QBID final regulations address treatment of suspended losses
Final qualified business income deduction regulations explain how suspended and disallowed losses, including excess business losses, work with the QBID.
The IRS announced the release of final regulations for the §199A qualified business income deduction (QBID). The final regulations address the treatment of previously suspended or disallowed losses for QBID purposes, including excess business losses. The regulations also clarify treatment of partially allowed losses and losses from a specified service trade or business (SSTB).
The final regulations are generally effective for tax years starting on or before August 24, 2020 (2020 for calendar year taxpayers), but taxpayers may choose to apply the rules, including the rule for partially allowed losses to earlier years if beneficial and consistently applied.
Final regulations add excess business losses for noncorporate entities to QBID calculation
Proposed regulations issued in 2019 explained that previously suspended or disallowed losses (other than those from years ending before January 1, 2018) that are allowed for the current tax year are taken into account when computing the QBID as a loss from a separate trade or business. The proposed regulations referred to losses limited under at-risk activities, passive activities, partner basis, and shareholder basis rules, but did not mention excess business losses for noncorporate entities.
The TCJA added new §461 which limits the business loss deduction that a noncorporate taxpayer may claim in the year the loss arises. An excess business loss is defined as the amount by which total deductions from all trades or businesses exceed total income and gains from all trades or businesses over a threshold amount (for 2018, $250,000 or $500,000 for joint filers). Any disallowed loss would then be carried forward in the same manner as net operating losses.
The final regulations add excess business losses to the list of losses that are taken into account when calculating the QBID and clarifies that the list provided in the regulations is not exhaustive. This change will have a greater impact beginning in tax year 2021 since the CARES Act suspends the excess business loss rules for tax years 2018 through 2020.
Partially allowed losses attributable to QBI are considered for QBID purposes
The proposed regulations did not address the rules for partially allowed losses in the year they are incurred. If a loss is partially allowed, only the portion of the loss that is attributable to QBI is considered when determining the taxpayer’s QBID.
Example: John is a 50% owner of ABC, an entity classified as a partnership. In 2018 John’s share of ABC’s loss is $100,000, of which $80,000 is negative qualified business income (QBI). Under at-risk loss rules, $60,000 of the loss is allowed in 2018. He will have to reduce the amount of allowed loss taken into account for QBID purposes. Since only 80% ($80,000/$100,000) of the loss is attributed to QBI he will only take $48,000 (80% × $60,000) of the allowable loss into account when determining his QBID for 2018. Thus, any QBID for the year is potentially increased by reducing the amount of any offsetting loss. The remaining $32,000 is carried forward as a loss from a separate business until it can be taken.
First-in, first-out method is still applicable
Additionally, the regulations clarify that the first-in, first-out (FIFO) method described in the proposed regulations is still applicable.
Example: Mike has disallowed passive activity losses (PALs) of $30,000 and $50,000 for 2018 and 2019, respectively, and has passive income of $35,000 in 2020. All income and losses are from qualified trades or businesses. Mike’s QBI for 2020 would equal the full $35,000. The 2018 PAL is the older of the two previously disallowed PALs and is otherwise allowed against passive income in the current tax year. Mike would offset his $35,000 of QBI first by the $30,000 from 2018 and then the remaining $5,000 will be offset by the PAL from 2019. The remaining $45,000 from 2019 will be carried forward to later years.
Losses from a specified service trade or business (SSTB) subject to phaseout limitations
Finally, for losses from an SSTB the regulations provide rules for the phaseout limitations.
- If the taxpayer’s income is below the threshold ($160,700 for single filers or $321,400 for joint filers in 2019) the entire suspended or disallowed loss is carried forward to subsequent years.
- If the taxpayer’s income is within the phase-in range (between $160,700 and $210,700 for single filers and $321,400 and $421,400 for joint filers in 2019) only the applicable percentage of the loss is carried forward to subsequent years.
- If the taxpayer’s income exceeds the phase-in range, then the loss is not carried forward to subsequent years for QBID purposes. This is determined in the year in which the loss is incurred.
See Example 2 in the regulations for an illustration of these concepts.
The regulations also include rules for treating amounts paid by regulated investment companies (RICs) as a conduit for REITs as qualified dividends for QBID purposes and rules regarding the § 663(c) separate share rule for estates and trusts related to QBID and charitable remainder trusts. See the final regulations for more information.
For more on QBID see the Insights article, "Choice of entity: Qualified business income deduction (QBID)"
Originally published in the 7/15/2020 edition of TAX in the News