S Corporations

<div class="Section1">A QSST is a trust in which: (1) there is only one current income beneficiary (who must be a citizen or resident of the U.S.), (2) all income must be distributed currently, and (3) corpus may not be distributed to anyone else during the life of such beneficiary. The income interest must terminate upon the earlier of the beneficiary’s death or termination of the trust, and if the trust terminates during the lifetime of the income beneficiary, all trust assets must be distributed to that beneficiary. The beneficiary must make an election for the trust to be treated as a QSST.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1361(d).<br /> <br /> </div>

<div class="Section1">Yes. While the safe harbor generally does apply to residential rental real estate, taxpayers are not entitled to rely upon the safe harbor if the taxpayer uses the property as a residence during the tax year. This exclusion applies to vacation properties that the taxpayer rents when not using the property for personal reasons. Notably, if the real estate is rented or leased under a triple net lease, the safe harbor remains unavailable under the final rule.</div><br /> <div class="Section1"><br /> <br /> When satisfying the “hours of rental real estate services” criteria, only certain activities are counted toward the 250-hour threshold that must be met in order to qualify to use the safe harbor rule. Activities such as rent collection, advertising the rental, property maintenance, negotiating leases and managing the real property generally count toward the threshold. However, financing activities and the construction of capital improvements to the property, as well as hours spent traveling to and from the real property, are excluded (in other words, the taxpayer’s activities as an “investor” are not counted).<br /> <br /> If any property within the rental real estate enterprise is classified as a specified service trade or business, the safe harbor is unavailable for the entire business. Further, if the taxpayer rents the real property to a trade or business that is operated either by the taxpayer or an entity under common control, the safe harbor is unavailable.<br /> <br /> Notably, if the real estate is rented or leased under a triple net lease, the safe harbor is unavailable.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Proc. 2019-38.<br /> <br /> </div>

<div class="Section1">An S corporation may own a qualified subchapter S subsidiary (QSSS). A QSSS is a domestic corporation that is not an ineligible corporation, if 100 percent of its stock is owned by the parent S corporation and the parent S corporation elects to treat it as a QSSS. Except as provided in regulations, a QSSS is not treated as a separate corporation, and its assets, liabilities, and items of income, deduction, and credit are treated as those of the parent S corporation.<a href="#_ftn1" name="_ftnref1">¹</a> Regulations provide special rules regarding the recognition of a QSSS as a separate entity for tax purposes if an S corporation or its QSSS is a bank.<a href="#_ftn2" name="_ftnref2">²</a> A QSSS will also be treated as a separate corporation for purposes of employment taxes and certain excise taxes.<a href="#_ftn3" name="_ftnref3">³</a> For tax years beginning after 2014, a QSSS will be treated as a separate corporation for purposes of the shared responsibility payment under the Affordable Care Act.<a href="#_ftn4" name="_ftnref4">⁴</a></div><br /> <div class="Section1"><br /> <br /> If a QSSS ceases to meet the above requirements, it will be treated as a new corporation acquiring all assets and liabilities from the parent S corporation in exchange for its stock. If the corporation’s status as a QSSS terminates, the corporation is generally prohibited from being a QSSS or an S corporation for five years.<a href="#_ftn5" name="_ftnref5">⁵</a> Regulations provide that in certain cases following a termination of a corporation’s QSSS election, the corporation may be allowed to elect QSSS or S corporation status without waiting five years if, immediately following the termination, the corporation is otherwise eligible to make an S corporation election or QSSS election, and the election is effective immediately following the termination of the QSSS election. Examples where this rule would apply include an S corporation selling all of its QSSS stock to another<br /> S corporation, or an S corporation distributing all of its QSSS stock to its shareholders and the former QSSS making an S election.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRC § 1361(b)(3).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Treas. Reg. § 1.1361-4(a)(3).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. §§ 1.1361-4(a)(7) and 1.1361-4(a)(8).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.1361-4(a)(8)(i)(E).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.  IRC § 1361(b)(3).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.  Treas. Reg. § 1.1361-5(c).<br /> <br /> </div>

<div class="Section1">Only pass-through entities that qualify as a “trade or business” are entitled to claim the new 20 percent deduction for qualified business income under Section 199A. Many business owners engaged in rental real estate activities had questioned whether their businesses would qualify for the deduction. In response, the IRS released proposed Revenue Procedure 2019-07, finalized by Revenue Procedure 2019-38, which provides a safe harbor so that rental real estate businesses will qualify as “trades or businesses” and can claim the 199A deduction if they satisfy certain criteria. For purposes of the safe harbor, “rental real estate enterprise” is defined to include any interest in real property held to generate rental or lease income, and can be comprised of an interest in a single property or multiple properties.</div><br /> <div class="Section1"><br /> <br /> To qualify under the safe harbor, the following requirements must be met:<br /> <blockquote>(1)  Separate books and records for each rental enterprise must be maintained,<br /> <br /> (2)  If the rental real estate enterprise has been in existence for less than four years, 250 or more hours of rental real estate services must be performed each year,<br /> <br /> (3)  If the rental real estate enterprise has been in existence for more than four years, at least 250 hours of rental real estate services must have been performed in at least three of the past five years (these services can be performed by employees or independent contractors of the business), and<br /> <br /> (4)  The taxpayer must maintain contemporaneous records regarding the rental real estate services that are performed each year, including time reports, logs or similar documents, with respect to (a) description of all services performed, (b) dates on which the services were performed and (c) who performed the services,<br /> <br /> (5)  The taxpayer must attach a statement to the relevant tax return indicating that the safe harbor is being relied upon<em>.</em></blockquote><br /> To qualify under the safe harbor, the interest in real property must also be held directly by the taxpayer or through an entity disregarded as an entity separate from the owner (i.e., a single-member LLC).<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Rev. Proc. 2019-38.<br /> <br /> </div>

<div class="Section1">An ESBT is a trust in which all of the beneficiaries are individuals, estates, or charitable organizations.<a href="#_ftn1" name="_ftnref1">¹</a> Each potential current beneficiary of an ESBT is treated as a shareholder for purposes of the shareholder limitation.<a href="#_ftn2" name="_ftnref2">²</a> A potential current beneficiary is generally, with respect to any period, someone who is entitled to, or in the discretion of any person may receive, a distribution of principal or interest of the trust. In addition, a person treated as an owner of a trust under the grantor trust rules (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="797">797</a>) is a potential current beneficiary.<a href="#_ftn3" name="_ftnref3">³</a> If for any period there is no potential current beneficiary of an ESBT, the ESBT itself is treated as an<br /> S corporation shareholder.<a href="#_ftn4" name="_ftnref4">⁴</a>&nbsp;Trusts exempt from income tax, QSSTs, charitable remainder annuity trusts, and charitable remainder unitrusts may not be ESBTs. An interest in an ESBT may not be obtained by purchase.<a href="#_ftn5" name="_ftnref5">⁵</a> If any portion of a beneficiary&rsquo;s basis in the beneficiary&rsquo;s interest is determined under the cost basis rules, the interest was acquired by purchase.<a href="#_ftn6" name="_ftnref6">⁶</a> An ESBT is taxed at the highest income tax rate under IRC Section 1(e) (39.6 percent for 2013-2017, 37&nbsp;percent for 2018-2025).<a href="#_ftn7" name="_ftnref7">⁷</a>&nbsp;The 2017 tax reform legislation expanded the definition of a qualifying beneficiary under an electing small business trust (ESBT) to include nonresident aliens.<a href="#_ftn8" name="_ftnref8">⁸</a>&nbsp;This provision is effective beginning January&nbsp;1, 2018.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;1361(e).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;1361(c)(2)(B)(v).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.1361-1(m)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.1361-1(h)(3)(i)(F).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect;&nbsp;1361(e).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; Treas. Reg. &sect;&nbsp;1.1361-1(m)(1)(iii).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; IRC &sect;&nbsp;641(c).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp; IRC &sect;&sect;&nbsp;1361(c)(2)(B)(v), 1361(b)(1)(C).<br /> <br /> </div></div><br />

<div class="Section1">A corporation will be treated as having one class of stock if all of its outstanding shares confer identical rights to distribution and liquidation proceeds.<a href="#_ftn1" name="_ftnref1">¹</a> “Bona fide agreements to redeem or purchase stock at the time of death, disability or termination of employment” will be disregarded for purposes of the one-class rule unless a principal purpose of the arrangement is to circumvent the rule. Similarly, bona fide buy-sell agreements will be disregarded unless a principal purpose of the arrangement is to circumvent the one-class rule and they establish a purchase price that is not substantially above or below the fair market value of the stock. The IRS confirmed that this was the case, so that a buy-sell agreement could be disregarded, even when an equity compensation plan was involved that called for a forfeiture price for shares that could have been as low as $0.<a href="#_ftn2" name="_ftnref2">²</a></div><br /> <div class="Section1"><br /> <br /> Agreements that provide for a purchase price or redemption of stock at book value or a price between book value and fair market value will not be considered to establish a price that is substantially above or below fair market value.<a href="#_ftn3" name="_ftnref3">³</a> Regulations provide that agreements triggered by divorce and forfeiture provisions that cause a share of stock to be substantially nonvested will be disregarded in determining whether a corporation’s shares confer identical rights to distribution and liquidation proceeds.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  Treas. Reg. § 1.1361-1(l)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.  Let. Rul. 201918013.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.  Treas. Reg. § 1.1361-1(l)(2)(iii). <em><em>See</em></em> IRC §§ 1361, 1362.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.  Treas. Reg. § 1.1361-1(l)(2)(iii)(B).<br /> <br /> </div>

<div class="Section1">A QSST is a trust that has only one current income beneficiary (who must be a citizen or resident of the U.S.), all income must be distributed currently, and the trust corpus may not be distributed to anyone else during the life of such beneficiary. The income interest must terminate upon the earlier of the beneficiary&rsquo;s death or termination of the trust. If the trust terminates during the lifetime of the income beneficiary, all trust assets must be distributed to that beneficiary. The beneficiary must make an election for the trust to be treated as a QSST.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> When the stock is initially transferred to the trust, the taxpayer must file a separate S corporation election. For both the QSST and the electing small business trust (ESBT, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8974">8974</a>), the election must be filed &ldquo;within the 16 day and two month period beginning on the day that the stock is transferred to the trust.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> <hr><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.IRC &sect; 1361(d).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.Treas. Reg. &sect;&sect; 1.1361-1(j)(6)(iii); 1.1361-1 (m)(2)(iii).<br /> <br /> </div></div><br />

<div class="Section1"><em>Editor&rsquo;s Note:</em>&nbsp;The 2017 tax reform legislation modified the treatment of S corporations that convert to C corporations. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for details.<div class="Section1"><br /> <br /> The basis of each shareholder&rsquo;s stock is <em>increased</em> by the shareholder&rsquo;s share of items of separately stated income (including tax-exempt income), by his or her share of any non-separately computed income, and by any excess of deductions for depletion over basis in property subject to depletion.<a href="#_ftn1" name="_ftnref1">¹</a> An S corporation shareholder may <em>not</em> increase basis due to excluded discharge of indebtedness income.<a href="#_ftn2" name="_ftnref2">²</a>&nbsp;The basis of each shareholder&rsquo;s stock is <em>decreased</em> (not below zero) by items of distributions from the corporation that are not includable in the income of the shareholder, separately stated loss and deductions and non-separately computed loss, any expense of the corporation not deductible in computing taxable income and not properly chargeable to capital account, and any depletion deduction with respect to oil and gas property to the extent that the deduction does not exceed the shareholder&rsquo;s proportionate share of the property&rsquo;s adjusted basis.<br /> <br /> For tax years beginning after 2005, if an S corporation makes a charitable contribution of property, each shareholder&rsquo;s basis is reduced by the pro-rata share of the basis in the property.<a href="#_ftn3" name="_ftnref3">³</a> If the aggregate of these amounts exceeds the basis in the stock, the excess reduces the shareholder&rsquo;s basis in any indebtedness of the corporation to the shareholder.<a href="#_ftn4" name="_ftnref4">⁴</a> A shareholder may not take deductions and losses of the S corporation that, when aggregated, exceed the basis in the S corporation stock plus the basis in any indebtedness of the corporation to the shareholder.<a href="#_ftn5" name="_ftnref5">⁵</a> Such disallowed deductions and losses may be carried over.<a href="#_ftn6" name="_ftnref6">⁶</a> In other words, the shareholder may not deduct in any tax year more than what is &ldquo;at risk&rdquo; in the corporation.<br /> <br /> Generally, earnings of an S corporation are not treated as earnings and profits. A corporation may have accumulated earnings and profits for any year in which a valid election was not in effect or as the result of a corporate acquisition in which there is a carryover of earnings and profits under IRC Section&nbsp;381.<a href="#_ftn7" name="_ftnref7">⁷</a> Corporations that were S corporations before 1983 but were not S corporations in the first tax year after 1996 are able to eliminate earnings and profits that were accumulated before 1983 in their first tax year beginning after May&nbsp;25, 2007.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> A distribution from an S corporation that does not have accumulated earnings and profits lowers the shareholder&rsquo;s basis in the corporation&rsquo;s stock.<a href="#_ftn9" name="_ftnref9">⁹</a> Any excess is generally treated as capital gain.<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> If the S corporation does have earnings and profits, distributions are treated as distributions by a corporation without earnings and profits, to the extent of the shareholder&rsquo;s share of an accumulated adjustment account (i.e., post-1982 gross receipts less deductible expenses, which have not been distributed). Any excess distribution is treated under the usual corporate rules.&nbsp;That is, it is a dividend up to the amount of the accumulated earnings and profits. Any excess is applied to reduce the shareholder&rsquo;s basis. Finally, any remainder is treated as a gain as if the stock had been sold.<a href="#_ftn11" name="_ftnref11">¹¹</a> However, in any tax year, shareholders receiving the distribution may, if all agree, elect to have all distributions in the year treated first as dividends to the extent of earnings and profits and then as return of investment to the extent of adjusted basis and any excess as capital gain.<a href="#_ftn12" name="_ftnref12">¹²</a> If the IRC Section&nbsp;1368(e)(3) election is made, it will apply to all distributions made in the tax year.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> Certain distributions from an S corporation in redemption of stock receive sale/exchange treatment. (Generally, only gain or loss, if any, is recognized in a sale.) In general, redemptions that qualify for &ldquo;exchange&rdquo; treatment include redemptions not essentially equivalent to a dividend, substantially disproportionate redemptions of stock, complete redemptions of stock, certain partial liquidations, and redemptions of stock to pay estate taxes.<a href="#_ftn14" name="_ftnref14">¹⁴</a><br /> <br /> If the S corporation distributes appreciated property to a shareholder, gain will be recognized to the corporation as if the property had been sold at fair market value; the gain will pass through to shareholders like any other gain.<a href="#_ftn15" name="_ftnref15">¹⁵</a><br /> <br /> The rules discussed above generally apply in tax years beginning after 1982. Nonetheless, certain casualty insurance companies and certain corporations with oil and gas production will continue to be taxed under the rules applicable to Subchapter S corporations in effect prior to these rules.<a href="#_ftn16" name="_ftnref16">¹⁶</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;1367(a)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;108(d)(7)(A).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;1367(a)(2), as amended by&nbsp;TEAMTRA 2008,&nbsp;TRUIRJCA 2010, ATRA 2012 and PATH 2015.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&nbsp;1367(b)(2)(A).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect;&nbsp;1366(d)(1).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; IRC &sect;&nbsp;1366(d)(2).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; IRC &sect;&nbsp;1371(c).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp; SBWOTA 2007 &sect;&nbsp;8235.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp; IRC &sect;&nbsp;1367(a)(2)(A).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp; IRC &sect;&nbsp;1368(b).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp; IRC &sect;&nbsp;1368(c).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp; IRC &sect;&nbsp;1368(e)(3).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp; Let. Rul. 8935013.<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>.&nbsp; IRC &sect;&sect;&nbsp;302, 303.<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>.&nbsp; IRC &sect;&sect;&nbsp;1371(a), 311(b).<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>.&nbsp; Subchapter S Revision Act of 1982, &sect;&nbsp;6.<br /> <br /> </div></div><br />

<div class="Section1"><em>Editor&rsquo;s Note: <em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a discussion of the substantial changes to S corporation taxation made by the 2017 tax reform legislation.<div class="Section1"><br /> <br /> An S corporation is a corporation that elects to be treated, in general, as a pass-through entity, thus avoiding most tax at the corporate level.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;To be eligible to make the election, a corporation must meet certain requirements as to the kind and number of shareholders, classes of stock, and sources of income. An S corporation must be a domestic corporation with only a single class of stock and may have up to 100 shareholders (none of whom are nonresident aliens) who are individuals, estates, and certain trusts. An S corporation may not be an ineligible corporation. An ineligible corporation is one of the following: (1) a financial institution that uses the reserve method of accounting for bad debts; (2) an insurance company; (3) a corporation electing (under IRC Section&nbsp;936) credits for certain taxes attributable to income from Puerto Rico and other U.S. possessions; and (4) a current or former domestic international sales corporation (DISC). Qualified plans and certain charitable organizations may be S corporation shareholders.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> Members of a family are treated as one shareholder. &ldquo;Members of the family&rdquo; is defined as &ldquo;the common ancestor, lineal descendants of the common ancestor, and the spouses (or former spouses) of such lineal descendants or common ancestor.&rdquo; Generally, the common ancestor may not be more than six generations removed from the youngest generation of shareholders who would be considered members of the family.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> Trusts that may be S corporation shareholders include: (1) a trust all of which is treated as owned by an individual who is a citizen or resident of the United States under the grantor trust rules (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="797">797</a>); (2) a trust that was described in (1) above immediately prior to the deemed owner&rsquo;s death and continues in existence after such death may continue to be an S corporation shareholder for up to two years after the owner&rsquo;s death; (3) a trust to which stock is transferred pursuant to a will may be an S corporation shareholder for up to two years after the date of the stock transfer; (4) a trust created primarily to exercise the voting power of stock transferred to it; (5) a qualified subchapter S trust (QSST, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8973">8973</a>); (6) an electing small business trust (ESBT, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8974">8974</a>); and (7) in the case of an S corporation that is a bank, an IRA, or Roth IRA.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; See IRC &sect;&sect;&nbsp;1361, 1362, 1363.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;1361.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;1361(c)(1).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&sect;&nbsp;1361(c)(2), 1361(d).<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Entities that are taxed under the rules governing passthrough taxation are generally entitled to a 20&nbsp;percent deduction for qualified business income (QBI, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>). This deduction is equal to the sum of:<br /> <blockquote>(a)&nbsp; the lesser of the combined QBI amount for the tax year or an amount equal to 20&nbsp;percent of the excess of the taxpayer&rsquo;s taxable income over any net capital gain and cooperative dividends, plus<br /> <br /> (b)&nbsp; the lesser of 20&nbsp;percent of qualified cooperative dividends or taxable income (reduced by net capital gain).<a href="#_ftn1" name="_ftnref1">¹</a></blockquote><br /> The sum discussed above may not exceed the taxpayer&rsquo;s taxable income for the tax year (reduced by net capital gain). Further, the 20&nbsp;percent deduction with respect to qualified cooperative dividends is limited to taxable income (reduced by net capital gain).<br /> <br /> The deductible amount for each qualified trade or business is the lesser of:<br /> <blockquote>(a)&nbsp; 20&nbsp;percent of the QBI with respect to the trade or business or<br /> <br /> (b)&nbsp; the greater of (x) 50&nbsp;percent of W-2 wage income or (y) the sum of 25&nbsp;percent of the W-2 wages of the business plus 2.5&nbsp;percent of the unadjusted basis, immediately after acquisition, of all qualified property (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a>).<a href="#_ftn2" name="_ftnref2">²</a></blockquote><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong><em>&nbsp;</em>The regulations provide guidance on how UBIA should be calculated in the case of a like-kind exchange or involuntary conversion. The regulations follow the Section&nbsp;168 regulations in providing that property acquired in a like-kind exchange, or by conversion, is treated as MACRS property, so that the depreciation period is determined using the date the relinquished property was first placed into service unless an exception applies. The exception applies if the taxpayer elected&nbsp;<em>not</em>&nbsp;to apply&nbsp;Treasury Regulation&nbsp;&sect;&nbsp;1.168(i)-6. As a result, most property acquired in a like-kind exchange or involuntary conversion under the new rules will have two relevant placed in service dates. For calculating UBIA, the relevant date is the date the taxpayer places the property into service. For calculating its depreciable period, the relevant date is the date the taxpayer placed the original, relinquished property into service<em>.</em><br /> <br /> <hr><br /> <br /> Concurrently with the proposed regulations, the IRS released Notice 2018-64, which contains a proposed revenue procedure with guidance for calculating W-2 wages for purposes of the Section&nbsp;199A deduction for qualified business income.&nbsp;This guidance was finalized in Revenue Procedure 2019-11. The guidance provides three methods for calculating W-2 wages, including the &ldquo;unmodified box method,&rdquo; the &ldquo;modified Box 1 method,&rdquo; and the &ldquo;tracking wages method.&rdquo;&nbsp;The guidance further specifies that wages calculated under these methods are only taken into account in determining the W-2 wage limitations if properly allocable to QBI under Proposed&nbsp;Treasury Regulation Section&nbsp;1.199A-2(g).<br /> <br /> The unmodified box method involves taking the lesser of (1) the total of Box 1 entries for all W-2 forms or (2) the total of Box 5 entries for all W-2 forms (in either case, those that were&nbsp;filed with the SSA by the taxpayer for the year). Under the modified Box 1 method, the taxpayer subtracts from its total Box 1 entries amounts that are not wages for federal income tax withholding purposes, and then adds back the total of Box 12 entries for certain employees. The tracking wages method requires the taxpayer to actually track employees&rsquo; wages, and<br /> (1) total the wages subject to income tax withholding and (2) subtract the total of all Box 12 entries of certain employees.<br /> <br /> Revenue Procedure 2019-11 clarifies that, in the case of short taxable years, the business owner is required to use the &ldquo;tracking wages method&rdquo; with certain modifications. The total amount of wages subject to income tax withholding and reported on Form W-2 can only include amounts that are actually or constructively paid to the employee during the short tax year and reported on a Form W-2 for the calendar year with or within that short tax year. With respect to the amounts reported in Box 12, only the portion of the total amount reported that was actually deferred or contributed during the short year can be included in W-2 wages.<br /> <br /> If the taxable income is below the applicable threshold levels (in 2025, $197,300 for single filers and $394,600 for joint returns), the deduction is simply 20 percent.<a href="#_ftn3" name="_ftnref3">³</a> For 2024, the applicable threshold levels are $191,950 for single filers and $383,900 for joint returns.<br /> <br /> If the taxable income exceeds the relevant threshold amount, but not by more than $50,000 ($100,000 for joint returns), and the amount determined under (b), above, is less than the amount under (a), above, then the deductible amount is determined without regard to the calculation required under (b). However, the deductible amount allowed under (a) is reduced by the amount that bears the same ratio to the &ldquo;excess amount&rdquo; as (1) the amount by which taxable income exceeds the threshold amount bears to (2) $50,000 ($100,000 for joint<br /> returns).<br /> <br /> The &ldquo;excess amount&rdquo; means the excess of the amount determined under (a), above, over the amount determined under (b), above, without regard to the reduction described immediately above.<br /> <br /> &ldquo;Combined qualified business income&rdquo; for the year is the sum of the deductible amounts for each qualified trade or business of the taxpayer and 20&nbsp;percent of the taxpayer&rsquo;s qualified REIT dividends and qualified publicly traded partnership income.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> &ldquo;Qualified cooperative dividends&rdquo; includes a patronage dividend, per-unit retain allocation, qualified written notice of allocation, or any similar amount that is included in gross income and received from (a) a tax-exempt benevolent life insurance association, a mutual ditch or irrigation company, cooperative telephone company, like cooperative organization or a taxable or tax-exempt cooperative that is described in Section&nbsp;1381(a), or (2) a taxable cooperative governed by tax rules applicable to cooperatives before the enactment of subchapter&nbsp;T of the Code in 1962.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> &ldquo;Qualified publicly traded partnership income&rdquo; means the sum of:<br /> <blockquote>(1)&nbsp; the net amount of the taxpayer&rsquo;s allocable share of each qualified item of income, gain, deduction, and loss from a publicly-traded partnership that does not elect to be taxed as a corporation (so long as the item is connected with a U.S. trade or business and is included or allowed in determining taxable income for the year and is not excepted investment-type income, also not including the taxpayer&rsquo;s reasonable compensation, guaranteed payments for services or Section&nbsp;707(a) payments for services), and<br /> <br /> (2)&nbsp; gain recognized by the taxpayer on disposing its interest in the partnership that is treated as ordinary income.<a href="#_ftn7" name="_ftnref7">⁷</a></blockquote><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; IRC &sect;&nbsp;199A(a)<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; IRC &sect;&nbsp;199A(b)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp; IRC &sect;&nbsp;199A(b)(3).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp; IRC &sect;&nbsp;199A(b)(1).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp; IRC &sect;&nbsp;199A(e)(3).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp; IRC &sect;&nbsp;199A(e)(4).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp; IRC &sect;&nbsp;199A(e)(5).<br /> <br /> &nbsp;<br /> <br /> </div></div><br />