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Treasury, IRS issue 199A business tax deduction guidance

Rules and regulations and guidance

If you've been thinking since the enactment of the Tax Cuts and Jobs Act (TCJA) about devising a way to do your current job as an independent contractor instead of as an employee, think again.

The Treasury Department today dashed many such tax-driven work-related dreams.

Treasury issued (finally!) proposed regulations on the new Section 199A deduction that it says will prevent employees from improperly reclassifying themselves as independent contractors.

Lower tax on self-employment income: That work recharacterization seemed appealing in the immediate aftermath of the new tax law.

Amid all that was included in the hastily written TCJA, it was the 199A deduction that caught the attention of many taxpayers and tax pros almost as soon as the new tax law was enacted on Dec. 22, 2017.

This is a 20-percent individual income tax deduction for income from pass-through businesses, such as sole proprietorships and partnerships. Eligible taxpayers can claim this new deduction for the first time on tax year 2018 federal income tax returns they file next year.

The obvious appeal of 199A is that it offers taxpayers who get their income from their own businesses the opportunity to pay less tax than if they had received the same amount of compensation via salary.

And that got lots of folks considering moving off of company payrolls and doing their work as self-employed contractors.

Everyone's been trying to put the tax worms back in the can since.

Treasury weighs in: The U.S. Treasury officially joined the tax worm wrangling today with its release of 199A proposed regulations.

"The pass-through deduction is an important tax cut for small and mid-size businesses, reducing their effective tax rates to their lowest levels since the 1930s," said Treasury Secretary Steven T. Mnuchin in his announcement accompanying the regs' release.

To that end, Treasury said its long-anticipated guidance is designed to "ensure that this historic tax cut will be available to the broadest spectrum of American businesses, consistent with the law, while minimizing compliance costs and streamlining the process for claiming the deduction."

The regs also include what Treasury is calling anti-abuse safeguards to prevent improper tax avoidance schemes, such as the previously noted relabeling of employees as independent contractors.

Clarity, flexibility and anti-abuse, oh my! Overall, Treasury says its proposed regs, which you can read in full in the Department's PDF document, will:

  • Ensure that all small business income below $315,000 for married couples filing jointly (and $157,500 for single filers) is eligible for the deduction; and
  • Provide clarity and flexibility for filers over those income thresholds.

The promised clarity and flexibility include:

  • Aggregation rules for filers with pass-through income from multiple sources;
  • Guidance relating to specified service, trade or business (SSTB) income above the thresholds, which may be subject to limitation for the purposes of claiming the deduction; and
  • Allowance of a de minimis exception to avoid unnecessary compliance costs for businesses earning only a small percentage of SSTB income.

IRS separate guidance, too: Meanwhile, over on Constitution Avenue, N.W., in downtown D.C., the Internal Revenue Service also released separate guidance for calculating W-2 wages for the purposes of the 199A deduction.

The IRS notes that the new tax break generally is equal to the lesser of 20 percent of a filer's qualified business income plus 20 percent of the taxpayer's qualified real estate investment trust dividends and qualified publicly traded partnership income or 20 percent of taxable income minus net capital gains.

The deduction generally is available to eligible taxpayers whose 2018 taxable incomes are less than $315,000 if filing a joint return or less than $157,500 for all other taxpayers.

When a taxpayer's income is more than the $157,500 or $315,000 taxable income thresholds, the 199A deduction may be limited.

In IRS Notice 2018-64 details methods for calculating Form W-2 wages for purposes of the limitations on the deduction.

And if you have more questions about the deduction — and who doesn't? — you can find more in the IRS' online FAQs on Section 199A.

Finally, be sure to talk with your tax pro. Just give them some time to completely digest today's announcements.

UPDATE, Aug. 9, 2018: Good things come to those who wait. That's why I waited for Tony Nitti, tax partner in WithumSmith+Brown's National Tax Service Group and Forbes contributor, to provide his take on the 199A deduction regs.

Nitti notes that the 184 pages issued yesterday provide much-needed clarity on many, but not all, of the issues raised by the confusing statute. But unfortunately, he points out, "some of that clarity was not of the taxpayer-friendly variety, but that's how things go in the tax world."

Check out Nitti's analysis of the good and bad of the proposed regulations.  

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