INTRODUCTION
The Tax Cuts and Jobs Act ("T.C.J.A."), signed into law on December 22, 2017, contained several major changes with respect to individuals and entities. This article discusses a new provision allowing individuals, trusts, and other non-corporate taxpayers1 to claim a deduction equal in amount to 20% of the "qualified business income" and certain other income from business, subject to certain ceilings.
This new provision is programmed to sunset for taxable years beginning after December 31, 2025, but it may be repealed earlier, depending on the results of the next presidential election, or extended on a rolling basis beyond the sunset date, as has happened for certain provisions in the area of Subpart F. It applies to both
U.S. persons and non-U.S. persons, generally as long as the income relates to a "qualified" U.S. business.
Like many other provisions of the T.C.J.A., the qualified business income deduction was drafted with only limited public input that took place during a relatively short period of time. It clearly is designed to distinguish between businesses carried on in non-corporate form that employ many people in skilled and non-skilled positions and personal services businesses where owner-managers provide the key skill sets for generating profit. Business owners in the former group should be able to qualify for the benefit. Regrettably, business owners in the latter group tend to look like employees in this context, and it is unlikely that they will obtain the full benefit.
Aside from revealing broad policy objectives, a simple reading of the statute will shed little light on the business income that qualifies for the deduction. One reason is the drafting style of the statute, which hides important concepts in unusual ways. As a result, a full understanding of the winners and losers under this provision requires a thorough deconstruction of the statute. In order to achieve clarity, this article is written in question and answer format that logically guides the reader through the provisions and does not hide the results among new terms defined in hidden subdivisions of subsections.
ENTITLEMENT TO THE DEDUCTION
Taxpayers Entitled to the Code §199A Deduction
Q. 1: Can every taxpayer take the Code §199A deduction?
No. Only taxpayers other than C corporations can take the deduction. 2
Q. 2: Can non-U.S. taxpayers take the Code §199A deduction?
Yes. Both U.S. and non-U.S. taxpayers can take the deduction if they otherwise qualify.
Income Benefitting from the Code §199A Deduction
Q. 3: What type of taxable income must a taxpayer generate in order to benefit from the Code §199A deduction?
Each of the following types of income may benefit from the deduction:
- Qualified cooperative dividends
- Qualified R.E.I.T. dividends
- Qualified publicly traded partnership income
- Qualified business income3
Q. 4: What is a cooperative and what are qualified cooperative dividends?
A cooperative is any organization that is exempt from tax under Code §521, which relates to farmers' cooperatives. It also includes any taxable corporation that operates on a cooperative basis and allocates amounts to patrons on the basis of the business done with or for such patrons. 4 Examples are grain, citrus, and dairy businesses. These corporations are allowed a deduction for patronage dividends and per-unit retain allocations.
Qualified cooperative dividends are certain amounts received by patrons from cooperatives.5 They include a patronage dividend, any per-unit retain allocation, and any qualified written notice of allocation. In this way, the cooperative and its patrons split income: The patron is taxed on the qualified dividends received from the cooperative, and the cooperative is taxed on its taxable income in excess of qualified cooperative dividends paid.
A patron is any person with whom or for whom the cooperative association does business on a cooperative basis. A patronage dividend is an amount paid to a patron under a valid enforceable written obligation that is determined by reference to the net earnings of the cooperative organization from business done with or for its patrons. A per-unit retain allocation means any allocation to a patron with respect to products marketed for the patron where the amount is fixed. These payments are also deductible.
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Footnotes
1 Forthcoming regulations are expected to discuss the application of the provision to tiered partnership structures.
2 Code §199A(a).
3 To facilitate a clear understanding of the provisions, these categories are discussed in order from simplest computations to most complex.
4 Code §1381(a)(2). Certain organizations are excluded from treatment as a cooperative. These include mutual savings banks and insurance companies and rural electrical and telephone companies.
5 Code §199A(e)(4).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
