8596 / Can employees seek to recharacterize themselves as independent contractors in order to take advantage of the QBI deduction under Section 199A?
Generally, no. Qualified business income excludes income that is earned from the trade or business of being an employee. Unlike in the case of SSTBs, no phase-in applies—all income earned from the trade or business of being an employee is excluded from QBI regardless of the taxpayer's income level.1 Because of this, many employees would now rather be characterized as independent contractors in order to take advantage of the Section 199A QBI deduction. See Q 8722 to Q 8736 for a discussion of how the IRS determines whether an individual is an employee or an independent contractor, and the consequences of improper classification, as these factors are relevant in the determinization for the QBI deduction, as well.
Under the regulations, if an individual was classified as an employee for tax purposes and, while continuing to perform substantially the same services for the same employer (whether directly or indirectly), was re-classified as an independent contractor, the IRS will presume that the individual remains an employee for Section 199A purposes.2
Planning Point: The individual may be denied independent contractor status under this rule for Section 199A purposes and continue to be an independent contractor for other tax purposes.
The presumption contained in the proposed regulations is a rebuttable presumption—if the individual can show that he or she is, in fact, properly classified as an independent contractor under general legal principles applicable to making this determination, Section 199A will be available.
The final regulations retain this presumption and add a requirement that the presumption applies for three years after the employment classification changes (three year "look-back" requirement), so that the individual must present three years' worth of evidence to rebut the presumption before being re-classified as an independent contractor for 199A purposes.3
1. Prop. Treas. Reg. § 1.199A-5(a)(3).
2. Prop. Treas. Reg. § 1.199A-5(d)(3).
3. Treas. Reg. § 1.199A-5(d)(3).