Proposed regulations for the Qualified Business Income (or QBI) deduction were recently released which helped to further define and make rules on this new tax incentive for certain business owners. 

What is QBI?

In order to determine the QBI deduction granted to certain business owners, a taxpayer has to determine what constitutes QBI. 

This income generally includes all gross income, gain, deduction and loss to the extent such items are connected with the conduct of a trade or business within the United States and are included or allowed in determining taxable income for the taxable year.  The code section lists certain items which are not included in the definition of qualified business income which includes:

• capital gains
• dividends
• interest attributed to an investment of working capital or reserves
• certain gains or losses in commodities transactions or excess foreign currency gains
• reasonable compensation received by a shareholder form an S corporation or guaranteed payments received by a partner.

Proposed Regulations Provide Clarification

Initially, when the Tax Cuts and Jobs Act was first passed, there were several comments and questions to this definition to ask for clarification on certain items and Treasury’s proposed regulations answer the following questions:

1. Can QBI include gain or loss that is treated as ordinary income under Code Section 751, which deals with unrealized receivables and inventory items?  
   • Yes, any gain attributable to assets of a partnership giving rise to ordinary income under Section 751(a) or (b) may constitute QBI if other requirements under Section 199A are satisfied.
2. Are guaranteed payments for the use of capital under Section 707(c) included in QBI?
   • No, but the partnership’s deduction associated with such a payment may constitute QBI. 
3. Can previously suspended losses prior to enactment of 199A be taken into account as QBI?  
   • No. Generally suspended losses are treated as items attributable to the trade or business in the year they are allowed, but for any losses or deductions that were disallowed for tax years beginning before January 1, 2018, such items are not included in QBI in a later year.
4. Can a net operating loss (NOL) disallowed by Code Section 461(l) (excess business loss disallowance carryover rule) be taken into account as QBI?
   • Yes, to the extent the NOL includes amounts disallowed under 461(l).

Tax Planning

For business owners planning for their taxes in 2019 and beyond, these clarifications can be helpful. If your business has unrealized receivables, inventory or previously suspended losses, these rules help you to understand what your actual QBI deduction may be for tax planning purposes.

Business owners should consult with their tax attorney about how these changes will impact their businesses and how they can take advantage of the new 199A deduction.