NEWSLETTERS

The Internal Revenue Service is looking toward automated solutions to cover the recent workforce reductions implemented by the Trump Administration, Department of the Treasury Secretary Bessent told a House Appropriations subcommittee.

The Internal Revenue Service is looking toward automated solutions to cover the recent workforce reductions implemented by the Trump Administration, Department of the Treasury Secretary Bessent told a House Appropriations subcommittee.

During a May 6, 2025, oversight hearing of the House Appropriations Financial Services and General Government Subcommittee, Bessent framed the current employment level at the IRS as “bloated” and is using the workforce reduction as a means to partially justify the smaller budget the agency is looking for.

“We are just taking the IRS back to where it was before the IRA [Inflation Reduction Act] bill substantially bloated the personnel and the infrastructure,” he testified before the committee, adding that “a large number of employees” took the option for early retirement.

When pressed about how this could impact revenue collection activities, Bessent noted that the agency will be looking to use AI to help automate the process and maintain collection activities.

“I believe, through smarter IT, through this AI boom, that we can use that to enhance collections,” he said. “And I would expect that collections would continue to be very robust as they were this year.”

He also suggested that those hired from the supplemental funding from the IRA to enhance enforcement has not been effective as he pushed for more reliance on AI and other information technology resources.

There “is nothing that shows historically that by bringing in unseasoned collections agents … results in more collections or high-end collections,” Bessent said. “It would be like sending in a junior high school student to try to a college-level class.”

Another area he highlighted where automation will cover workforce reductions is in the processing of paper returns and other correspondence.

“Last year, the IRS spent approximately $450 million on paper processing, with nearly 6,500 full-time staff dedicated to the task,” he said. “Through policy changes and automation, Treasury aims to reduce this expense to under $20 million by the end of President Trump’s second term.”

Bessent’s testimony before the committee comes in the wake of a May 2, 2025, report from the Treasury Inspector General for Tax Administration that highlighted an 11-percent reduction in the IRS workforce as of February 2025. Of those who were separated from federal employment, 31 percent of revenue agents were separated, while 5 percent of information technology management are no longer with the agency.

When questioned about what the IRS will do to ensure an equitable distribution of enforcement action, Bessent stated that the agency is “reviewing the process of who is audited at the IRS. There’s a great deal of politicization of that, so we are trying to stop that, and we are also going to look at distribution of who is audited and why they are audited.”

Bessent also reiterated during the hearing his support of making the expiring provisions of the Tax Cuts and Jobs Act permanent.

By Gregory Twachtman, Washington News Editor

A taxpayer's passport may be denied or revoked for seriously deliquent tax debt only if the taxpayer's tax liability is legally enforceable. In a decision of first impression, the Tax Court held that its scope of review of the existence of seriously delinquent tax debt is de novo and the court may hear new evidence at trial in addition to the evidence in the IRS's administrative record.

A taxpayer's passport may be denied or revoked for seriously deliquent tax debt only if the taxpayer's tax liability is legally enforceable. In a decision of first impression, the Tax Court held that its scope of review of the existence of seriously delinquent tax debt is de novo and the court may hear new evidence at trial in addition to the evidence in the IRS's administrative record.

The IRS certified the taxpayer's tax liabilities as "seriously delinquent" in 2022. For a tax liability to be considered seriously delinquent, it must be legally enforceable under Code Sec. 7345(b).

The taxpayer's tax liabilities related to tax years 2005 through 2008 and were assessed between 2007 and 2010. The standard collection period for tax liabilities is ten years after assessment, meaning that the taxpayer's liabilities were uncollectible before 2022, unless an exception to the statute of limitations applied. The IRS asserted that the taxpayer's tax liabilities were reduced to judgment in a district court case in 2014, extending the collections period for 20 years from the date of the district court default judgment. The taxpayer maintained that he was never served in the district court case and the judgment in that suit was void.

The Tax Court held that its review of the IRS's certification of the taxpayer's tax debt is de novo, allowing for new evidence beyond the administrative record. A genuine issue of material fact existed whether the taxpayer was served in the district court suit. If not, his tax debts were not legally enforceable as of the 2022 certification, and the Tax Court would find the IRS's certification erroneous. The Tax Court therefore denied the IRS's motion for summary judgment and ordered a trial.

A. Garcia Jr., 164 TC No. 8, Dec. 62,658

The IRS has reminded taxpayers that disaster preparation season is kicking off soon with National Wildfire Awareness Month in May and National Hurricane Preparedness Week between May 4 and 10. Disasters impact individuals and businesses, making year-round preparation crucial. 

The IRS has reminded taxpayers that disaster preparation season is kicking off soon with National Wildfire Awareness Month in May and National Hurricane Preparedness Week between May 4 and 10. Disasters impact individuals and businesses, making year-round preparation crucial. In 2025, FEMA declared 12 major disasters across nine states due to storms, floods, and wildfires. Following are tips from the IRS to taxpayers to help ensure record protection:

• Store original documents like tax returns and birth certificates in a waterproof container;
• keep copies in a separate location or with someone trustworthy. Use flash drives for portable digital backups; and
• use a phone or other devices to record valuable items through photos or videos. This aids insurance or tax claims. IRS Publications 584 and 584-B help list personal or business property.

Further, reconstructing records after a disaster may be necessary for tax purposes, insurance or federal aid. Employers should ensure payroll providers have fiduciary bonds to protect against defaults, as disasters can affect timely federal tax deposits.

IR-2025-55

A decedent's estate was not allowed to deduct payments to his stepchildren as claims against the estate.

A decedent's estate was not allowed to deduct payments to his stepchildren as claims against the estate.

A prenuptial agreement between the decedent and his surviving spouse provided for, among other things, $3 million paid to the spouse's adult children in exchange for the spouse relinquishing other rights. Because the decedent did not amend his will to include the terms provided for in the agreement, the stepchildren sued the estate for payment. The tax court concluded that the payments to the stepchildren were not deductible claims against the estate because they were not "contracted bona fide" or "for an adequate and full consideration in money or money's worth" (R. Spizzirri Est., Dec. 62,171(M), TC Memo 2023-25).

The bona fide requirement prohibits the deduction of transfers that are testamentary in nature. The stepchildren were lineal descendants of the decedent's spouse and were considered family members. The payments were not contracted bona fide because the agreement did not occur in the ordinary course of business and was not free from donative intent. The decedent agreed to the payments to reduce the risk of a costly divorce. In addition, the decedent regularly gave money to at least one of his stepchildren during his life, which indicated his donative intent. The payments were related to the spouse's expectation of inheritance because they were contracted in exchange for her giving up her rights as a surviving spouse. As a results, the payments were not contracted bona fide under Reg. §20.2053-1(b)(2)(ii) and were not deductible as claims against the estate.

R.D. Spizzirri Est., CA-11

The IRS issued interim final regulations on user fees for the issuance of IRS Letter 627, also referred to as an estate tax closing letter. The text of the interim final regulations also serves as the text of proposed regulations.These regulations reduce the amount of the user fee imposed to $56.

The IRS issued interim final regulations on user fees for the issuance of IRS Letter 627, also referred to as an estate tax closing letter. The text of the interim final regulations also serves as the text of proposed regulations.These regulations reduce the amount of the user fee imposed to $56.

Background

In 2021, the Treasury and Service established a $67 user fee for issuing said estate tax closing letter. This figure was based on a 2019 cost model.

In 2023, the IRS conducted a biennial review on the same issue and determined the cost to be $56. The IRS calculates the overhead rate annually based on cost elements underlying the statement of net cost included in the IRS Annual Financial Statements, which are audited by the Government Accountability Office.

Current Rate

For this fee review, the fiscal year (FY) 2023 overhead rate, based on FY 2022 costs, 62.50 percent was used. The IRS determined that processing requests for estate tax closing letters required 9,250 staff hours annually. The average salary and benefits for both IR paybands conducting quality assurance reviews was multiplied by that IR payband’s percentage of processing time to arrive at the $95,460 total cost per FTE.

The Service stated that the $56 fee was not substantial enough to have a significant economic impact on any entities. This guidance does not include any federal mandate that may result in expenditures by state, local, or tribal governments, or by the private sector in excess of that threshold.

T.D. 10031

NPRM REG-107459-24

The Tax Court appropriately dismissed an individual's challenge to his seriously delinquent tax debt certification. The taxpayer argued that his passport was restricted because of that certification. However, the certification had been reversed months before the taxpayer filed this petition. Further, the State Department had not taken any action on the basis of the certification before the taxpayer filed his petition.

The Tax Court appropriately dismissed an individual's challenge to his seriously delinquent tax debt certification. The taxpayer argued that his passport was restricted because of that certification. However, the certification had been reversed months before the taxpayer filed this petition. Further, the State Department had not taken any action on the basis of the certification before the taxpayer filed his petition.

Additionally, the Tax Court correctly dismissed the taxpayer’s challenge to the notices of deficiency as untimely. The taxpayer filed his petition after the 90-day limitation under Code Sec. 6213(a) had passed. Finally, the taxpayer was liable for penalty under Code Sec. 6673(a)(1). The Tax Court did not abuse its discretion in concluding that the taxpayer presented classic tax protester rhetoric and submitted frivolous filings primarily for purposes of delay.

Affirming, per curiam, an unreported Tax Court opinion.

Z.H. Shaikh, CA-3

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

The IRS released the optional standard mileage rates for 2019. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

• business,
• medical, and
• charitable purposes.

Some members of the military may also use these rates to compute their moving expense deductions.

2019 Standard Mileage Rates
The standard mileage rates for 2019 are:

• 58 cents per mile for business uses;
• 20 cents per mile for medical uses; and
• 14 cents per mile for charitable uses.

Taxpayers may use these rates, instead of their actual expenses, to calculate their deductions for business, medical or charitable use of their own vehicles.

FAVR Allowance for 2019
For purposes of the fixed and variable rate (FAVR) allowance, the maximum standard automobile cost for vehicles places in service after 2018 is:

• $50,400 for passenger automobiles, and
• $50,400 for trucks and vans.

Employers can use a FAVR allowance to reimburse employees who use their own vehicles for the employer’s business.

2019 Mileage Rate for Moving Expenses
The standard mileage rate for the moving expense deduction is 20 cents per mile. To claim this deduction, the taxpayer must be:

• a member of the Armed Forces of the United States,
• on active military duty, and
• moving under an military order and incident to a permanent change of station.

The Tax Cuts and Jobs Act of 2017 suspended the moving expense deduction for all other taxpayers until 2026.

Unreimbursed Employee Travel Expenses
For most taxpayers, the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction for unreimbursed employee travel expenses. However, certain taxpayers may still claim an above-the-line deduction for these expenses. These taxpayers include:

• members of a reserve component of the U.S. Armed Forces,
• state or local government officials paid on a fee basis, and
• performing artists with relatively low incomes.

Notice 2018-3, I.R.B. 2018-2, 285, as modified by Notice 2018-42, I.R.B. 2018-24, 750, is superseded.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS has provided interim guidance for the 2019 calendar year on income tax withholding from wages and withholding from retirement and annuity distributions. In general, certain 2018 withholding rules provided in Notice 2018-14, I.R.B. 2018-7, 353, will remain in effect for the 2019 calendar year, with one exception.

The IRS and the Treasury Department intend to develop income tax withholding regulations to reflect changes made by the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97), as well as other changes in the Code since the regulations were last amended, and certain miscellaneous changes consistent with current procedures.

Withholding Allowances
The IRS delayed the release of the 2018 Form W-4, Employee’s Withholding Allowance Certificate, in order to reflect changes made by the TCJA, such as changes in itemized deductions available, increases in the child tax credit, the new credit for other dependents, and the suspension of personal exemption deductions. Notice 2018-14 provided relief for employers and employees affected by the delay.

In June, the IRS released a draft 2019 Form W-4 and instructions, which incorporated changes that were meant to improve the accuracy of income tax withholding and make the withholding system more transparent. However, in response to stakeholders’ comments, the IRS later announced that the redesigned Form W-4 would be postponed until 2020. The IRS intends to release a 2019 Form W-4 before the end of 2018 that makes minimal changes to the 2018 Form W-4.

The 2019 Form W-4 and the computational procedures in IRS Publication 15 (Circular E), Employer’s Tax Guide, will continue to use the term "withholding allowances" and related terminology to incorporate the withholding allowance factors specified in Code Sec. 3402(f) and the additional allowance items in Code Sec. 3402(m). Until further guidance is issued, references to a "withholding exemption" in the Code Sec. 3402 regulations and guidance will be applied as if they were referring to a withholding allowance.

Changes in Status
The guidance provides that if an employee experiences a change of status on or before April 30, 2019, that reduces the number of withholding allowances to which he or she is entitled, and if that change is solely due to the changes made by the TCJA, the employee generally must furnish a new Form W-4 to the employer by May 10, 2019. However, if an employee no longer reasonably expects to be entitled to a claimed number of allowances due to a change in personal circumstances that is not solely related to TCJA changes, the employee must furnish his or her employer a new Form W-4 within 10 days after the change. Similarly, if an employee claims married filing status on Form W-4 but divorces his or her spouse, the employee must furnish the employer a new Form W-4 within 10 days after the change.

Failure to Furnish
The IRS and the Treasury Department intend to withdraw the regulations under Code Sec. 3401(e), and modify other regulations, so that an employee who fails to furnish a Form W-4 will be treated as "single" but entitled to the number of withholding allowances determined under computational procedures provided in IRS Publication 15. Until further guidance is issued, however, employees who fail to furnish a Form W-4 will be treated as single with zero withholding allowances.

Additional Allowances
Until further guidance is issued, a taxpayer may include his or her estimated Code Sec. 199A passthrough deduction in determining whether he or she can claim the additional withholding allowance under Code Sec. 3402(m) on Form W-4.

Alternative Procedure
The IRS and the Treasury Department intend to update the withholding regulations to explicitly allow employees to determine their Form W-4 entries by using the IRS withholding calculator ( www.irs.gov/W4App) or IRS Publication 505, Tax Withholding and Estimated Tax, instead of having to complete certain schedules included with the Form W-4. However, the regulations are expected to provide that an employee cannot use the withholding calculator if the calculator’s instructions state that it should not be used due to his or her individual tax situation. The employee will need to use Publication 505 instead.

Alternative Methods
The IRS and the Treasury Department intend to eliminate the combined income tax withholding and employee FICA tax withholding tables under Reg. §31.3402(h)(4)-1(b), due to this alternative procedure’s unintended complexity and burden.

Lock-In Letters
The IRS may issue a "lock-in letter" to an employer, which sets the maximum number of withholding allowances an employee may claim. If the employer no longer employs the employee, the employer must send a written response to the IRS office designated in the lock-in letter that the employee is not employed by the employer. The IRS and the Treasury Department intend to eliminate the written response requirement. Pending further guidance, employers should not send a written response to the IRS under Reg. §31.3402(f)(2)-1(g)(2)(iv).

Pension, Annuity Payments
The payor of certain periodic payments for pensions, annuities, and other deferred income generally must withhold tax from the payments as if they were wages, unless the individual payee elects not to have withholding apply. Before 2018, if a withholding certificate was not furnished to the payor, the withholding rate was determined by treating the payee as a married individual claiming three withholding exemptions. The TCJA amended this rule so that the rate "shall be determined under rules prescribed by the Secretary." The IRS has determined that, for 2019, withholding on periodic payments when no withholding certificate is in effect continues to be based on treating the payee as a married individual claiming three withholding allowances.

Comments Requested
The IRS and the Treasury Department request comments on both the interim guidance and the guidance that should be provided in regulations. Comments must be received by January 25, 2019. Comments should be submitted to: CC:PA:LPD:PR (Notice 2018-92), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C., 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2018-92), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., 20224. Alternatively, taxpayers may submit comments electronically to Notice.comments@irscounsel.treas.gov (include "Notice 2018-92" in the subject line of any electronic submission).

Last year’s Tax Reform created a new 20-percent deduction of qualified business income for passthrough entities, subject to certain limitations. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) created the new Code Sec. 199A passthrough deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, the provision was enacted only temporarily through 2025. The controversial deduction has remained a buzzing topic of debate among lawmakers, tax policy experts, and stakeholders. In addition to its impermanence, the new passthrough deduction’s ambiguous statutory language has created many questions for taxpayers and practitioners.

Last year’s Tax Reform created a new 20-percent deduction of qualified business income for passthrough entities, subject to certain limitations. The Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97) created the new Code Sec. 199A passthrough deduction for noncorporate taxpayers, effective for tax years beginning after December 31, 2017. However, the provision was enacted only temporarily through 2025. The controversial deduction has remained a buzzing topic of debate among lawmakers, tax policy experts, and stakeholders. In addition to its impermanence, the new passthrough deduction’s ambiguous statutory language has created many questions for taxpayers and practitioners.

The IRS released the much-anticipated proposed regulations on the new passthrough deduction, REG-107892-18, on August 8. The guidance has generated a mixed reaction on Capitol Hill, and while significant questions may have been answered, it appears that many remain. Indeed, an IRS spokesperson told Wolters Kluwer Tax & Accounting before the regulations were released that the IRS’s goal was to issue complete regulations but that the guidance "would not cover every question that taxpayers have."

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new passthrough deduction and proposed regulations. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

I. Qualified Business Income and Activities

Wolters Kluwer: What is the effect of the proposed regulations requiring that qualified business activities meet the Code Sec. 162 trade or business standard? And for what industries might this be problematic?

Joshua Wu: The positive aspect of incorporating the Section 162 trade or business standard is that there is an established body of case law and administrative guidance with respect to what activities qualify as a trade or business. However, the test under Section 162 is factually-specific and requires an analysis of each situation. Sometimes courts reach different results with respect to activities constituting a trade or business. For example, gamblers have been denied trade or business status in numerous cases. In Groetzinger, 87-1 ustc ¶9191, 480 U.S. 23 (1987), the Court held that whether professional gambling is a trade or business depends on whether the taxpayer can show he pursued gambling full-time, in good faith, regularly and continuously, and possessed a sincere profit motive. Some courts have held that the gambling activity must be full-time, from 60 to 80 hours per week, while others have questioned whether the full-time inquiry is a mandatory prerequisite or permissive factor to determine whether the taxpayer’s gambling activity is a trade or business. See e.g., Tschetschot , 93 TCM 914, Dec. 56,840(M)(2007). Although Section 162 provides a built-in body of law, plenty of questions remain.

Aside from the gambling industry, the real estate industry will continue to face some uncertainty over what constitutes a trade or business under Code Secs. 162 and 199A. The proposed regulations provide a helpful rule, where the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business if the rental or licensing and the other trade or business are commonly controlled. But, that rule does not help taxpayers in the rental industry with no ties to another trade or business. The question remains whether a taxpayer renting out a single-family home or a small group of apartments is engaged in a trade or business for purposes of Code Secs. 162 and 199A. Some case law indicates that just receiving rent with nothing more may not constitute a trade or business. On the other hand, numerous cases have found that managing property and collecting rent can constitute a trade or business. Given the potential tax savings at issue, I suspect there will be additional cases in the real estate industry regarding the level of activity required for the leasing of property to be considered a trade or business.

Qualified Business Income

Wolters Kluwer: How does the IRS define qualified business income (QBI)?

Joshua Wu: QBI is the net amount of effectively connected qualified items of income, gain, deduction, and loss from any qualified trade or business. Certain items are excluded from QBI, such as capital gains/losses, certain dividends, and interest income. Proposed Reg. §1.199A-3(b) provides further clarity on QBI. Most importantly, they provide that a passthrough with multiple trades or businesses must allocate items of QBI to such trades or businesses based on a reasonable and consistent method that clearly reflects income and expenses. The passthrough may use a different reasonable method for different items of income, gain, deduction, and loss, but the overall combination of methods must also be reasonable based on all facts and circumstances. Further, the books and records must be consistent with allocations under the method chosen. The proposed regulations provide no specific guidance or examples of what a reasonable allocation looks like. Thus, taxpayers are left to determine what constitutes a reasonable allocation.

Unadjusted Basis Immediately after Acquisition

Wolters Kluwer: What effect does the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to a trade or business have on determining QBI?

Joshua Wu: For taxpayers above the taxable income threshold amounts, $157,500 (single or married filing separate) or $315,000 (married filing jointly), the Code limits the taxpayer’s 199A deduction based on (i) the amount of W-2 wages paid with respect to the trade or business, and/or (ii) the unadjusted basis immediately after acquisition (UBIA) of qualified property held for use in the trade or business.

Where a business pays little or no wages, and the taxpayer is above the income thresholds, the best way to maximize the deduction is to look to the UBIA of qualified property. Rather than the 50 percent of W-2 wages limitation, Section 199A provides an alternative limit based on 25 percent of W-2 wages and 2.5 percent of UBIA qualified property. The Code and proposed regulations define UBIA qualified property as tangible, depreciable property which is held by and available for use in the qualified trade or business at the close of the tax year, which is used at any point during the tax year in the production of qualified business income, and the depreciable period for which has not ended before the close of the tax year. The proposed regulations helpfully clarify that UBIA is not reduced for taxpayers who take advantage of the expanded bonus depreciation allowance or any Section 179expensing.

De Minimis Exception

Wolters Kluwer: How is the specified service trade or business (SSTB) limitation clarified under the proposed regulations? And how does the de minimis exception apply?

Joshua Wu: The proposed regulations provide helpful guidance on the definition of a SSTB and avoid what some practitioners feared would be an expansive and amorphous area of section 199A. Under the statute, if a trade or business is an SSTB, its items are not taken into account for the 199A computation. Thus, the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial and brokerage services, investment management, trading, dealing in securities, and any trade or business where the principal asset of such is the reputation or skill of one or more of its employees or owners, do not result in a 199A deduction.

There is a de minimis exception to the general rule for taxpayers with taxable income of less than $157,500 (single or married filing separate) or $315,000 (married filing jointly). Once those thresholds are hit, the 199A deduction phases-out until it is fully eliminated at $207,500 (single) or $415,000 (joint).

The proposed regulations provide guidance for each of the SSTB fields. Importantly, they also limit the "reputation or skill" category. The proposed regulations state that the "reputation or skill" clause was intended to describe a "narrow set of trades or businesses, not otherwise covered by the enumerated specified services." Thus, the proposed regulations limit this definition to cases where the business receives income from endorsing products or services, licensing or receiving income for use of an individual’s image, likeness, name, signature, voice, trademark, etc., or receiving appearance fees. This narrow definition is unlikely to impact most taxpayers.

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new Code Sec. 199A passthrough deduction and its recently-released proposed regulations, REG-107892-18. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

Wolters Kluwer recently spoke with Joshua Wu, member, Clark Hill PLC, about the tax implications of the new Code Sec. 199A passthrough deduction and its recently-released proposed regulations, REG-107892-18. That exchange included a discussion of the impact that the new law and IRS guidance, both present and future, may have on taxpayers and tax practitioners.

II. Aggregation, Winners & Losers

Wolters Kluwer: How do the proposed regulations provide both limitations and flexibility regarding the available election to aggregate trades or businesses?

Joshua Wu: Treasury agreed with various comments that some level of aggregation should be permitted to account for the legal, economic and other non-tax reasons that taxpayers operate a single business across multiple entities. Permissive aggregation allows taxpayers the benefit of combining trades or businesses for applying the W-2 wage limitation, potentially resulting in a higher limit. Under Proposed Reg. §1.199A-4, aggregation is allowed but not required. To use this method, the business must (1) qualify as a trade or business, (2) have common ownership, (3) not be a SSTB, and (4) demonstrate that the businesses are part of a larger, integrated trade or business (for individuals and trusts). The proposed regulations give businesses the benefits of electing aggregation without having to restructure the businesses from a legal standpoint. Businesses failing to qualify under the above test will have to consider whether a legal restructuring would be possible.

Wolters Kluwer: How does Notice 2018-64 Methods for Calculating W-2 Wages for Purposes of Section 199A, which accompanied the release of the proposed regulations, coordinate with aggregation?

Joshua Wu: Notice 2018-64 contains a proposed revenue procedure with guidance on three methods for calculating W-2 wages for purposes of section 199A. The Unmodified Box method uses the lesser of totals in Box 1 of Forms W-2 or Box 5 (Medicare wages). The Modified Box 1 method takes the total amounts in Box 1 of Forms W-2 minus amounts not wages for income withholding purposes, and adding total amounts in Box 12 (deferrals). The Tracking wages method is the most complex and tracks total wages subject to income tax withholding. The calculation method is dependent on the group of Forms W-2 included in the computation and, thus, will vary depending upon whether businesses are aggregated under §1.199A-4 or not. Taxpayers with businesses generating little or no Medicare wages may consider aggregating with businesses that report significant wages in Box 1 that are still subject to income tax withholding. Under the Modified Box 1 method, that may result in a higher wage limitation.

Crack & Pack

Wolters Kluwer: What noteworthy anti-abuse safeguards did the proposed regulations seek to establish? How do the rules address "cracking" or "crack and pack" strategies?

Joshua Wu: Treasury included some anti-abuse provisions in the proposed regulations. One area that Treasury noted was the use of multiple non-grantor trusts to avoid the income threshold limitations on the 199A deduction. Taxpayers could theoretically use multiple non-grantor trusts to increase the 199A deduction by taking advantage of each trust’s separate threshold amount. The proposed regulations, under the authority of 643(f), provide that two or more trusts will be aggregated and treated as a single trust if such trusts have substantially the same grantor(s) and substantially the same primary beneficiary or beneficiaries, and if a principal purpose is to avoid tax. The proposed regulations have a presumption of a principal purpose of avoiding tax if the structure results in a significant tax benefit, unless there is a significant non-tax purpose that could not have been achieved without the creation of the trusts.

Another anti-abuse issue relates to the "crack and pack" strategies. These strategies involve a business that is limited in its 199A deduction because it is an SSTB spinning off some of its business or assets to an entity that is not an SSTB and could claim the 199A deduction. For example, a law firm that owns its building could transfer the building to a separate entity and lease it back. The law firm is an SSTB and, thus, is subject to the 199A limitations. However, the real estate entity is not an SSTB and can generate a 199A deduction (based on the rental income) for the law partners. The proposed regulations provide that a SSTB includes any business with 50 percent common ownership (direct or indirect) that provides 80 percent or more of its property or services to an excluded trade or business. Also, if a trade or business shares 50 percent or more common ownership with an SSTB, to the extent that trade or business provides property or services to the commonly-owned SSTB, the portion of the property or services provided to the SSTB will be treated as an SSTB. The proposed regulations provide an example of a dentist who owns a dental practice and also owns an office building. The dentist rents half the building to the dental practice and half to unrelated persons. Under [Proposed Reg.] §1.199A-5(c)(2), the renting of half of the building to the dental practice will be treated as an SSTB.

Winners & Losers

Wolters Kluwer: Generally, what industries can be seen as "winners" and "losers" in light of the proposed regulations?

Joshua Wu: The most obvious "losers" in the proposed regulations are the specified services businesses (e.g., lawyers, accountants, doctors, etc.) who are further limited by the anti-abuse provisions in arranging their affairs to try and benefit from 199A. On the other hand, certain specific service providers benefit from the proposed regulations. For example, health clubs or spas are exempt from the SSTB limitation. Additionally, broadcasters of performing arts, real estate agents, real estate brokers, loan officers, ticket brokers, and art brokers are all exempt from the SSTB limitation.

Wolters Kluwer: What areas of the Code Sec. 199A provision stand out as most complex when calculating the deduction, and how does this complexity vary among taxpayers?

Joshua Wu: With respect to calculating the deduction, one complex area is planning to maximize the W-2 wages limitation. Because compensation as W-2 wages can reduce QBI, and potentially the 199A deduction, determining the efficient equilibrium point between having enough W-2 wages to limit the impact of the wage limitation, while preserving QBI, will be a fact-driven complex planning issue that must be determined by each taxpayer. Another area of complexity will be how taxpayers track losses which may reduce future QBI and, thus, the 199A deduction. The proposed regulations provide that losses disallowed for taxable years beginning before January 1, 2018, are not taken into account for purposes of computing QBI in a later taxable year. Taxpayers will be left to track pre-2018 and post-2018 losses and determine if a loss in a particular tax year reduces QBI or not.

III. Looking Ahead

Questions Remain

Wolters Kluwer: An IRS spokesperson told Wolters Kluwer that the IRS did not expect the proposed regulations to answer all questions surrounding the deduction. Indeed, Acting IRS Commissioner David Kautter has said that stakeholder feedback would help finalize the regulations. What significant questions remain unanswered for taxpayers and tax practitioners, and has additional uncertainty been created with the release of the IRS guidance?

Joshua Wu: On the whole, the proposed regulations did a good job addressing the most important areas of Section 199A. However, there are many areas where additional guidance would be helpful. Such guidance may be in the form of additional regulations or other administrative pathways. For example, the proposed regulations did not address the differing treatment between a taxpayer operating as a sole proprietor versus an S corporation. Wages paid to an S corporation shareholder boosts the W-2 limitation but are not considered QBI. Thus, with the same underlying facts, the 199Adeduction may vary between taxpayers operating as a sole proprietor versus those operating as an S corporation.

Possible Changes to Proposed Regulations

Wolters Kluwer: In what ways do you see the passthrough deduction rules changing when the final regulations are released?

Joshua Wu: I suspect that the core components of the proposed regulations will not change significantly. However, I would not be surprised if Treasury were to include more specific examples with respect to real estate and whether certain types of activity constitute a trade or business. Additionally, the proposed regulations will likely generate comments and questions from various industry groups related to the SSTB definitions and specific types of services (e.g., do trustees and executors fall under the legal services definition). Treasury may change the definitions of SSTBs in response to comments and clarify definitions for industry groups.

Tax Reform 2.0

Wolters Kluwer: The White House and congressional Republicans are currently moving forward on legislative efforts known as "Tax Reform 2.0." The legislative package proposes making permanent the passthrough deduction. How does the impermanence of this deduction currently impact taxpayers? (Note: On September 13, the House Ways and Means Committee marked up a three-bill Tax Reform 2.0 package. The measure is expected to reach the House floor for a full chamber vote by the end of September.)

Joshua Wu: The 199A deduction has a significant impact on the choice of entity question for businesses. With the 21 percent corporate rate, we have seen many taxpayers considering restructuring away from passthrough entities to a C corporation structure. The 199A deduction is a large consideration in whether to restructure or not, but its limited effective time does raise questions about the cost effectiveness of planning to obtain the 199A deduction where the benefit will sunset in eight years.

Key Takeways

Wolters Kluwer: Aside from advice on specific taxpayer situations, what key takeaways should tax practitioners generally alert clients to ahead of the 2019 tax filing season?

Wolters Kluwer: Aside from advice on specific taxpayer situations, what key takeaways should tax practitioners generally alert clients to ahead of the 2019 tax filing season?

Joshua Wu: Practitioners should remind clients who may benefit from the 199A deduction to keep detailed records of any losses for each line of business, as this may impact the calculation of QBI in the future. Practitioners should also help clients examine the whole of their activity to define their "trades or businesses." This will be essential to calculating the 199A deduction and planning to maximize any such deduction. Finally, practitioners should remember that some of the information that may be necessary to determine a 199A deduction may not be in their client’s possession. Practitioners need to plan in advance with their clients regarding how information about each trade or business will be obtained (e.g., how will a limited partner in a partnership obtain information regarding the partnership’s W-2 wages and/or UBIA of qualified property).

Wolters Kluwer: Any closing thoughts or comments?

Joshua Wu: Practitioners and taxpayers should remember that the regulations are only proposed and may change before they become final. Any planning undertaken this year should carefully weigh the economic costs and be rooted in the statutory language of 199A. It will be some time before case law helps clarify the nuances of Section 199A, and claiming the deduction allows the IRS to more easily impose the substantial understatement penalty if a taxpayer gets it wrong.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

The IRS has released long-awaited guidance on new Code Sec. 199A, commonly known as the "pass-through deduction" or the "qualified business income deduction." Taxpayers can rely on the proposed regulations and a proposed revenue procedure until they are issued as final.

Code Sec. 199A allows business owners to deduct up to 20 percent of their qualified business income (QBI) from sole proprietorships, partnerships, trusts, and S corporations. The deduction is one of the most high-profile pieces of the Tax Cuts and Jobs Act ( P.L. 115-97).

In addition to providing general definitions and computational rules, the new guidance helps clarify several concepts that were of special interest to many taxpayers.

Trade or Business

The proposed regulations incorporate the Code Sec. 162 rules for determining what constitutes a trade or business. A taxpayer may have more than one trade or business, but a single trade or business generally cannot be conducted through more than one entity.

Taxpayers cannot use the grouping rules of the passive activity provisions of Code Sec. 469 to group multiple activities into a single business. However, a taxpayer may aggregate trades or businesses if:

• each trade or business is itself a trade or business;
• the same person or group owns a majority interest in each business to be aggregated;
• none of the aggregated trades or businesses can be a specified service trade or business; and
• the trades or businesses meet at least two of three factors which demonstrate that they are in fact part of a larger, integrated trade or business.

Specified Service Business

Income from a specified service business generally cannot be qualified business income, although this exclusion is phased in for lower-income taxpayers.

A new de minimis exception allows some business to escape being designated as a specified service trade or business (SSTB). A business qualifies for this de minimis exception if:

• gross receipts do not exceed $25 million, and less than 10 percent is attributable to services; or
• gross receipts exceed $25 million, and less than five percent is attributable to services.

The regulations largely adopt existing rules for what activities constitute a service. However, a business receives income because of an employee/owner’s reputation or skill only when the business is engaged in:

• endorsing products or services;
• licensing the use of an individual’s image, name, trademark, etc.; or
• receiving appearance fees.

In addition, the regulations try to limit attempts to spin-off parts of a service business into independent qualified businesses. Thus, a business that provides 80 percent or more of its property or services to a related service business is part of that service business. Similarly, the portion of property or services that a business provides to a related service business is treated as a service business. Businesses are related if they have at least 50-percent common ownership.

Wages/Capital Limit

A higher-income taxpayer’s qualified business income may be reduced by the wages/capital limit. This limit is based on the taxpayer’s share of the business’s:

• W-2 wages that are allocable to QBI; and
• unadjusted basis in qualified property immediately after acquisition.

The proposed regulations and Notice 2018-64, I.R.B. 2018-34, provide detailed rules for determining the business’s W-2 wages. These rules generally follow the rules that applied to the Code Sec. 199 domestic production activities deduction.

The proposed regulations also address unadjusted basis immediately after acquisition (UBIA). The regulations largely adopt the existing capitalization rules for determining unadjusted basis. However, "immediately after acquisition" is the date the business places the property in service. Thus, UBIA is generally the cost of the property as of the date the business places it in service.

Other Rules

The proposed regulations also address several other issues, including:

• definitions;
• basic computations;
• loss carryovers;
• Puerto Rico businesses;
• coordination with other Code Sections;
• penalties;
• special basis rules;
• previously suspended losses and net operating losses;
• other exclusions from qualified business income;
• allocations of items that are not attributable to a single trade or business;
• anti-abuse rules;
• application to trusts and estates; and
• special rules for the related deduction for agricultural cooperatives.

Effective Dates

Taxpayers may generally rely on the proposed regulations and Notice 2018-64 until they are issued as final. The regulations and proposed revenue procedure will be effective for tax years ending after they are published as final. However:

• several proposed anti-abuse rules are proposed to apply to tax years ending after December 22, 2017;
• anti-abuse rules that apply specifically to the use of trusts are proposed to apply to tax years ending after August 9, 2018; and
• if a qualified business’s tax year begins before January 1, 2018, and ends after December 31, 2017, the taxpayer’s items are treated as having been incurred in the taxpayer’s tax year during which business’s tax year ends.

Comments Requested

The IRS requests comments on all aspects of the proposed regulations. Comments may be mailed or hand-delivered to the IRS, or submitted electronically at www.regulations.gov (indicate IRS and REG-107892-18). Comments and requests for a public hearing must be received by September 24, 2018.

The IRS also requests comments on the proposed revenue procedure for calculating W-2 wages, especially with respect to amounts paid for services in Puerto Rico. Comments may be mailed or hand-delivered to the IRS, or submitted electronically to Notice.comments@irscounsel.treas.gov, with “ Notice 2018-64” in the subject line. These comments must also be received by September 24, 2018.