The IRS and Treasury on June 25 released final regulations under section 199A – the qualified business income (QBI) deduction – that clarify the treatment of previously suspended losses, and the determination of the section 199A deduction for taxpayers holding interests in regulated investment companies (RICs), split-interests trusts, and charitable remainder trusts.
In February 2019, the IRS and Treasury published both final regulations interpreting section 199A, and a notice of proposed rulemaking (proposed regulations) providing guidance on a number of items, including the treatment of previously disallowed losses included in QBI, and the determination of the section 199A deduction for taxpayers owing interests in RICs, split-interest trusts and charitable remainder trusts. These final regulations adopt the February 2019 proposed regulations, with some clarifying changes and additional modifications – most notably in regard to suspended losses and the treatment of RICs.
Previously suspended losses
The February 2019 proposed regulations provide that previously disallowed losses or deductions, due for example to basis limitations or the passive activity rules, that are allowed in a future taxable year are generally taken into account on a first-in first-out basis when computing QBI. Losses or deductions carried forward from years prior to 2018 are not included in QBI.
In response to specific taxpayer questions regarding the treatment of losses suspended under certain provisions not specifically referenced in the proposed regulations (in particular excess business loss under section 461(l)), the final regulations add section 461(l) to the listed of disallowed losses covered by the provision, and clarify in the preamble that the list in the final regulations is not exhaustive.
Additionally, the final regulations clarify how the complex phase-in rules apply in the event a taxpayer has a suspended or disallowed loss from a specified service trade or business (SSTB), adding two helpful examples demonstrating that the portion of such losses to ultimately be treated as QBI is determined in the year the loss is generated, not the year it is recognized.
Treatment of RICs
The shareholders of a RIC may, if the RIC has certain items of income or gain, treat dividends paid by a RIC in the same (or similar) manner as the shareholders would treat the underlying item of income or gain had they recognized it directly. This ‘conduit treatment’ was adopted in the proposed regulations, but solely with respect to the treatment of qualified Real Estate Investment Trust (REIT) dividends – allowing such amounts to be considered section 199A dividends. The final regulations adopt this treatment solely with respect to REIT dividends, with the IRS and Treasury noting that they continue to consider whether the same treatment is appropriate for qualified PTP income or other income of a RIC.
Summary and observations
While these final regulations do not stray from the proposed regulations, the guidance with respect to QBI and the utilization of loss carryovers is helpful. It is worth noting that these final regulations do not address some of the ongoing uncertainty regarding how the QBI loss carryover rules will work in light of the recent reinstatement of the five-year NOL carryback rules in the CARES Act. Clarification in this area is likely to come in future guidance from the IRS and Treasury.