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Section 199A deduction

Elusive new pass-through deduction demands an early start

Individuals, estates, and trusts that are owners of pass-through businesses are starting to address what’s required to qualify for the section 199A deduction. And they may be realizing it is both a tax benefit and a compliance challenge.

The section 199A deduction: It’s complicated

Tax season may begin early this year for pass-through businesses. That’s because this is the first year individuals, estates, and trusts (“owners”) that are owners of these pass-through businesses will be able to claim the section 199A deduction. The 2017 Tax Act (P.L.115-97) included this deduction to even the playing field with corporations that benefited from its significant cut in the corporate tax rate. The deduction is effective for tax years beginning in 2018 and is available for tax years beginning before December 31, 2025. It allows owners to deduct up to 20 percent of the domestic qualified business income (QBI) earned by the business on the owner’s tax return, subject to other significant limitations. The government issued final regulations for this deduction in February 2019.

But those who have started to address what’s required to qualify for the deduction may be realizing that 199A is both a tax benefit and a compliance challenge. Unlike a simple reduction in a tax rate, which is clean and relatively easy to calculate, this deduction is complex. It requires multiple assessments and calculations, new information to be gathered and shared by each pass-through with its owners, and is subject to numerous significant limitations. The provision may also cause some business owners to consider changes in the way some businesses are structured so as to be positioned to better benefit from this provision.

In short, the compliance burden is both complex and mandatory—all pass-through entities must now provide this critical information to their owners on a going-forward basis.

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Claiming the pass-through deduction: Three principal questions

Even at a basic level, those who want to claim the section 199A deduction must be able to answer three principal questions:

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Pass-through businesses should immediately start assessing the business and financial information necessary to answer the questions above. The many complexities involved with the new pass-through deduction, from both an accounting and planning perspective, mean that treating this tax season as any other may, at the least, limit the benefits of the deduction, and, at the worst, push pass-throughs into decision making that may have unintended, negative long-term implications.

This is a new compliance burden unlike any other faced by pass-throughs, and tax teams should get a jumpstart to respond to these potentially rewarding, but exacting new requirements.

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