United States

A preliminary view of the section 199A proposed regulations

Certain issues may invite public comments


The government has issued a lengthy package of proposed regulations to implement the 20 percent deduction of section 199A.[1] As proposed regulations, they are effectively a first draft and public comments on possible improvements to the government’s proposals have been requested. Here are some preliminary observations.


The proposals narrow the scope of the exclusions for a Specified Service Trade or Business (SSTB). Most particularly, they significantly narrow the exclusion of companies whose principal asset is the skill or reputation of their employees or owners. While the proposals generally provide a relatively thorough description of the various other excluded fields, the definition of ‘consulting’ may need some clarification.

In addition, further clarification is needed on businesses or groups of businesses that combine substantial amounts of SSTB and non-SSTB activities (e.g., where SSTB revenues are between 5 percent and 95 percent of the total, and non-SSTB revenues are between 95 percent and 5 percent).

The proposals shed little guidance on precisely how to determine when an ostensible single trade or business with multiple operations is, in fact, made up of distinct and separate ‘trades or businesses’ for tax purposes – but they do include a well-considered ‘aggregation’ rule to allow certain multiple, commonly owned trades or businesses to apply the wage and asset tests on a combined basis for purposes of calculating the section 199A deduction. In addition, third-party payroll services and similar arrangements apparently will be looked-through to attribute wages to the true, common-law employer.

The proposals do not address the important question of when real estate rental activity constitutes a ‘trade or business.’ This is instead left to current law – section 162 – which is far from clear. Given the generous treatment accorded to REITs, that are not required to satisfy any ‘trade or business’ test for their rental income, there might be disparate treatment between an individual taxpayer with one rental property (subject to the section 162 trade or business rules and case law) and a REIT with many hundreds of properties (excused from meeting the trade or business test). Perhaps any REIT-eligible rental real estate activity should automatically be treated as a ‘trade or business’ for purposes of section 199A.

The rules for like-kind exchanges and other non-recognition transfers of property with Unadjusted Basis Immediately After Acquisition (UBIA) appear intended to prevent ‘trafficking’ in UBIA. If that is the objective, there may be a better approach that is more consistent with the legislative intent underlying the UBIA rules. Similarly, it should be possible for additional UBIA to arise when a partner purchases a partnership interest (instead of purchasing an undivided interest in the partnership’s property) and makes a section 743 adjustment with respect to qualifying property.

In addition, some modifications may be needed to the wage and asset rules when there are substantial mid-year asset sales.

Detailed observations

A. SSTB definitions

The definition of ‘consulting’ is very broad – encompassing services that include ‘advice and counsel’ toward meeting a client’s objective – and may override exceptions that were intentionally made in other areas.[2] For example, in addressing the definition of services performed in the brokerage field, the proposed regulations specifically exclude ‘real estate agents.’[3] However, a major portion of the services a real estate agent is likely to perform, particularly a buyer’s representative, may be providing advice and counsel. The same may be true of architects and engineers, who were evidently intended by Congress not to be excluded. Perhaps it should be clarified that, where there is a clear intention not to exclude a specific service, a more general rule of exclusion that might apply should not override the more specific mandate of non-exclusion. Also, it is difficult to understand the distinction between providing advice and counsel, which are considered to be ‘consulting,’ and education, teaching, or training, which the proposal declares to be outside the definition of ‘consulting.’[4] Perhaps the term ‘consulting’ should be narrowed to cover only the provision of advice and counsel regarding the development and implementation of business or organizational strategies, the field traditionally known as management consulting.

B. Combined SSTB and Non-SSTB activities

The proposed regulations contain a pro-taxpayer de minimis rule for situations in which only a small portion of a taxpayer’s trade or business income is derived from one of the listed SSTB fields. Generally, the rule provides that if a trade or business has gross receipts from the performance of services in an SSTB of less than 5 percent (10 percent in certain cases), no portion of the trade or business will be considered an SSTB. That SSTB income is effectively excused from the rules. However, the regulations are silent with respect to the proper treatment where the SSTB activities of a trade or business exceed 5 percent (10 percent in some cases) – possibly suggesting that the entire business is disqualified. On the other hand, this seemingly harsh result appears to be contradicted by the implications of a pro-government rule that applies to commonly owned businesses with shared expenses in which non-SSTB activities are 5 percent or less of total revenues. There, the non-SSTB income is disregarded as ‘incidental’ to the SSTB and is entirely ineligible for the deduction.[5]

The obvious question is what rules apply in between the de minimis rule and the ‘incidental’ rule – say, where expenses are shared by an SSTB and a commonly owned non-SSTB each contributing 50 percent of the combined revenues. The incidental rule implies that the SSTB income in such a case will not taint the non-SSTB because the non-SSTB income is more than 5 percent of the total.

For example, consider a dermatology practice whose revenues are 75 percent from dermatology and 25 percent from the sale of cosmetics. The implication of the ‘incidental’ rule is that where non-SSTB activities exceed 5 percent of the income and expenses attributable to combine business, the non-SSTB activities should qualify as QBI. That is, the cosmetics revenues and their associated expenses (taking into account an arm’s length allocation of any shared items) should be considered to generate QBI of the business or group of businesses generating those revenues. In addition to confirming this result, the regulations should clarify that this is the rule regardless of whether the activities technically constitute a single trade or business with multiple activities, or two or more separate, commonly owned trades or businesses. Alternatively, separate trade or business status might always be assumed for SSTB and non-SSTB activities – unless the de minimis or the ‘incidental’ rules apply.

Indeed, the dermatology example in the proposed regulations – a sole proprietorship owned and operated by the dermatologist through a single disregarded entity that sells cosmetics and provides dermatology services using shared facilities and expenses – is actually described as consisting of two distinct trades or businesses.[6] Based on that example, it would be difficult to imagine any situation where SSTB and non-SSTB activities – whether conducted in a single entity or multiple, commonly owned entities – do not constitute separate trades or businesses – thus invoking the ‘incidental rule’ and impliedly blessing any case (subject to appropriate allocations of income and expenses) where the non-SSTB revenues are 5 percent or more of the total.

In addition to the rules disregarding de minimis SSTB activities and incidental non-SSTB activities – presumably requiring allocations and perhaps a section 482 analysis in the in-between cases – a special rule treats a non-SSTB that provides 80 percent or more of its services or property to a commonly owned SSTB as an SSTB, and excludes a pro rata portion of such revenues (presumably including associated expenses) if they are under 80 percent.[7] This rule is arguably too restrictive where the receipt of substantial revenues from third parties demonstrates that the SSTB is paying an arm’s length price to the non-SSTB.

C.  Aggregating non-SSTB businesses to use ‘excess’ wages or UBIA

The rules allowing for the aggregation of commonly owned, separate businesses in certain cases appear to reach the right answers, thus reducing pressure on whether there are, in fact, multiple businesses or a single business.[8] (As mentioned above, the dermatology example illustrating the ‘incidental’ rule would suggest that every separate line of distinct revenues constitutes a separate business, even if conducted by the same people in the same entity with shared facilities and expenses).

Through a somewhat involved ‘two-out-of-three’ factor test, the aggregation rules seem to be getting at the presence of two discrete factors: there must be a substantial, potential sharing of income, expenses, or other value between the businesses (of the type and magnitude that would ordinarily require an arm’s length pricing analysis to ensure that the income of the separate businesses was not distorted by such sharing), and that potential sharing of value must exist for substantial business reasons, not primarily to increase deductions under section 199A. (That might be a more direct formulation of the two-out-of-three test in the proposal.) If the conditions for aggregation are met, no section 482 analysis is required (because everything is aggregated into one business). In addition, there are no limitations on using wages or assets from one activity against net income from another activity. Even if a section 482 analysis were conducted and demonstrated that there was arm’s length pricing of shared items, permitting the separate businesses to clearly reflect their income without aggregation, the wages and assets of the separate activities could still be aggregated.

There may still be some reasons why it could matter whether the taxpayer owns a single business or multiple businesses. Based on the issues raised here, and a review of the standards under section 446, a rule along the following lines might be considered:

Where desired, the taxpayer may treat two or more lines of business as distinct trades or business if they have, in substance, distinct books and records. Books and records are distinct, in substance, even if they are combined or recorded in combination, as long as all material items attributable to each distinct business – such as the net income of each business – are readily determinable from the face of the records. If there are material items of income, expense, or other value shared by the businesses, they are distinct businesses with separate books and records, in substance, only where appropriate evidence exists of arm’s length pricing or allocations of the type that would be required for purposes of section 482 or a similar fairness opinion if they were not commonly owned.

D.  When does profit-seeking become a business?

The law continues to be unclear on what level of activity rises to the level of a trade or business. In the case of rental real estate activity, however, no ‘trade or business’ test applies to rental properties held by a REIT. The REIT rules are normally viewed as intended to favor smaller investors, but in this case a requirement to demonstrate trade or business status is not imposed on a REIT, but is imposed on smaller investors or landlords that would find qualifying for REIT status unnecessary and prohibitively expensive. In the case of real estate rental activities not conducted through a REIT it arguably makes sense to provide that any rental real estate activity that would generate REIT-eligible real estate rents would be considered to be a trade or business for purposes of section 199A. Of course, the wage and asset tests would continue to apply to non-REIT landlords, even though they do not apply to REITs.

In addition, consideration could be given to a rule allowing all such real estate rental businesses to be aggregated or treated as a single trade or business.


The proposed regulations limit the ability to use the UBIA associated with an asset when the asset is transferred in a tax-free exchange, such as the formation of a partnership or S corporation, the tax-free distribution of assets from such entities, or a like-kind exchange.[9] For the most part, these limitations appear to be intended to address a concern with ‘trafficking’ in UBIA – such as where a low-value or zero-value, high-UBIA asset is transferred to a partnership in exchange for a partnership interest whose value reflects the value to the other partners of being able to utilize the ‘excess’ UBIA of that asset. The remedy proposed by the proposed regulations is to reduce an asset’s UBIA to the adjusted basis of the asset at the time of the transfer – which seems harsh and unwarranted in many cases.[10] In addition, the proposed regulations use the allocation of the tax basis depreciation of the asset to govern the allocation of the UBIA, which may inadvertently create the kind of UBIA shifts the proposed rules are seemingly designed to prevent.[11]

If ‘trafficking’ in UBIA is the government’s concern, the approach taken by the proposed regulations could be improved to make it both more effective and more consistent with the underlying legislative intent of the UBIA rules. The following approach could be considered.

The general rule would be that the UBIA of an asset carries over without modification in a tax-free exchange.

With S corporations, the UBIA would be allocated among the shareholders on a pro rata basis. In the case of a partnership, the UBIA would be allocated among the partners in the same proportion as the book or section 704(b) depreciation with respect to that asset. Moreover, that would be computed without regard to any allocations of depreciation that vary from the allocations of income from the asset.

Thus, a contributing partner who contributes depreciable property with UBIA of $10 million, a basis of $4 million, and a value of $8 million, receiving a 50 percent share of the profits from that property (and all other properties), would be allocated 50 percent of the partnership’s $10 million of UBIA on its original schedule. If the second partner received 50 percent of the profits from that property (and all other properties) contributed $8 million worth of land with no UBIA and a basis of $10 million, the second partner would be allocated 50 percent of the $10 million of UBIA associated with the depreciable property contributed by the first partner. UBIA could then continue to be allocated in these proportions, even if the property was fully depreciated for book purposes.

In certain potentially abusive cases – such as where a partner contributing such property was reducing, say, by more than 50 percentage points, their percentage interest in the profits generated by such property, and the fair market value of the property was less than, say, 20 percent of its UBIA, the contributing partner’s UBIA should still not be adversely affected. However, the non-contributing partners’ UBIA with respect to such property would be redetermined by reference to its section 704(b) book value (fair market value upon contribution) instead of its original UBIA in the hands of the contributing partner. That would prevent the shifting of UBIA to the non-contributing partner.

By the same token, if a partner purchases a partnership interest and the purchase gives rise to a section 743 adjustment reflecting a special, increased amount of basis and depreciation attributable to treating the purchase in a manner similar a purchase of the underlying property, the section 743 adjustment should give rise to additional, new UBIA for the purchasing partner, to the extent the increased basis exceeds the original UBIA that is carrying over to the partnership. The proposed regulations do not allow this.[12]

In addition, in a like-kind exchange, the UBIA of the relinquished property should carry over to the new property, and any supplemental property acquired other than in the tax-free exchange should be treated as newly acquired property with a new UBIA. Since there is no change in ownership of the UBIA in a like-kind exchange, no anti-abuse rule to prevent ‘trafficking’ in UBIA is needed.

Finally, where property is sold before the last day of the taxable year, the statute contemplates and may even require regulations to provide appropriate rules for the computation of UBIA other than on a year-end basis. Such rules are proposed for the wage computation, but not for the UBIA computation. Where there are substantial asset sales or purchases, there does not appear to be any reason why the taxpayer should not be permitted to make all of his UBIA and QBI computations using two or more short taxable years or periods, taking into account the income and the UBIA for such shorter periods, using the UBIA of property held at the end of the period. In addition, more flexibility (perhaps the ability to use ‘any reasonable method’) should be permitted to allocate wages. In particular, a special rule might address the treatment of wages for short period returns with recapture income.


[1] REG-107892-18

[2] Prop. Treas. Reg. section 1.199A-5(b)(2)(vii).

[3] Prop. Treas. Reg. section 1.199A-5(b)(2)(x).

[4] Prop. Treas. Reg. section 1.199A-5(b)(2)(vii).

[5] Prop. Treas. Reg. section 1.199A-5(c)

[6] Prop. Treas. Reg. section 1.199A-5(c)(3)(ii)

[7] Prop. Treas. Reg. section 1.199A-5(c)

[8] Prop. Treas. Reg. section 1.199A-4.

[9] Prop. Treas. Reg. section 1.199A-2.

[10] Prop. Treas. Reg. section 1.199A-2(c) and examples

[11] Prop. Treas. Reg. section 1.199A-2(c)

[12] Prop. Treas. Reg. section 1.199A-2(c).


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