Qualified Business Income Deduction Strategies

As we enter the third quarter of the 2024 tax year, many companies are beginning to consider various tax strategies for structuring new trade or business. Qualified Business Income (QBI) Deduction, also known as the section 199A deduction, that many taxpayers have utilized since enactment for the Tax Cuts and Jobs Act on December 20, 2017, is set to expire on December 31, 2025. Since its enactment, a number of organizational structures have been tailored in recent years to allow investors access to this deduction. As the benefit is set to expire in less than two years, companies have started to determine whether using the same structuring and strategies for potential new mergers, funds, and businesses will continue to provide the biggest benefit and tax savings for their owners and investors.

Under IRC Section 199A, owners and investors of various pass-through businesses, such as sole proprietorships, S Corporations, and Partnerships, are permitted to deduct up to 20% of their QBI. In addition, the regulation allows owners receiving qualified REIT dividends, publicly traded partnership (PTP) income, and certain agricultural or horticultural cooperatives to deduct 20% of dividends or income as well. The deduction is separately reported by the taxpayer on their income tax return, and is not part of any other deduction, standard or itemized, available to the taxpayer.

Starting in 2018, many corporations began to structure new organizations to report a business’ income and loss conducted with “continuity, regularity, and the intent of earning a profit” under IRC §162, in order to conform with the QBI definition. In addition, these new companies considered the most efficient way to limit the activity from falling under any exception, limitation, and threshold that was mentioned within the §199A regulations. An example of this includes new businesses reporting activity as pass-through income by operating the business activity under an S corporation or LLC rather than a C corporation.

Another example is companies creating various lower tier, pass-through entities to split up business functions between a non-specified service trade or business operation (non-SSTB) and specified service trade or business (SSTB). This structure type permitted companies to maximize the QBI deductions by separating non-SSTB and SSTB business activity. It easily allowed both the company and taxpayer to know if the activity fell within either the SSTB limitation thresholds or non-SSTB wage qualified property limitation.

A third structuring example to receive the deduction includes various real estate funds considering the placement of their activity under a qualified real estate investment trust or REIT. This allows the dividend received by the fund to be allocated to investors under §199A.

In all the aforementioned scenarios, investors are easily able to allocate the type of business activity being reported to consider limitations at their level.

Though complex, the efforts to create such structures for the purpose of utilizing the 20% deduction benefit was strategic, as the benefit outweighed the overall up-front costs to the participating companies. Now, with only 18 months remaining before the expiration of the benefits, companies are contemplating if the upfront costs to receive the QBI deduction benefit for two years is worth it.

In response, companies have begun to look elsewhere within the Internal Revenue Code for available credits and savings when setting up new structures. For example, some now consider classifying new companies as corporations, rather than partnerships or S corporations, to have the investor receive the partial exclusion for gain under IRC §1202. Others consider a corporate classification so the company can issue restricted stock to investors whose tax treatment falls under §1244. Although these are only two broad examples being considered with the ending of QBI, the prediction is other structural and classification changes are ahead.

For more information, consult with your tax professional.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.