How does the aggregation of activities under Section 199A affect eligibility for the qualified business income deduction?
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Aggregation of activities under Section 199A can have a significant impact on both the eligibility for and the calculation of the qualified business income (QBI) deduction. Below is a comprehensive explanation of the legal framework, requirements, and practical effects of aggregation, as well as the limitations and planning considerations.
1. Legal Framework for Aggregation
a. Statutory and Regulatory Basis
- Section 199A provides a deduction of up to 20% of QBI from qualified trades or businesses, subject to various limitations.
- The aggregation rules are set forth in Treasury Regulation §1.199A-4, which allows, but does not require, taxpayers to aggregate multiple trades or businesses for purposes of applying the QBI deduction limitations.
b. Purpose of Aggregation
- Aggregation allows taxpayers to treat multiple trades or businesses as a single trade or business for purposes of calculating the QBI deduction, including the application of the W-2 wage and unadjusted basis immediately after acquisition (UBIA) of qualified property limitations.
2. Requirements for Aggregation
To aggregate trades or businesses, the following criteria must be met:
- Common Ownership: The same person or group of persons, directly or by attribution under sections 267(b) or 707(b), must own 50% or more of each trade or business to be aggregated. For S corporations, this means 50% or more of the issued and outstanding shares; for partnerships, 50% or more of the capital or profits interests.
- Ownership Duration: The common ownership must exist for a majority of the taxable year, including the last day of the year.
- Same Tax Year: All items attributable to each trade or business to be aggregated must be reported on returns with the same tax year (excluding short tax years).
- No SSTBs: None of the trades or businesses to be aggregated can be a specified service trade or business (SSTB) as defined in Section 199A(d)(2) and Reg. §1.199A-5.
- Two of Three Additional Factors: The trades or businesses must satisfy at least two of the following:
- Provide products, property, or services that are the same or customarily offered together.
- Share facilities or significant centralized business elements (e.g., personnel, accounting, legal, manufacturing, purchasing, HR, IT).
- Operate in coordination with, or reliance upon, one or more of the businesses in the aggregated group (e.g., supply chain interdependencies).
3. Effect of Aggregation on QBI Deduction Eligibility and Calculation
a. Calculation of the Deduction
- Without Aggregation: Each trade or business is treated separately. The QBI, W-2 wages, and UBIA limitations are applied on a per-business basis. If one business has low or no W-2 wages or qualified property, the deduction for that business may be limited or eliminated.
- With Aggregation: The QBI, W-2 wages, and UBIA of all aggregated businesses are combined. The limitations are then applied to the aggregated totals, which can allow excess wages or property from one business to offset deficiencies in another, potentially increasing the overall deduction.
Example:
If Business A has high QBI but low W-2 wages, and Business B has low QBI but high W-2 wages, aggregating them may allow the combined W-2 wages to support a larger deduction than if each business were considered separately.
b. Netting of Losses
- If one business in the aggregation has negative QBI, that loss offsets the positive QBI of the other businesses in the group. The W-2 wages and UBIA from loss businesses are included in the aggregated calculation, which can be beneficial compared to the non-aggregated approach, where the loss business’s wages and UBIA are ignored.
c. Impact on Eligibility
- Aggregation does not change whether a business is a qualified trade or business, but it can affect whether the taxpayer is subject to the W-2 wage and UBIA limitations, and how those limitations are applied.
- Aggregation is not permitted if any of the businesses are SSTBs, unless the taxpayer’s income is below the applicable threshold and phase-in range.
4. Reporting and Consistency Requirements
- Once a taxpayer elects to aggregate businesses, the aggregation must be reported consistently in all subsequent years unless there is a significant change in facts and circumstances.
- Taxpayers must attach a statement to their return each year identifying the aggregated trades or businesses, including descriptions, EINs, and any changes (e.g., acquisitions, dispositions).
- Failure to properly disclose aggregation can result in the IRS disaggregating the businesses and prohibiting aggregation for the next three years.
5. Planning Considerations and Limitations
- Aggregation is Optional: Taxpayers are not required to aggregate, and the decision should be based on whether aggregation increases the QBI deduction in the current and future years.
- Binding Election: Once made, the aggregation election is binding for future years unless facts change.
- No Aggregation on Amended Returns: Generally, aggregation cannot be made on an amended return, except for the 2018 tax year.
- Potential Downsides: Aggregation is not always beneficial. For example, if one business’s deduction is maximized under the 50% W-2 wage limitation and another under the 25% wage plus 2.5% UBIA limitation, aggregation could reduce the total deduction.
6. Summary Table of Aggregation Effects
7. Conclusion
Aggregation under Section 199A is a powerful tool that can increase the QBI deduction by allowing taxpayers to combine the QBI, W-2 wages, and UBIA of qualified property from multiple businesses, thereby optimizing the application of the deduction’s limitations. However, aggregation is subject to strict eligibility criteria and reporting requirements, and its benefits depend on the specific facts and circumstances of the taxpayer’s businesses. Taxpayers should carefully analyze whether aggregation is advantageous and ensure compliance with all procedural requirements.
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