IRS's Qualified Business Income Deduction

April 8, 2019

Download the Public Interest Comment (PDF)


Section 199A of the Tax Cuts and Jobs Act of 2017 reduced the maximum corporate income tax rate from 35 percent to 21 percent. Most businesses, however, are sole proprietorships and partnerships; their income is passed through to the owners and taxed at the owner’s marginal personal income tax rate. The tax reform legislation provided a deduction equal to 20 percent of qualified business income for owners of businesses operated through sole proprietorships, partnerships, S corporations, trusts, or estates.

The legislation also provided a 20 percent credit for individuals and some trusts and estates for qualified income from real estate investment trusts (REITs) and publicly traded partnerships (PTPs). These entities typically pass through both income and tax liabilities to the owners. Final regulations implementing most aspects of Section 199A were published in the Federal Register on February 8, 2019.[1]

The current rulemaking addresses several topics not addressed in those final regulations.[2] The proposed regulation specifies how to treat previous suspended losses when calculating the 199A deduction, allows the deduction to be passed through to investors who own REITs through a regulated investment company (RIC) (such as a mutual fund), declines to pass through the deduction to investors who own PTPs through a RIC, and specifies special calculations applicable to some trusts and estates.

This comment focuses on the proposed rule’s treatment of distributions from REITs and PTPs owned by RICs. We offer three suggestions that could help the IRS better identify the consequences of alternative approaches:

Use a pre-199A baseline in the economic analysis. The IRS is deciding whether income from REITs and PTPs owned by RICs should benefit from the same 199A deduction that the statute provides for income from REITs and PTPs owned directly by individual taxpayers. The IRS cannot know whether extending the 199A deduction is economically efficient unless it knows whether the 199A deduction itself moves the tax code toward or away from economic efficiency. To discover this, the economic analysis must compare the efficiency of the tax code with and without the 199A deduction.

Assess social benefits and costs of the 199A deduction. The overall economic benefit of the 199A deduction (and the marginal benefit of extending it to REITs and PTPs owned by RICs) is the increase in the value of output from REITs and PTPs because the reduced tax rate lowers their cost of capital. The social cost of this deduction is the reduction in output from other sectors of the economy that must bear a higher tax burden to fund the deduction.

Reconsider the decision to treat PTPs differently. If the economic analysis we suggest shows that the 199A deduction is economically efficient, we see little reason to treat RIC distributions of PTP income differently from RIC distributions of REIT income. The notice of proposed rulemaking (NPRM) argues that allowing the 199A deduction would create excessive complexity for taxpayers due to its interaction with other tax rules that apply to PTPs. Individual taxpayers, however, are free to decide whether the tax savings are worth shouldering the additional complexity.