Section 199A, as added by the Tax Cuts and Jobs Act, P.L. 115-97, §11011 (12/22/2017), allows a non-corporate taxpayer to deduct up to 20% of its qualified business income, subject to applicable limitations, in reducing taxable income. Qualified business income from a domestic source income attributable to a domestic business operated as a sole proprietorship or through a passthrough entity including a partnership, S corporation, trust, or estate referred to collectively as a “relevant passthrough entity” under the final regulations issued in early February of this year. Section 199A applies to tax years commencing in 2018 through 2025.
General Landscape of Section 199A
Under section 199A(a), the allowable deduction for any taxable year is an amount equal to: (i) under section 199A(a)(1), the combined qualified business income of the taxpayer or (ii) under section 199A(a)(2), an amount equal to 20% of the excess, if any, of the taxable income of the taxpayer less net capital gain which includes qualified dividends. Under section 199A(b), the term “combined qualified business income” is an amount equal to: (i) under section 199A(b)(1)(A), the sum of the amounts determined under section 199A(a)(2) for each qualified trade or business carried on by the taxpayer (or through an RPE in which he is an owner), plus (ii) under section 199A(b)(1)(B), 20% of the aggregate amount of REIT dividends and qualified publicly traded partnership income of the taxpayer for the taxable year.
Next, under section 199A(b)(2), the deductible amount for each qualified trade or business that the taxpayer directly carries on or indirectly is treated as carrying on through an RPE, is the lesser of: (i) under section 199A(b)(2)(A) 20% of the taxpayer’s qualified business income as to each such trade or business; or (ii) under section 199A(b)(2)(B), the greater of: (i) under section 199A(b)(2)(B)(i) 50% of the W-2 wages paid or accrued as to each qualified trade or business; or (ii) under section 199(b)(2)(B)(ii), 25% of the W-2 wages paid or accrued with respect to each qualified trade or business plus 2.5% of the unadjusted basis immediately after the acquisition of all qualified property (“UBIA”). The limitations under section 199A(b)(2)(B), which will also be discussed in an upcoming post, may materially limit the benefit of the section 199A deduction in particular instances. While taxpayers engaged in a qualified trade or business may be eligible to benefit from the 20% deduction, thereby reducing the maximum rate of federal income tax to 29.4% from 37% as to the taxpayer’s qualified business income, the limitation rule, i.e., 50% of W-2 wages or 25% of W-2 wages plus 2.5% of UBIA, may substantially limit the allowable deduction. Any excess is not permitted to be carried over. Ironically, for taxpayers deriving income from a “specified service trade or business” (SSTB) having taxable income below the threshold amount, see section 199A(b)(3), and as further subject to a phase-in rule in section 199A(b)(3)(B), such taxpayer’s SSTB is allowed to receive the 20 percent deduction as if the income from the SSTB were qualified business income. As noted, C corporations, including a consolidated group of (C) corporations, do not qualify for the 20% deduction under section 199A.
The Starting Point: What is Qualifying Trade or Business For Purposes of Section 199A?
The final regulations, T.D. 9847, issued on February 11, 2019, are set out in six sections, each of which provides rules pertinent to the calculation of the section 199A deduction. As to the definition of qualified business income (“QBI”), the final regulations clarify the definition of “net capital gain” which amount is reduced in computing QBI. The definition set forth in last Summer’s proposed regulations as to the definition of a trade or business, which adopts by reference the case law interpretation of such phrase under section 162(a), provide in Treas. Reg. § 1.199A-1(b)(14) that the phrase “trade or business” is defined under section 162(a), i.e., the carrying on of a trade or business, other than the trade or business of performing services as an employee. Whether a taxpayer or RPE is carrying on a trade or business exists is a factual determination as there is no statutory or regulatory definition. The judicial precedent in this area have consistently recognized that there are two factors that a taxpayer must prove, by a preponderance of the evidence, that it is carrying on a trade or business: (i) that the trade or business is primarily engaged in for the production of profit; and (ii) that the operation of the business be continuous, substantial and material. Where a taxpayer engages in a investment activity for his own account, regardless of the frequency and materiality of the effort, the Supreme Court has held that such activity is not the “carrying on of a trade or business” under section 162(a) and therefore would not be for purposes of section 199A.
In issuing final regulations the Treasury and the Service received several hundred comments under the Administrative Procedures Act comment period. A part of the Preamble to the final regulations sets forth several areas which the rule-makers considered and then rejected in connection with defining a qualified business. This portion of the Preamble should be helpful in explaining to tax advisors and tax return preparers what is not a qualified trade or business under section 199A. For example, comments were received that suggested the final regulations adopt the definitions or rules regarding a trade or business found in other provisions of the Code, including sections 469 pertaining to the passive activity loss rules and 1411, which is the Medicare tax provision on certain investment income. In response, the Preamble noted that section 469(c)(6) and Treas. Reg. §1.469-4(b)(1) broadly define trade or business activities other than rental activities to include any activity performed: (i) in connection with a trade or business within the meaning of section 162, (ii) with respect to which expenses are allowable as a deduction under section 212, (iii) conducted in anticipation of the commencement of a trade or business, or (iv) that involves research and experimentation expenditures (per section 174). Treas. Reg. §1.469-4(b)(2) defines a rental activity as an activity that constitutes a rental activity within the meaning of Treas. Reg. §1.469-1T(e)(3). Passive activities for purposes of section 469 are defined as any activity that involves the conduct of a trade or business in which the taxpayer does not materially participate and includes all rental activity. The point made by the Service is that the definition of trade or business for section 469 purposes is significantly broader than the definition for purposes of section 162 as section 469, by design, was intended to capture a larger universe of activities, including passive activities. The purpose Congress had in enacting a deduction limitation rule in section 469 serves a very different purpose than the allowance of a deduction under section 199A. Further, section 199A does not require that a taxpayer materially participate in a trade or business in order to qualify for the section 199A deduction. The recommendation to adopt the section 469 definition of “activity” for purposes of section 199A in defining a trade or business was rejected. The Treasury Department and the IRS also declined to define trade or business by reference to section 1411 as Treas. Reg. §1.1411-1(d)(12) defines trade or business by reference to section 162 in a manner similar to Treas. Reg. §1.199A-1(b)(14).
The Preamble further notes comments were received that suggested the section 199A regulations incorporate the real estate professional provisions in section 469(c)(7) in a manner similar to the cross references in section 163(j) and Treas. Reg. §1.1411-4(g)(7). Under section 469, a real estate professional may treat rental real estate activities described in section 469(c)(7)(C) as non-passive activities provide the taxpayer can prove that she materially participates in such activities. Treas. Reg. §1.469-5T(a) contains seven tests in meeting the material participation test, but as noted above, these tests only determine whether an individual materially participates in a rental real estate activity. They cannot be used to determine whether the activity itself is a trade or business. Unlike section 469, the section 199A deduction is not determined based on the taxpayer’s level of participation in a trade or business, nor does it require that an individual materially participate in the trade or business. Instead, section 199A is dependent on whether the individual has QBI from a trade or business. Consequently, the Treasury Department and the IRS decline to adopt these comments because the Treas. Reg. §1.469-5T material participation tests are not a proxy to establish regular, continuous, and considerable activity that rises to the level of a trade or business for purposes of section 199A.
Rental Real Estate Activities a Trade or Business Under Section 199A?
Many APA comments addressed how rental real estate activities would be treated for purposes of section 199A. Commenters noted inconsistency in the case law in determining whether a taxpayer renting real estate is engaged in a trade or business. For example under section 355, which pertains to tax-free spin-off, split-off or split-up transaction, there is an active business requirement. More particularly for a transaction to qualify under section 355: (i) each of the distributing corporations and the controlled corporation (or, if the stock of more than one controlled corporation is distributed, as in a liquidating split-up of a holding company, each of the controlled corporations) must be engaged immediately after the distribution in the active conduct of a trade or business; (ii) each such active business must have been conducted throughout the five-year period ending on the date of the distribution; and (iii) each such active business must not have been acquired, directly or indirectly, by a purchase or other transaction in which any gain or loss was recognized.
Under the regulations to section 355 a trade or business is defined as:
“A corporation shall be treated as engaged in a trade or business … if a specific group of activities are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation which forms a part of, or a step in, the process of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.” 
Some commenters suggested including safe harbors, tests, or a variety of factors, which if satisfied, would qualify a rental real estate activity as a trade or business. Others suggested that all rental real estate activity should qualify as a trade or business. Further, one commenter suggested that rental income from real property held for the production of rents within the meaning of section 62(a)(4) should be considered a trade or business for purposes of section 199A. The Preamble further noted that another comment suggested that the final regulations provide that an individual whose taxable income does not exceed the threshold amount will be considered to be conducting a trade or business with respect to any real estate rental of which the individual owns at least ten percent and in which the individual actively participates within the meaning of section 469(i).
The Preamble to the final regulations then informs the factors that the Service will consider in determining whether a rental real estate activity is a section 162 trade or business, including: (i) the type of rented property (commercial real property versus residential property), (ii) the number of properties rented, (iii) the owner’s or the owner’s agents day-to-day involvement, (iv) the types and significance of any ancillary services provided under the lease, and (v) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).
What the Service punted on was to include in the final regulations a set of “bright line rules” on whether a rental real estate activity is a section 162 trade or business for purposes of section 199A is beyond the scope of these regulations. Moreover, the final regulations did not adopt a rule deeming all rental real estate activity to be a trade or business for purposes of section 199A.
Nevetheless, the Treasury and the Service felt it would not be easy for tax advisors to determine whether a particular rental real estate operation constituted a trade or business under section 162(a) and therefore under section 199A. Concurrently with the issuance of the final regulations, the Service issued IRS Notice 2019-07, 2019-07, 2019-9 IRB 740 which provides a safe harbor under which a rental real estate enterprise may be treated as a trade or business solely for purposes of section 199A. This safe harbor is available to taxpayers who seek to claim the deduction under section 199A with respect to a rental real estate enterprise.
Where the safe harbor requirements are met, the real estate enterprise will be treated as a trade or business in applying the regulations under section 199A. Relevant passthrough entities (RPEs) as defined in § 1.199A-1(b)(10) may also use this safe harbor in order to determine whether a rental real estate enterprise is a trade or business as defined in section 199A(d). Failure to meet the safe harbor does not preclude a taxpayer from otherwise establishing that a rental real estate enterprise is a trade or business for purposes of section 199A.
Under the safe harbor notice, a rental real estate enterprise is defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. The individual or RPE relying on Rev. Proc. 2019-07, supra, must hold the interest directly or through an entity disregarded as an entity separate from its owner under § 301.7701-3. Taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents (with the exception of those described in
Under the proposed safe harbor, a rental real estate enterprise may be treated as a trade or business for purposes of section 199A if at least 250 hours of services are performed each taxable year with respect to the enterprise. This includes services performed by owners, employees, and independent contractors and time spent on maintenance, repairs, collection of rent, payment of expenses, provision of services to tenants, and efforts to rent the property. Hours spent by any person with respect to the owner’s capacity as an investor, such as arranging financing, procuring property, reviewing financial statements or reports on operations, planning, managing, or constructing long-term capital improvements, and traveling to and from the real estate are not considered to be hours of service with respect to the enterprise. The proposed safe harbor requires that separate books and records and separate bank accounts be maintained for the rental real estate enterprise. Property leased under a triple net lease or used by the taxpayer (including an owner or beneficiary of an RPE) as a residence for any part of the year under section 280A would not be eligible under the proposed safe harbor. (emphasis in italics added).
Under the safe harbor procedure, a rental real estate enterprise is defined as an interest in real property held to produce rents and may consist of an interest in multiple properties. Rental services include: (i) advertising to rent or lease the real estate; (ii) negotiating and executing leases; (iii) verifying information contained in prospective tenant applications; (iv) collecting rent; (v) daily operation, maintenance, and repair of the property; (vi) managing the real estate; (vii) purchasing materials; and (viii) supervising employees and independent contractors.
Determining Whether Multiple Trades or Businesses Are Conducted by an Entity
Among comments received by the Service were suggestions that there should be safe harbors or factors to determine how to delineate separate section 162 trades or businesses within an entity and when an entity’s combined activities should be considered a single section 162 trade or business. Relevant factors would include whether the activities: have separate books and records, facilities, locations, employees, and bank accounts; operate separate types of businesses or activities; are held out as separate to the public; and are housed in separate legal entities. One commenter suggested adopting the separate trade or business rules provided in regulations under sections 446 and 469.
The Treasury Department and the IRS declined to adopt these recommendations and further stated that Treas. Reg. § 1.446-1(d) does not provide guidance on when trades or businesses will be considered separate and distinct. Instead, it provides that a taxpayer can use different methods of accounting for separate and distinct trades or businesses and specifies two circumstances in which trades or businesses will not be considered separate and distinct. Section 1.446-1(d)(2) provides that no trade or business will be considered separate and distinct unless a complete separate set of books and records is kept for such trade or business. [
The Treasury Department and the IRS acknowledged, however, that an entity can conduct more than one section 162 trade or business. This conclusion was stated to be inherent in the reporting requirements in Treas. Reg. §1.199A-6, which require an entity to separately report QBI, W-2 wages, UBIA of qualified property, and SSTB information for each trade or business engaged in by the entity. Whether a single entity has multiple trades or businesses is a factual determination. However, court decisions that help define the meaning of “trade or business” provide taxpayers guidance in determining whether more than one trades or businesses exist.
It is important to note that the IRS view is that multiple trades or businesses will generally not exist within an entity unless different methods of accounting could be used for each trade or business under Treas. Reg. §1.446-1(d). Treas. Reg. §1.446-1(d) explains that no trade or business is considered separate and distinct unless a complete and separable set of books and records is kept for that trade or business. Further, trades or businesses will not be considered separate and distinct if, by reason of maintaining different methods of accounting, there is a creation or shifting of profits and losses between the businesses of the taxpayer so that income of the taxpayer is not clearly reflected.
Consistency in Reporting Trades or Businesses
In cases in which other Code provisions use a trade or business standard that is the same or substantially similar to the section 162 standard adopted in these final regulations, the Preamble states that taxpayers should report such items consistently. For example, if taxpayers who own tenancy in common interests in rental property treat such joint interests as a trade or business for purposes of section 199A but do not treat the joint interests as a separate entity for purposes of Treas. Reg. §301.7701-1(a)(2), the IRS will consider the facts and circumstances surrounding the differing treatment. Similarly, taxpayers should consider the appropriateness of treating a rental activity as a trade or business for purposes of section 199A where the taxpayer does not comply with the information return filing requirements under section 6041.
This post is part of a series of posts under section 199A in highlighting the various critical terms, requirements, computations and other consequences of this new rule.
This blog post is intended solely for informational and educational purposes. It neither constitutes nor was intended to constitute the rendering of legal advice and therefore does not constitute legal advice rendered by this author or by Fox Rothschild LLP for which reliance may be made by the reader. Persons interested in finding out the specific consequences to section 199A or other information set forth herein must consult with their independent tax advisor, lawyer with Fox Rothschild LLP or Jerry August c/o email@example.com.
 However, C corporations realized a 14 percentage point reduction in corporate income tax from the maximum rate of 35% to a flat 21% rate. Domestic C corporations as well, exclusively benefit from the participation exemption under section 250 as well as the FDII (37.5% of foreign-derived intangible income realized during the taxable year and GILTI (50% of global intangible low-tax income includible under §951A for such taxable year) and the special participation exemption under section 245A which allows a full deduction equal to the foreign-source portion of a dividend received from a specified 10% owned foreign corporation by a domestic corporation which is a US shareholder with respect to such corporation.
 With respect to a relevant passthrough entity (RPE), the proposed regulations define an RPE as a partnership (other than a publicly traded partnership (PTP)) or an S corporation that is owned, directly or indirectly, by at least one individual, estate, or trust. A trust or estate is treated as an RPE to the extent it passes through QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, or qualified PTP income. In response to a comment, the final regulations provide that other passthrough entities, including common trust funds as described in Treas. Reg. §1.6032-T and religious or apostolic organizations described in section 501(d), are also treated as RPEs if the entity files a Form 1065, U.S. Return of Partnership Income, and is owned, directly or indirectly, by at least one individual, estate, or trust. Each taxpayer is allocated his or her share of QBI, W-2 wages and UBIA based on such individual’s percentage interest in such tax items in accordance with the operative agreement or beneficial interest in the trust or estate. The final regulations, addressing the determination of W-2 wages and unadjusted basis immediately after the acquisition (UBIA) of qualified property, refer to concurrently issued guidance in Rev. Proc. 2009-11, 2019-9 IRB 742 on the definition of W-2 wages, including amounts treated as elective deferrals. Three methods are set forth for calculating W-2 wages. Only wages properly and timely reported on Forms W-2 that meet the requirements under the final regulations are included. Forms W-2 provided to statutory employees as identified in section 3121(d)(3) are not included for this purpose. The three methods are the “unmodified box method”, the “modified Box 1 method” and the “tracking wages method”. Under the unmodified box method, W-2 wages are calculated by taking, without modification, the lesser of (A) the total entries in Box 1 of all Forms W-2 filed with the Social Security Administration (SSA) by the taxpayer regarding employees of the taxpayer for employment by the taxpayer, or (B) the total entries in Box 5 of all Forms W-2 filed with the SSA by the taxpayer regarding employees of the taxpayer for employment by the taxpayer.
Under the modified Box 1 method, the taxpayer makes modifications to the total entries in Box 1 of Forms W-2 filed regarding employees of the taxpayer, calculated as prescribed in the revenue procedure.
Under the tracking wages method, the taxpayer tracks total wages subject to federal income tax withholding and makes appropriate modifications. Rev. Proc. 2009-11, supra, also provides a special rule for taxpayers with a short tax year.
 Comm’r v. Groetzinger, 480 U.S. 23 (1987); Gajewski v. Comm’r, 723 F.2d 1062 (2d Cir. 1983), cert. denied, 469 U.S. 818 (1984), rev’g 45 T.C.M. 967 (1983), on remand, 84 T.C. 980 (1985). As to the profit motive requirement see, ie.g., Doggett v. Burnet, 65 F.2d 191 (D.C.Cir. 1933), rev’g 23 BTA 744 (1931).
 Higgins v. Comm’r, 312 US 212 (1941). In Higgins, supra, the IRS successfully argued before the Board of Tax Appeals (the precursor to the US Tax Court) that the evidence proffered by the petitioner-taxpayer that his activities were those of carrying on a trade or business failed to meet the required burden of proof. The BTA found, which decision would be affirmed by the US Supreme Court, that the petitioner merely kept records and collected interest and dividends from his securities, through managerial attention for his investments. In its opinion the Supreme Court stated that: “No matter how large the estate or how continuous or extended the work required may be, such facts are not sufficient as a matter of law to permit the courts to reverse the decision of the Board”. Its conclusion is adequately supported by this record, and rests upon a conception of carrying on business similar to that expressed by this Court for an antecedent section
 A few of the many sections in the Code that require the carrying on of a trade or business or being engaged in an active trade or business see §§367(a)(3)(transfer to foreign corporation), §465(c)(leasing exception under §465); §465(c)(7)(at-risk rule exception for active business); §904(d)(2)(A)(foreign tax credit); §954(c)(2)(A)(CFC’s foreign personal holding company income). See also Med Chem (P.R.) v. Comm’r, 116 TC 308 (2001)(§936 “active business” requirement failed), aff’d 295 F.3d 118 (1st Cir. 2002); Martin Ice Cream Co. v. Comm’r, 110 TC 189 (1998)(controlled corporation owning only intangible property not an active business for purposes of §355(b)(1)(A)); Rev. Rul. 57-492, 1957-2 CB 247 (oil exploration, drilling, etc. prior to income collection does not constitute the active conduct of a trade or business).
 See Treas. Reg. § 1.355-3(b)(2)(ii); Rev. Rul. 57-492, 1957-2 CB 247 (oil exploration, drilling, and related activities prior to income collection not the active conduct of a trade or business); Treas.Reg. § 1.355-3(c), Ex. (3) (mineral rights owned by ranching corporation not an active trade or business before corporation engages in any activity with respect to its mineral rights); Spheeris v. Comm’r, 54 TC 1353 (1970) , aff’d, 461 F2d 271 (7th Cir. 1972) (no active conduct of trade or business where rental property destroyed by fire and no income collected for two and one-half years preceding distribution). See Lender Management, LLC et al v. Comm’r, TC Memo 2017-246, where Judge Kerrigan, on behalf of the Tax Court in a group of consolidated cases, held that under the facts, related investment advisory firm to family investment partnerships constituted a trade or business for purposes of §162(a).