Today, Treasury and the IRS released final regulations on the 20% deduction for pass-through businesses under Section 199A. Simultaneous with the final regulations, the IRS also released: (1) proposed regulations (REG-13465-18), (2) Notice 2019-07 and (3) Revenue Procedure 2019-11.

The final regulations adopt, with changes, the proposed regulations issued on August 8, 2018. Highlights of the final regulations include:

• Allowing taxpayers to rely on either the proposed regulations, in whole, or the final regulations, in whole, for tax years ending in calendar year 2018
• Retaining the Section 162 trade or business standard, but clarifying that a C corporation cannot be a commonly controlled trade or business for purposes of the trade or business definition relating to rental activity
• Changing the manner in which a partnership allocates the basis of qualified property
• Changing the computation of qualified property's basis after a Section 351 contribution, a Section 721 contribution and a Section 1031 exchange
• Allowing an "excess Section 743(b) basis adjustment" to be treated as qualified property
• Allowing a relevant pass-through entity (RPE), such as a partnership, to aggregate under Reg. Section 1.199A-4
• Modifying common ownership anti-abuse rules to eliminate:
• The treatment of a trade or business as a specified service trade or business (SSTB) when it provides more than 80% of its property or services to an SSTB (the rule would treat a proportional amount of the trade or business as an SSTB)
• The "incidental rule," which treated a trade or business as an SSTB if the trade or business had 50% or more common ownership with another SSTB, shared expenses with that SSTB and represented no more than 5% of the gross receipts of the combined businesses
• Modifying the anti-abuse presumption regarding persons previously treated as employees
• Clarifying ownership rules for purposes of the aggregation rule
• Revising the presumption related to the failure of an RPE to separately identify or report an item related to Section 199A
• Clarifying that the S and non-S portions of an electing small business trust are treated as a single trust for purposes of determining the taxable income threshold amount

Other items addressed by the final regulations include:

• Guidance on disregarded entities
• Treatment of special basis adjustments under Section 743(b)
• Ordering rules for previously disallowed, suspended or limited losses
• Compliance and reporting rules relating to aggregation of trades or businesses

The proposed regulations address issues not covered in the August 8 proposed regulations, such as treating previously disallowed losses as losses from a separate trade or business and allowing a regulated investment company (RIC) that receives qualified dividends from a real estate investment trust to pay "Section 199A dividends" under certain circumstances. The IRS and Treasury are still considering whether to allow a RIC receiving income from a publicly traded partnership to pay Section 199A dividends. The proposed regulations do not address whether common trust funds are RPEs, an issue that commentators urged Treasury and the IRS to address.

Notice 2019-07 outlines a proposed safe harbor that would treat a rental real estate enterprise as a trade or business only for purposes of Section 199A and its regulations. To qualify for the safe harbor, the rental real estate enterprise would have to meet various requirements. The proposed safe harbor would generally apply to taxpayers with tax years ending after December 31, 2017. Taxpayers may rely on the safe harbor until it is published in a revenue procedure.

Revenue Procedure 2019-11 outlines three methods for determining the amount of W-2 wages, which is needed to calculate the limitation on the deduction for qualified business income under Section 199A. The revenue procedure applies to tax years ending after December 31, 2017.

A Tax Alert on the 199A guidance is forthcoming. An invitation to a webcast on the 199A guidance will be sent shortly.