(c).[19]

The regulations impacting charitable remainder trusts are effective for tax years beginning after August 24, 2020, based on the scheduled publication date in the Federal Register.[20]

[1] TD 9899, 6/24/20 (scheduled for publication in the Federal Register on June 25, 2020), https://s3.amazonaws.com/public-inspection.federalregister.gov/2020-11832.pdf?utm_medium=email&utm_campaign=pi+subscription+mailing+list&utm_source=federalregister.gov (retrieved June 24, 2020)

[2] TD 9899, SUPPLEMENTARY INFORMATION, Summary of Comments and Explanation of Revisions, Section I

[3] Reg. §1.199A-3(b)(1)(iv)(A)

[4] Reg. §1.199A-3(b)(1)(iv)(B)

[5] Reg. §1.199A-3(e)(2)(iii)

[6] Reg. §1.199A-3(b)(1)(iv)(C)(1)

[7] Reg. §1.199A-3(b)(1)(iv)(C)(2)

[8] Reg. §1.199A-3(e)(2)(iii)

[9] Reg. §1.199A-3(d)(2)

[10] Reg. §1.199A-3(d)(4)(i)

[11] Reg. §1.199A-3(d)(4)(ii)

[12] Reg. §1.199A-3(e)(2)(iv)

[13] Reg. §1.199A-6(d)(3)(iii)

[14] Reg. §1.199A-6(e)(2)(iii)

[15] Reg. §1.199A-6(d)(3)(v)

[16] Reg. §1.199A-6(d)(3)(v)

[17] Reg. §1.199A-6(d)(3)(v)

[18] Reg. §1.199A-6(d)(3)(v)

[19] Reg. §1.199A-6(d)(3)(v)

[20] Reg. §1.199A-6(e)(2)(iv)