Proposed Regulations Provide Welcome Guidance for 20% Pass-Through Deduction

by K&L Gates LLP

K&L Gates LLP

Among the more noteworthy changes made by the Tax Cuts and Jobs Act of 2017 was the creation of Code Section 199A [1], which grants a deduction to owners of certain pass-through businesses (i.e., sole proprietorships, partnerships, and S corporations) of up to 20% of qualifying business income (“QBI”) earned by a qualified trade or business. Numerous key aspects of Section 199A were unclear and generated substantial debate about the manner in which the new deduction would be applied. On August 8, 2018, the Department of Treasury issued proposed regulations (REG-107892-18) (the “Proposed Regulations”) that address many of these open questions, though many important issues remain [2]. This alert discusses several key areas and how the Proposed Regulations attempt to address those areas of uncertainty surrounding Section 199A.

Trade or Business Standard

As an initial matter, the Section 199A deduction is available only with respect to activities rising to the level of a “trade or business.” The Code uses several different trade or business standards and it was initially unclear which “trade or business” standard Congress intended to apply for these purposes. The Proposed Regulations provide that each activity must satisfy Section 162’s trade or business standard, which generally requires an activity to be conducted with “continuity and regularity” and with the primary purpose of earning income or making a profit. The adoption of the Section 162 trade or business standard could prove problematic for professionals engaging in rental real estate who will be required to establish that their rental activities meet the Section 162 standard. The Proposed Regulations provide an exception, however, for taxpayers that rent or lease tangible or intangible property to a commonly controlled trade or business. This self-rental activity is treated as a Section 162 trade or business.

Specified Service Trade or Business

 One of the hottest areas of debate surrounding Section 199A involves the definition of a “specified service trade or business” (an “SSTB”). To claim the deduction under Section 199A, a trade or business must be a “qualified trade or business,” which includes all trades or businesses except for (i) an SSTB, or (ii) “the trade or business of performing services as an employee.” Under Section 199A, the definition of an SSTB includes (i) any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, and (ii) any trade or business that involves the performance of services that consist of investing, investment management, trading, or dealing in securities, partnership interests or commodities.

The Proposed Regulations attempt to provide clarity by building on the relative dearth of case law and administrative guidance interpreting Section 1202. Although it is beyond the scope of this alert to review the details of each service field, we note three significant developments. First, the Proposed Regulations construe the field of “financial services” to exclude banking (i.e., taking deposits or making loans) and exclude from the definition of “brokerage services” those services provided by real estate and insurance agents and brokers. Second, the Proposed Regulations provide that the field of “consulting” does not include consulting services that are embedded in, or ancillary to, the sale of goods if there is no separate payment for the consulting services. This provides both a planning opportunity as well as a potential trap for the unwary for trades or businesses that provide consulting services in addition to the sale or manufacture of goods, such as computer software and programming businesses. Third, the Proposed Regulations narrowly interpret the circumstances in which Section 199A’s inclusion as an SSTB of “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners” would apply. There had been concern that this category would act as a “catch-all” and ensnare many activities that otherwise would be permissible. The Proposed Regulations, however, limit the application of the “reputation or skill” category to the following: (i) endorsement income for products and services; (ii) income from the licensing of an individual’s image or likeness; and (iii) appearance fees or income. To illustrate this concept, the Proposed Regulations posit a scenario where a well-known chef that owns multiple restaurants also receives an endorsement fee of $500,000 for the use of her name on a line of cookware due to her skills and reputation as a chef. The chef is in the trade or business of being a chef and owning restaurants, which does not constitute an SSTB. However, the chef is also in the business of receiving endorsement income, which does constitute an SSTB.

Prior to the issuance of the Proposed Regulations, it was unclear whether an otherwise qualified trade or business could be “tainted” for purposes of Section 199A by the inclusion of a modestly-sized SSTB. The Proposed Regulations address this concern by creating a de minimis exception under which a trade or business that both sells products and performs otherwise prohibited services can avoid SSTB classification. Specifically, the de minimis exception applies to trades or businesses that have (i) gross receipts of $25 million or less if under 10% of the gross receipts are attributable to an SSTB, or (ii) gross receipts exceeding $25 million if under 5% of the gross receipts are attributable to an SSTB. While the de minimis exception affords some latitude for the inclusion of an SSTB, we note that the satisfaction of the requisite thresholds may be problematic for businesses of substantial size.

Following the enactment of Section 199A, there was significant debate about the ability of a taxpayer to separate an integrated SSTB (such as a law, consulting, or accounting firm) into component businesses that would qualify for the Section 199A deduction and whether the construction of separate entities would be necessary. For example, a law firm could create an employee leasing affiliate and an entity to hold or lease real property. These activities, standing alone, would not constitute an SSTB. The preamble to the Proposed Regulations makes clear that such strategies are inconsistent with the purpose of Section 199A, and the Proposed Regulations attempt to defeat business separations that maintain a high degree of common ownership by including within the definition of an SSTB any trade or business with 50% or more common ownership (directly or indirectly) that provides 80% or more of its property or services to an SSTB. Additionally, if a trade or business has 50% or more common ownership with an SSTB, the portion of the property or services provided to the SSTB will be treated as an SSTB.

The Proposed Regulations also provide that the SSTB determination is best made at the entity level, and thus each pass-through entity is required to determine its SSTB status and disclose that information to its partners, shareholders, and owners.

A Net Loss

When an individual owns multiple qualified trades or businesses, Section 199A directs the individual to calculate the QBI from each separate trade or business and then net the amounts. If a taxpayer’s combined QBI from all qualified trades or businesses results in a negative amount, the taxpayer’s QBI is zero for the current taxable year and the negative amount is carried forward to the subsequent taxable year and treated as negative QBI from a separate qualified trade or business for Section 199A purposes. An area of uncertainty involved a situation where a taxpayer owns a qualified trade or business that produces positive QBI and another qualified trade or business that produces a loss, netting to produce a positive amount. Assuming that the taxpayer does not elect to aggregate (discussed below), when a taxpayer’s net amount of QBI is a positive amount, but at least one of the qualified trades or businesses generates a loss, the Proposed Regulations instruct that such loss must be allocated among the qualified trades or businesses that produce positive QBI in proportion to such positive amounts.

Election to Aggregate

As previously noted, the computation of QBI generally applies to each business on a stand-alone basis before netting the amounts. Section 199A was not clear whether taxpayers would be permitted to aggregate businesses, similar to the grouping regime available for passive activity losses under Section 469. The ability to aggregate businesses is important because it would allow taxpayers to calculate their Section 199A deduction using aggregate QBI, W-2 wages, and unadjusted depreciable property bases. For example, suppose a real estate developer has two partnerships—Partnership 1 has high QBI and a low basis in unadjusted depreciable property, whereas Partnership 2 has a low QBI and a high basis in unadjusted depreciable property. In the absence of aggregation, Partnership 1’s deduction would be limited by its low property basis and Partnership 2 would not have adequate QBI for purposes of the calculation.

The Proposed Regulations would permit (but not require) taxpayers to elect to aggregate separate trades or businesses for purposes of Section 199A. This election is made at the ownership level and generally cannot be revoked once made. In order to make such an election, the taxpayer must first demonstrate that each of the separate trades or businesses to be aggregated meet certain eligibility criteria, including: (i) satisfaction of the trade or business standard; (ii) the same person or group of persons (not required to be the electing taxpayer) owns a majority interest in each business; (iii) no business can be an SSTB; and (iv) establish that the trades or businesses are part of a larger integrated business. The election to aggregate provides a variety of planning opportunities for taxpayers who own multiple businesses and desire to maximize the Section 199A deduction.

Independent Contractors

Although Section 199A prohibits an employee from taking the 20% deduction against his or her wage income, the deduction is available to independent contractors, subject to the limitations discussed above. This advantageous treatment of independent contractors had led many to speculate that Section 199A would lead to a flurry of taxpayers seeking to be reclassified as independent contractors. The Proposed Regulations therefore create a series of rules that are intended to prevent potential abuse. Under the Proposed Regulations, an employee that suddenly becomes an independent contractor while providing substantially the same services, directly or indirectly, to a former employer will be presumed to remain an employee for purposes of Section 199A. This presumption can be overcome if the former employee can show that he or she is performing services in a capacity other than as an employee, as determined under existing Treasury Regulation Sections 31.3121(d)-1, 31.3306(i)-1, and 31.3401(c)-1.

Effective Date

While Section 199A is applicable to taxable years beginning after December 31, 2017 and before January 1, 2026, it was not clear how to treat taxpayers that owned pass-throughs with taxable years beginning before and ending after January 1, 2018. The Proposed Regulations provide that a taxpayer shall treat QBI, W-2 wages, and unadjusted basis of depreciable property as having been received or incurred in the year the pass-through’s taxable year ends. In other words, an individual owning a pass-through with a taxable year beginning before January 1, 2018 will get the benefit of QBI (and W-2 wages and unadjusted depreciable property basis) earned before the effective date.

The Proposed Regulations are scheduled to be published in the Federal Register on August 16, 2018. Comments and requests for public hearing are invited and must be received by a date that is 45 days after August 16, 2018. Taxpayers that wish to submit comments on the Proposed Regulations thus must do so on or before October 1, 2018.

[1] All Section references are to the Internal Revenue Code of 1986, as amended (the “Code”).
[2] Also on August 8, 2018, the Department of Treasury issued Notice 2018-64, which includes a proposed revenue procedure pertaining to the calculation of W-2 wages for purposes of Section 199A.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© K&L Gates LLP | Attorney Advertising

Written by:

K&L Gates LLP

K&L Gates LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide

JD Supra Privacy Policy

Updated: May 25, 2018:

JD Supra is a legal publishing service that connects experts and their content with broader audiences of professionals, journalists and associations.

This Privacy Policy describes how JD Supra, LLC ("JD Supra" or "we," "us," or "our") collects, uses and shares personal data collected from visitors to our website (located at (our "Website") who view only publicly-available content as well as subscribers to our services (such as our email digests or author tools)(our "Services"). By using our Website and registering for one of our Services, you are agreeing to the terms of this Privacy Policy.

Please note that if you subscribe to one of our Services, you can make choices about how we collect, use and share your information through our Privacy Center under the "My Account" dashboard (available if you are logged into your JD Supra account).

Collection of Information

Registration Information. When you register with JD Supra for our Website and Services, either as an author or as a subscriber, you will be asked to provide identifying information to create your JD Supra account ("Registration Data"), such as your:

  • Email
  • First Name
  • Last Name
  • Company Name
  • Company Industry
  • Title
  • Country

Other Information: We also collect other information you may voluntarily provide. This may include content you provide for publication. We may also receive your communications with others through our Website and Services (such as contacting an author through our Website) or communications directly with us (such as through email, feedback or other forms or social media). If you are a subscribed user, we will also collect your user preferences, such as the types of articles you would like to read.

Information from third parties (such as, from your employer or LinkedIn): We may also receive information about you from third party sources. For example, your employer may provide your information to us, such as in connection with an article submitted by your employer for publication. If you choose to use LinkedIn to subscribe to our Website and Services, we also collect information related to your LinkedIn account and profile.

Your interactions with our Website and Services: As is true of most websites, we gather certain information automatically. This information includes IP addresses, browser type, Internet service provider (ISP), referring/exit pages, operating system, date/time stamp and clickstream data. We use this information to analyze trends, to administer the Website and our Services, to improve the content and performance of our Website and Services, and to track users' movements around the site. We may also link this automatically-collected data to personal information, for example, to inform authors about who has read their articles. Some of this data is collected through information sent by your web browser. We also use cookies and other tracking technologies to collect this information. To learn more about cookies and other tracking technologies that JD Supra may use on our Website and Services please see our "Cookies Guide" page.

How do we use this information?

We use the information and data we collect principally in order to provide our Website and Services. More specifically, we may use your personal information to:

  • Operate our Website and Services and publish content;
  • Distribute content to you in accordance with your preferences as well as to provide other notifications to you (for example, updates about our policies and terms);
  • Measure readership and usage of the Website and Services;
  • Communicate with you regarding your questions and requests;
  • Authenticate users and to provide for the safety and security of our Website and Services;
  • Conduct research and similar activities to improve our Website and Services; and
  • Comply with our legal and regulatory responsibilities and to enforce our rights.

How is your information shared?

  • Content and other public information (such as an author profile) is shared on our Website and Services, including via email digests and social media feeds, and is accessible to the general public.
  • If you choose to use our Website and Services to communicate directly with a company or individual, such communication may be shared accordingly.
  • Readership information is provided to publishing law firms and authors of content to give them insight into their readership and to help them to improve their content.
  • Our Website may offer you the opportunity to share information through our Website, such as through Facebook's "Like" or Twitter's "Tweet" button. We offer this functionality to help generate interest in our Website and content and to permit you to recommend content to your contacts. You should be aware that sharing through such functionality may result in information being collected by the applicable social media network and possibly being made publicly available (for example, through a search engine). Any such information collection would be subject to such third party social media network's privacy policy.
  • Your information may also be shared to parties who support our business, such as professional advisors as well as web-hosting providers, analytics providers and other information technology providers.
  • Any court, governmental authority, law enforcement agency or other third party where we believe disclosure is necessary to comply with a legal or regulatory obligation, or otherwise to protect our rights, the rights of any third party or individuals' personal safety, or to detect, prevent, or otherwise address fraud, security or safety issues.
  • To our affiliated entities and in connection with the sale, assignment or other transfer of our company or our business.

How We Protect Your Information

JD Supra takes reasonable and appropriate precautions to insure that user information is protected from loss, misuse and unauthorized access, disclosure, alteration and destruction. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. You should keep in mind that no Internet transmission is ever 100% secure or error-free. Where you use log-in credentials (usernames, passwords) on our Website, please remember that it is your responsibility to safeguard them. If you believe that your log-in credentials have been compromised, please contact us at

Children's Information

Our Website and Services are not directed at children under the age of 16 and we do not knowingly collect personal information from children under the age of 16 through our Website and/or Services. If you have reason to believe that a child under the age of 16 has provided personal information to us, please contact us, and we will endeavor to delete that information from our databases.

Links to Other Websites

Our Website and Services may contain links to other websites. The operators of such other websites may collect information about you, including through cookies or other technologies. If you are using our Website or Services and click a link to another site, you will leave our Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We are not responsible for the data collection and use practices of such other sites. This Policy applies solely to the information collected in connection with your use of our Website and Services and does not apply to any practices conducted offline or in connection with any other websites.

Information for EU and Swiss Residents

JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

  • Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
  • Your Rights
    • Right of Access/Portability: You can ask to review details about the information we hold about you and how that information has been used and disclosed. Note that we may request to verify your identification before fulfilling your request. You can also request that your personal information is provided to you in a commonly used electronic format so that you can share it with other organizations.
    • Right to Correct Information: You may ask that we make corrections to any information we hold, if you believe such correction to be necessary.
    • Right to Restrict Our Processing or Erasure of Information: You also have the right in certain circumstances to ask us to restrict processing of your personal information or to erase your personal information. Where you have consented to our use of your personal information, you can withdraw your consent at any time.

You can make a request to exercise any of these rights by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

You can also manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard.

We will make all practical efforts to respect your wishes. There may be times, however, where we are not able to fulfill your request, for example, if applicable law prohibits our compliance. Please note that JD Supra does not use "automatic decision making" or "profiling" as those terms are defined in the GDPR.

  • Timeframe for retaining your personal information: We will retain your personal information in a form that identifies you only for as long as it serves the purpose(s) for which it was initially collected as stated in this Privacy Policy, or subsequently authorized. We may continue processing your personal information for longer periods, but only for the time and to the extent such processing reasonably serves the purposes of archiving in the public interest, journalism, literature and art, scientific or historical research and statistical analysis, and subject to the protection of this Privacy Policy. For example, if you are an author, your personal information may continue to be published in connection with your article indefinitely. When we have no ongoing legitimate business need to process your personal information, we will either delete or anonymize it, or, if this is not possible (for example, because your personal information has been stored in backup archives), then we will securely store your personal information and isolate it from any further processing until deletion is possible.
  • Onward Transfer to Third Parties: As noted in the "How We Share Your Data" Section above, JD Supra may share your information with third parties. When JD Supra discloses your personal information to third parties, we have ensured that such third parties have either certified under the EU-U.S. or Swiss Privacy Shield Framework and will process all personal data received from EU member states/Switzerland in reliance on the applicable Privacy Shield Framework or that they have been subjected to strict contractual provisions in their contract with us to guarantee an adequate level of data protection for your data.

California Privacy Rights

Pursuant to Section 1798.83 of the California Civil Code, our customers who are California residents have the right to request certain information regarding our disclosure of personal information to third parties for their direct marketing purposes.

You can make a request for this information by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

Some browsers have incorporated a Do Not Track (DNT) feature. These features, when turned on, send a signal that you prefer that the website you are visiting not collect and use data regarding your online searching and browsing activities. As there is not yet a common understanding on how to interpret the DNT signal, we currently do not respond to DNT signals on our site.

Access/Correct/Update/Delete Personal Information

For non-EU/Swiss residents, if you would like to know what personal information we have about you, you can send an e-mail to We will be in contact with you (by mail or otherwise) to verify your identity and provide you the information you request. We will respond within 30 days to your request for access to your personal information. In some cases, we may not be able to remove your personal information, in which case we will let you know if we are unable to do so and why. If you would like to correct or update your personal information, you can manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard. If you would like to delete your account or remove your information from our Website and Services, send an e-mail to

Changes in Our Privacy Policy

We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at:

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit
  • New Relic - For more information on New Relic cookies, please visit
  • Google Analytics - For more information on Google Analytics cookies, visit To opt-out of being tracked by Google Analytics across all websites visit This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at:

- hide

This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.