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Identifying a Taxpayer's Trades or Businesses for Purposes of §199A

By Thomas G. Hineman on April 13, 2018

At the heart of the new §199A deduction is a series of tentative deductions separately determined for each trade or business in which the taxpayer owns an interest based on 20% of qualified business income (“QBI”).1 QBI is essentially the net business income of each such trade or business. Such tentative deductions may be limited by the wages limitation which limits the deduction to the greater of 50% of W-2 wages or a combination of 25% of W-2 wages and 2.5% of unadjusted basis in certain tangible depreciable property, subject to a phase-in. Also, the deduction may be denied in the case of a trade or business of engaging in certain tainted specified service trades or businesses, again subject to a phase-in.

Whether W-2 wages can be used bolster all or part of the deduction of 20% of QBI will depend upon whether those wages were paid by the same trade or business that generated the QBI or whether the activities can be aggregated as one trade or business for purposes of §199A. While it is not unusual for one closely held entity to provide payroll under a cost sharing arrangement with other commonly controlled entities, at this time it is not clear whether, or to what extent, grouping of commonly owned trades or businesses will be required, or permissible for purposes of §199A. Until further guidance, it appears that if employees are housed in one trade or business and another trade or business is conducted without employees, but under a cost sharing arrangement with the employer entity, the taxpayer’s share of W-2 wages of the employer entity potentially may only be taken into account in computing the W-2 wage limitation applicable to the employer entity. In that case, the taxpayer’s share of W-2 wages of the other trades or businesses would be zero and thus, whether those trades or businesses are entitled to any 199A deduction (if the wage limitation is fully phased in) would depend upon how much unadjusted basis those trades or businesses have in qualified property. A representative of the IRS recently acknowledged that this is one of several issues which the IRS intends to address.

In a Request for Immediate Guidance Regarding IRC Section 199A dated February 21, 2018, the AICPA has recommended that the IRS should give taxpayers the opportunity to aggregate or group separate legal activities for purposes of applying the 199A wage limitations so long as the activities are managed as one trade or business. However, that seems to beg the question of what are the guidelines for determining that such activities are managed as one trade or business.

Defining Trade or Business

Thus, the identification of each trade or business in which the taxpayer has an interest is critical to applying the §199A deduction computations. Section 199A does not discuss what constitutes a trade or business. With respect to the House Bill, which was not adopted by the Conference Agreement, the House Report notes that “a business activity means an activity that involves the conduct of a trade or business.” That is not particularly helpful, but the House Report goes on to state that an “activity has the same meaning as under the present-law (§469) passive loss rules.” However, the Conference Committee adopted the Senate Bill, with modifications, which does not speak in terms of “activity.”

Nevertheless, the regulations under §469 provide some guidance as to at least what is a trade or business for purposes of §469. Reg. §1.469-4(b)(1) states that trade or business activities are activities other than rental activities or activities incidental to holding property for investment. For purposes of identifying a trade or business the regulations refer to the conduct of a trade or business within the meaning of §162.

Reg. §1.1411-1(d) also states that for purposes of the net investment income tax the term “trade or business” refers to a trade or business under §162. Section 162 actually does not contain a definition of “trade or business.” The preamble to the §1411 regulations nevertheless states that the reference to §162 in its definition of trade or business “incorporates case law and administrative guidance applicable to §162.” T.D. 9644. With respect to a rental activity, T.D. 9644 further provides that

“within the scope of a §162 determination regarding a rental activity, key factual elements that may be relevant include, but are not limited to, the type of property (commercial real property versus a residential condominium versus personal property), the number of properties rented, the day-to-day involvement of the owner or its agent, and the type of rental (for example a net lease versus a traditional lease, short-term versus long-term lease). Therefore, due to the large number of factual combinations that exist in determining whether a rental activity rises to the level of a §162 trade or business, bright-line definitions are impractical and would be imprecise.” T.D. 9644.

T.D. 9644 also provides that the Treasury Department and the IRS do not believe that every real estate professional is necessarily engaged in the trade or business of rental real estate. The AICPA Request urges that the IRS should clarify that income from rental real estate owned in whole or in part by the taxpayer and leased to the taxpayer’s trade or business entity, as part of the taxpayer’s trade or business activity, is included in QBI for purposes of §199A.

The Supreme Court has indicated that a §162 activity is an activity engaged in with continuity and regularity, involving substantial time, with a primary purpose of earning income for profit.2 Reg. §1.1411-5(b)(3), Ex. 1 also provides that the rental of a commercial building by an individual to another entity does not constitute the conduct of a trade or business if such person is not involved in the activity of the commercial building on a regular and continuous basis.

Pending additional guidance from the IRS it appears that in order for an activity to constitute the conduct of a trade or business for purposes of §199A it would likely have to be conducted on a regular, continuous and substantial basis. Rental of property on a triple net lease, at least without the provision of substantial services, may not constitute a trade of business for purposes of §199A.

Differentiating Separate Trades or Businesses

There is also the question of how you differentiate one trade or business from another. This can become significant where wages are paid by an entity which conducts a specified service business but also has other activities that are not necessarily service related (or at least not the type of tainted specified services). In that case taxpayers may want to explore spinning off certain employee services, document management, etc. to a separate entity which, in turn enters into a contract to provide such services to the specified service entity for a fee. Whether such a spin-off of non-specified service activities will be successful in avoiding the taint of the specified service business will depend upon establishing that such activity constitutes a separate trade or business from the specified service business.

The New York State Bar Tax Section submitted lengthy comments to the IRS on March 23, 2018, regarding several interpretive issues under §199A, including the definition of “trade or business” for purposes of §199A (the “NYSBA Report”). The NYSBA Report suggests that §446 could be a good model for guidance concerning the existence of multiple trades or businesses. Section 446 permits a taxpayer who is engaged in more than one trade or business to adopt different accounting methods with respect to each trade or business. Reg. §1.446-1(d) provides that two trades or businesses must be “separate and distinct” in order for the taxpayer to be able to use different methods of accounting for each. Factors supportive of separate and distinct trades or businesses may include (a) maintenance of separate books and records for each business, (b) utilization of different employees in each business, (c) transaction of business at arm’s length and (d) geographical separation of the businesses.3 However, the “separate and distinct” requirement may not be satisfied where there is significant functional integration and interdependence among the businesses.4

While §446 may be an appropriate model for developing guidance as to identifying separate trades or businesses within a single entity, it does not inform as to identification of separate businesses within a parent-subsidiary or brother-sister group because separate entities are entitled to adopt separate accounting methods independent of §446.

The NYSBA Report therefore suggests that §469 authorities, with some modifications, may be a helpful resource for the IRS in crafting guidance under §199A. Reg. §1.469-4 provides rules for treatment of two or more businesses as an “appropriate economic unit.” While a facts and circumstances test is applied in determining an appropriate economic unit for purposes of §469, greatest weight is given to the following factors:

1. Similarities and differences in types of trades or businesses;
2. The extent of common control;

3. The extent of common ownership;
4. Geographical location; and

5. Interdependence between or among the activities.

The NYSBA Report suggests that the foregoing five factors may also be useful in identifying a taxpayer’s activities which should be grouped as a single trade or business or as multiple separate and distinct trades or businesses. The NYSBA Report notes that a taxpayer engaged in providing legal services in one state and a trade or business of renting commercial properties in another state may be treated under the five factor test as having two separate trades or businesses. On the other hand, it suggests that a doctor who rents an x-ray machine, in his individual capacity, to his wholly owned medical practice business may not be able to treat the two activities as separate and distinct. Presumably the issue there may be whether those activities are too interdependent to appropriately be treated as separate and distinct trades or businesses. That will likely be one of the key issues for the IRS in developing guidance with respect to commonly controlled businesses. While a mandatory grouping of interdependent activities would be helpful for an entity that does not have W-2 wages or significant unadjusted basis that leases real estate to a commonly controlled non-specified service operating entity, it could frustrate some taxpayers’ attempts to segregate certain activities from a specified service business.

The NYSBA Report also views §469’s “appropriate economic unit” approach as a sensible method of identifying whether a specified service trade or business would taint another activity which would otherwise be regarded as producing qualified trade or business income. That is, so long as QBI is generated by an activity that constitutes a separate trade of business there should arguably be no taint from the separate specified service trade or business.

There are other issues which should be considered in developing any plan to spin-off a non-specified service activity from a medical practice, law firm or other specified service trade or business, or otherwise characterize businesses within a single entity as separate. For instance, consideration should be given to the potential application of §269A which authorizes reallocation of income and deductions between a personal service corporation and its employee-owners if necessary to prevent avoidance or evasion of federal income tax or to clearly reflect the income of the personal service corporation or any of its employee-owners. Additionally, §482 should be considered in structuring an arm’s length payment by one controlled entity for goods or services provided by a separate commonly controlled entity.


Identification of each trade or business in which a taxpayer has an interest is critical to the application of the new §199A rules. If the IRS draws the guidelines too narrow there is the risk that many taxpayers’ existing legitimate business structures may fall short of achieving the expected §199A deduction benefits. Hopefully, the IRS will adopt guidance which provides clear, sensible rules for identification of separate trades or businesses. In the meantime, taxpayers are left to parse through the various provisions of the Internal Revenue Code which address the identification of a trade or business in various contexts.

This is the second in a series of blog posts regarding §199A. I intend to continue to periodically add additional blog posts which delve deeper into various issues and planning opportunities under §199A.

If anyone has any questions regarding the new § 199A pass-throughs deduction or how it may impact a particular trade or business activity, please contact Tom Hineman at 214-744-3700 or email thineman@meadowscollier.com.


1The aggregate tentative deductions computed separately for each trade or business are then included in the Combined Qualified Business Income Amount for purposes of the final §199A deduction computation.
2Comm’r v. R.P. Groetzinger, 480 U.S. 23 (1987); see also Reg. §1.1362-2(c)(5)(ii)(B)(2) [with respect to whether an activity constitutes a passive activity for purposes of the §1375 corporate tax on excess net passive income and §1362 termination rule].
3See Burgess Poultry Market, Inc. v. United States, 64-2 USTC ¶9515 (E.D. Tex. 1964).
4See Peterson Produce Co. v. United States, 205 F. Supp. 299 (W.D. Ark. 1962).