In Private Letter Ruling 201833012 (“PLR”), the IRS addressed an employer’s proposal to amend its 401(k) plan to include a student loan benefit program (the “Benefit Program”). Under the Benefit Program, the employer could make non-elective contributions to a 401(k) plan intended to match the participant’s student loan repayments. In effect, the employer makes 401(k) matching contributions based on student loan repayments in lieu of 401(k) deferrals. In the PLR, the IRS determined that the Benefit Program, as proposed, was permissible, potentially providing the opportunity for other employers to implement similar programs.
Under the Benefit Program, an employee who is making student loan repayments equal to 2% of their annual salary could voluntarily enroll in the Benefit Program. If an employee participates in the Benefit Program, the employee would not be eligible to receive regular matching 401(k) contributions from the employer as long as he or she participates in the Benefit Program. Instead, the employer would make a non-elective contribution to the plan equal to 5% of the employee’s eligible compensation for the pay period the employee is enrolled in the Benefit Program. However, an employee participating in the Benefit Program would still be eligible to make elective contributions to the 401(k) plan.
It is important to note that the PLR can be relied on only by the taxpayer requesting the letter and is limited to the specific program described in the PLR. It is hoped that the IRS will consider issuing regulations or guidance that can be relied upon generally by all 401(k) plans. Thus, employers should consult a tax professional to ensure compliance with all IRS qualifications before attempting to implement a similar program.
IRS Issues Final Regulations and Related Guidance on IRC § 199A
The IRS recently issued final regulations and three related pieces of guidance implementing the new IRC § 199A deduction for qualified business income (“QBI”). The QBI deduction allows many owners of sole proprietorships and passthrough entities to deduct up to 20% of their QBI for taxable years beginning after December 31, 2017 and before January 1, 2026. The QBI deduction is generally available to eligible taxpayers with 2018 taxable income at or below $315,000 for joint returns and $157,500 for other filers. Those with incomes above these levels are still eligible for the deduction, but are subject to limitations, such as the type of trade or business, the amount of W-2 wages paid in the trade or business, and the unadjusted basis immediately after acquisition (“UBIA”) of qualified property.
- Net Capital Gain Definition. The final regulations define net capital gain for purposes of IRC § 199A as net capital gain within the meaning of IRC § 1222(11) (the excess of net long-term capital gain for the tax year over the net short-term capital loss for that year) plus any qualified dividend income (as defined in IRC § 1(h)(11)(B)) for the taxable year.
- Relevant Passthrough Entity (“RPE”). The proposed regulations define an RPE as a partnership (other than a publicly traded partnership (“PTP”)) or an S corporation that is owned, directly or indirectly, by at least one individual, estate, or trust. A trust or estate is treated as an RPE to the extent it passes through QBI, W-2 wages, UBIA of qualified property, qualified real estate investment trust (“REIT”) dividends, or qualified PTP income. The final regulations expand the definition to include other passthrough entities, e.g., common trust funds and religious or apostolic organizations, if the entity files a Form 1065, U.S. Return of Partnership Income, and is owned, directly or indirectly, by at least one individual, estate, or trust.
- Trade or Business Definition. The final regulations retain and slightly reword the proposed regulation’s definition of trade or business. Specifically, for purposes of IRC § 199A, the final regulations define trade or business as a trade or business under IRC § 162 other than the trade or business of performing services as an employee.
- Disregarded Entities. The proposed regulations did not address the treatment of disregarded entities. The final regulations provide that an entity with a single owner that is treated as disregarded as an entity separate from its owner under any provision of the Code is disregarded for IRC § 199A purposes; thus, trades or businesses conducted by a disregarded entity are treated as conducted directly by the owner of the entity.
- Aggregating Trades or Businesses. The final regulations permit an RPE to aggregate trades or businesses it operates directly or through lower-tier RPEs. The resulting aggregation must be reported by the RPE and by all owners of the RPE. An individual or upper-tier RPE may not separate the aggregated trade or business of a lower-tier RPE, but instead must maintain the lower-tier RPE’s aggregation. An individual or upper-tier RPE may aggregate additional trades or businesses with the lower-tier RPE’s aggregation if the aggregation rules are otherwise satisfied.
- Special Rule for Renting Property to a Related Person. The proposed regulations provide that the rental of property to a related trade or business is treated as a separate trade or business if the two businesses are commonly controlled. The final regulations limit this special rule to situations in which the related party is an individual or a RPE. Further, the final regulations provide that the related party rules under IRC §§ 267(b) or 707(b) will be used to determine relatedness.
- Anti–Cracking and Packing Rule. The final regulations revised the anti-cracking and packing rule to eliminate the 80% test, i.e., that the business provides 80% or more of its goods or services to a commonly owned specified service trade or business (“SSTB”). Instead, if a business provides property or services to a 50% or more commonly owned SSTB, the portion of the business providing property or services to the SSTB will be treated as a separate SSTB with respect to related parties.
- Basis for Property Received in Tax-Free Transaction. Replacement property received in a like-kind exchange will have a UBIA based on the transferee’s unadjusted basis in the relinquished property, decreased by excess boot or increased by any money paid or fair market value of property not of a like kind to the relinquished property. Similarly, property contributed to a partnership or an S corporation will have a UBIA based on the transferee’s unadjusted basis in the contributed property, decreased by any money received by the transferee or increased by any money paid by the transferee in the transaction.
- Share of UBIA Property. The proposed regulations provide, in the case of a partnership with qualified property that does not produce tax depreciation during the year, each partner’s share of the UBIA of qualified property would be based on how gain would be allocated to the partners pursuant to IRC § 704(b) and 704(c) if the qualified property were sold in a hypothetical transaction for cash equal to the fair market value of the qualified property. The final regulations provide that for partnerships, only IRC § 704(b), not IRC § 704(c), applies to determine each partner’s share of the UBIA of qualified property.
- Performing Services As An Employee. Similar to the proposed regulations, the final regulations include a presumption that an individual who was previously treated as an employee and is subsequently treated as an independent contractor while performing substantially the same services for the same employer or a related person will be presumed to still be in the trade or business of performing services as an employee for purposes of IRC § 199A. However, the final regulations also include a three-year lookback rule for this presumption.
The related guidance includes:
- New proposed regulations, which provide guidance on several other aspects of the QBI deduction, including the treatment of previously suspended losses, “IRC § 199A dividends” paid by regulated investment companies, and the treatment of amounts received from split-interest trusts and charitable remainder trusts.
- Revenue Procedure 2019-11, which provides guidance on the W-2 wage determination for the QBI deduction, including three methods for calculating W-2 wages: the unmodified box method, the modified box 1 method, and the tracking changes method; and
- Notice 2019-07, which provides notice of a proposed revenue procedure detailing a proposed safe harbor for certain rental real estate enterprises that may be treated as a trade or business for purposes of IRC § 199A. Under the proposed safe harbor, a rental real estate enterprise may be treated as a trade or business for purposes of IRC § 199A if at least 250 hours of services are performed each taxable year with respect to the enterprise.
The final regulations and related guidance make numerous other changes not discussed here that are important to understand in order to ensure proper compliance and to obtain the maximum benefit from the QBI deduction.
Please contact us to determine how to best take advantage of this new guidance.