The Tax Cuts and Jobs Act (TCJA) made changes to the Internal Revenue Code (IRC) that some taxpayers may find beneficial, including the introduction of the 20% qualified business income (QBI) deduction for individual taxpayers who own qualifying trades or businesses. The QBI deduction is available to owners operating trades or businesses as sole proprietors or through relevant passthrough entities (RPEs)—essentially, all business entities other than subchapter C corporations. As explained in this recent PYA article, the TCJA presents new tax planning opportunities concerning QBI deductions. One such opportunity is an election available to owners of more than one RPE or those with sole proprietorships, via final Treasury regulations (Regulations), which allows the aggregation of certain tax attributes in order to maximize QBI deductions.
Because aggregation will not necessarily be beneficial to all taxpayers, a thorough analysis should be conducted in all cases before making this election. This analysis should consider both the current tax year, and all tax years ending on or before December 31, 2025, because a tax payer must adhere to an aggregation election once it is made, and generally cannot change it during that timeframe.
An individual taxpayer must meet all of the following five tests in order to aggregate multiple trades or businesses:
Test 1. The same person or group of persons, directly or by attribution (under certain IRC rules), owns 50% or more of each trade or business to be aggregated;
Test 2. The ownership (under Test 1) exists for a majority of the tax year, including the last day of that tax year;
Test 3. All items attributable to each trade or business to be aggregated are reported on returns, which have the same tax year;
Test 4. None of the trades or businesses to be aggregated is a specified service trade or business (as defined in the Regulations); and
Test 5. The trades or businesses to be aggregated meet at least two of the following:
- They provide products, property, or services that are the same or customarily offered together;
- They share facilities or significant centralized business elements; or
- They are operated in coordination with, or reliance upon, one or more of the businesses in the aggregated group.
Among the requisite aggregation tests, the 50% ownership test may require the most analysis, because it counts ownership both directly and indirectly under certain IRC rules of attribution. While direct ownership should be easy to determine (including for sole proprietors and limited liability companies [LLCs] with only a single member), the indirect ownership of RPEs by attribution is more complicated.
In many cases, under the attribution rules, ownership by family members may have the most applicability. Under these rules, an individual is “considered as owning” RPE ownership interests directly or indirectly owned by, or for, the following family members of the individual:
- Lineal descendants; and
- Siblings (whether a full- or half-sibling).
Regulations specify that even a family member who does not have any pre-attribution direct or indirect RPE ownership can become a deemed owner under these rules.
For attributed RPE ownership interests deemed owned under these rules, another rule prohibits the reattribution of those indirectly owned interests. On the other hand, RPE ownership interests owned, or deemed owned, directly can be reattributed.
In addition to family member attribution, the applicable IRC rules also allow many other types of relationships to result in attribution, some of which include:
- From a partner (or LLC member if the LLC is taxed as a partnership).
- From a corporation of which more than 50% of the outstanding stock’s value is directly or indirectly owned by or for such individual.
- Between grantor or fiduciary of any trust.
- Between an executor and beneficiary of an estate.
In addition to Test 1, Test 5 also requires careful analysis prior to making any aggregation decision. As stated before, under that rule, if two of the three economic tests are not met, there can be no aggregation. For instance, the Regulations contain an example of a taxpayer who owns an S corporation, which in turn owns a residential condominium and a commercial rental office building. Although the taxpayer meets the centralized business elements (Test 5b), the taxpayer cannot meet either of the other two economic tests, because one property is commercial and the other is residential, meaning there can be no interdependence or similarity (Tests 5a & c). Thus, the two rental properties are separate trades or businesses and cannot be aggregated.
While this article is not intended to present an exhaustive treatment of aggregation for QBI deduction maximization purposes, we have illustrated a few of the multi-factored analyses and complexities that should be considered prior to making an aggregation election. All the required analyses may be well worth undertaking, however, because of the potential economic value of an increased QBI deduction that could result.
For more information about the required analyses, and to arm yourself with the facts for making an informed aggregation election decision or other tax-planning, contact a PYA executive below at (800) 270-9629.
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