Larry's Tax Law

In this fourth installment of my multi-part series on the One Big Beautiful Bill Act (the “Act”), Steve Nofziger and I discuss a provision of the Act that impacts pass-through business entities and their owners, Code Section 199A.[1]

Background

Code Section 199A, commonly referred to as the Qualified Business Income (“QBI”) deduction, was enacted during President Trump’s first term in office as part of the Tax Cuts and Jobs Act (“TCJA”).  As you may recall, the TCJA changed the C corporation tax rate landscape that came with a top tax rate of 35% to a flat rate structure pegged at 21%.  Meanwhile, pass-through entities (S corporations, partnerships and sole proprietorships), which are predominately owned by individuals, were left with a graduated tax rate structure that quickly rises to a rate of 37%.  

To create more of an even playing field between pass-through entities and C corporations, the TCJA created a new deduction for pass-through entities with the enactment of Code Section 199A.  This provision allows owners of certain pass-through entities a 20% deduction of “qualified business income” (“QBI”).

Like many provisions of the TCJA, Code Section 199A was scheduled to sunset at the end of 2025.  The Act, signed into law by President Trump on July 4, 2025, made Code Section 199A a so-called permanent provision.  It also made several changes to its deduction framework.

It is not unreasonable to anticipate that there will be a federal tax policy transformation following a change in the political control of the White House, the U.S. Senate and the U.S. House of Representatives.  What may be unreasonable, however, is making knee-jerk tax planning decisions in anticipation of possible modifications to the Internal Revenue Code (the "Code").  Reactionary planning, unless it is well thought out and is based upon sound business judgment, could end up being disastrous.  During the present times, tax advisors and their clients need to be cautious in their tax planning and any related decision-making.   

Looking through a lens solely focused on federal taxation, it seems that commentators, tax advisors and taxpayers alike are all worried about the future.  Possible tax policy changes on the horizon that are being bantered about include:

The Service issued proposed regulations corresponding to IRC § 199A today.  As discussed in a prior blog post, IRC § 199A potentially allows individuals, trusts and estates to deduct up to 20% of qualified business income (“QBI”) received from a pass-through trade or business, such as an S corporation, partnership (including an LLC taxed as a partnership) or sole proprietorship.

BACKGROUND

Deduction

The deduction effectively reduces the new top 37% marginal income tax rate for business owners to approximately 29.6% (i.e., 80% of 37%) in order to put owners of pass-through entities on a more level playing field with owners of C corporations who now have the benefit of the greatly reduced 21% top corporate marginal tax rate under the Tax Cuts and Jobs Act (“TCJA”). The concept sounds simple, but the application is complex. The new Code provision contains complex definitions and limitations, requires esoteric calculations, and is accompanied by many traps and pitfalls.

BACKGROUND

The Tax Cuts and Jobs Act (“TCJA”) adopted a new 20% deduction for non-corporate taxpayers. It only applies to “qualified business income.” The deduction, sometimes called the “pass-through deduction,” is found in IRC § 199A. There has been a significant amount of media coverage of this new deduction. Rather than repeat what you have undoubtedly already read or heard, we chose to focus this blog post on the not so obvious aspects of IRC § 199A—the numerous pitfalls and traps that exist for the unwary.