Practitioners Call for 199A Soft Guidance, Safe Harbor Fix

Posted on Mar. 13, 2019

By Eric Yauch Practitioners are welcoming IRS signals that it may reconsider its positions on the passthroughdeduction rental safe harbor, saying the safe harbor isn’t helpful.

“I think many people are finding in practice that the safe harbor is maybe not thatrealistic and that most fact patterns don’t meet it,” Adam Sweet of Eide Bailly LLP told TaxNotes.

Sweet, a former IRS attorney, said the issue that practitioners have been most concerned aboutis the treatment of triple net leases and whether they rise to the trade or business level.

Triple net leases aren’t included in the safe harbor that was released in a proposed revenueprocedure (Notice 2019-7, 2019-9 IRB 740) along with the final section 199A regulations (T.D.9847) in January. However, the IRS has indicated that triple net leases can still show that theyrise to the level of a trade or business under section 162 to take advantage of the 20 percentpassthrough deduction.

At the Federal Bar Association conference in Washington March 8, IRS officials indicatedthat the rental safe harbor wasn’t set in stone and welcomed suggestions. Officials also heardquestions regarding the safe harbor at a March 13 District of Columbia Bar Taxation Communityevent.

Subregulatory guidance on “facts and circumstances in which the IRS would accept a triple netlease as being part of a trade or business would be helpful,” Sweet said.

Sweet said the proposed regulations (REG-107892-18) recognized that it’s possible to have asingle trade or business across multiple regarded entities; however, it seems clear that the250-hour safe harbor test is entity-specific, he added.

For example, it’s common in real estate to have 10 regarded partnerships with similarownership across the tier with a common management company. Those partnerships could bein separated entities for liability protection purposes but be considered one trade or business forbookkeeping purposes, Sweet said.

“If we put them together, we can get pretty comfortable that it’s a trade or business,” Sweetsaid. “But if we’re forced to test each partnership on its own, we get a little less comfortable.”He added that it would be helpful if the IRS clarified when it could see a trade or business beingconducted across multiple regarded entities.

The passthrough deduction, which was added to the code by the Tax Cuts and Jobs Act,provides a 20 percent deduction for passthrough owners up to specific income thresholds,

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above which specified service trades or businesses (SSTBs) are barred from using it, and theones that can are limited by wages paid and unadjusted basis in property immediately afteracquisition.

Employee Uncertainty

The deduction isn’t available for all types of income — wages received by individuals don’tcount as qualified business income, nor do most guaranteed payments received by partners.

However, those limitations still leave the door open for planning opportunities for somebusinesses that would fall into the SSTB category, like law firms. For example, an associate of alaw firm could set up his or her own firm and provide services to the old firm, assuming theincome thresholds aren’t exceeded.

Joshua Wu of Clark Hill PLC said the IRS and Treasury in the regulations added a presumptionthat former employees are still employees if they change their status to partners. In the law firmassociate planning context, that just raises more questions, he said.

Wu said Example 2 in the final regulations describes an associate attorney at a law firm treatedas an employee who changes his or her relationship with the firm by becoming a partner in asecond law firm that contracts to perform legal services for the first firm. In that example, theassociate attorney is presumed to be an employee of the second firm for 199A purposes basedon their prior status in the first law firm.

“The example leaves open how the IRS would treat other associate attorneys who may join thefirm after the new arrangement is in place,” Wu said. “Would some associate attorneys in thesecond law firm be able to receive the 199A deduction because they joined as laterals fromother firms, while associates formerly employed by the first firm could not?”

Start-Ups in the Dark

Wu said the final regulations did a good job of clarifying many SSTB definitions, but addedthat there are still open questions.

For example, in response to comments on the proposed regulations, the final regulationsremoved from the definition of health services that medical services “be provided directly to thepatent,” Wu said. While that change attempts to avoid arbitrary results raised in the comments,it also creates ambiguity regarding when a business is providing services directly related to amedical services field.

“Many startups specialize in connecting service providers to ultimate consumers or to otherbusinesses,” Wu said. “They do so through the use of technology and a wide array of businessrelationships where the service providers may be employed or contracted to the startup, anotherbusiness, or the ultimate consumer.”

Soft guidance on that issue would help, Wu said.

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Calculation Clarification

Sweet said that as partnerships start reporting section 199A items on Schedules K-1, they haveseveral questions about how to treat separately stated items in determining the deduction.

Sweet said one thing that’s unclear is how to treat charitable contributions when the partnershipor S corporation makes the contribution and then separately states it on the Schedule K-1.

Sweet said there are differences of opinion on how to treat those contributions. He noted thefinal regulations say that all items that are attributable to a trade or business are items ofqualified business income, but said practitioners have come down on both sides of the issue.

“It would be helpful if the IRS could provide guidance on these items that are separately statedthat go into the qualified business income calculation,” Sweet said.

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