copyright 5142018 lgutef new legislation— business...

© 2018 Land Grant University Tax Education Foundation, Inc. 23

NEW LEGISLATION—BUSINESS

221% Corporate Tax Rate . . . . . . 24Employer Credit for Paid Family

and Medical Leave . . . . . . . . 25Credit for Prior-Year Minimum Tax

Liability of Corporations . . . . 26Repeal of Alternative Minimum

Tax for Corporations . . . . . . . 26Repeal of Exclusion for Employee

Achievement Awards . . . . . . 26Contributions to Capital . . . . . . 26Denial of Deduction for Sexual

Harassment or Sexual Abuse Settlements . . . . . . . . . . . . . . 27

Denial of Deduction for Local Lobbying Expenses . . . . . . . . 27

Modification of Limitation on Excessive Employee Remuneration . . . . . . . . . . . . 27

Denial of Deduction for Certain Fines and Penalties . . . . . . . . 28

Business Interest Deduction Is Limited . . . . . . . . . . . . . . . . . . 28

Temporary 100% Bonus Depreciation for Certain Business Assets . . . . . . . . . . . . 33

Modifications of Treatment of Certain Farm Property . . . . . . 35

Applicable Recovery Period for Real Property . . . . . . . . . . 36

Use of Alternative Depreciation System for Electing Farming Businesses . . . . . . . . . . . . . . . 37

Modification of Net Operating Loss Deduction . . . . . . . . . . . 37

Amortization of Research and Experimental Expenditures . . 38

Expensing Depreciable Business Assets . . . . . . . . . . . . 38

Repeal of Domestic Production Activities Deduction . . . . . . . 39

Qualified Business Income Deduction . . . . . . . . . . . . . . . 39

Reduction in Dividends Received Deduction . . . . . . . 48

Expensing of Costs of Replanting Citrus Plants . . . . . . . . . . . . . . 48

Production Period for Beer, Wine, and Distilled Spirits . . . . . . . . 48

Small Business Accounting Method Reform and Simplification . . 49

Entertainment, Transportation, and Food and Beverage Expenses . . . . . . . . . . . . . . . . . 50

COPYRIGHT 5/14/2018 LGUTEF

24 NEW LEGISLATION—BUSINESS

21% Corporate Tax Rate

I.R.C. §§ 11, 1445; TCJA § 13001

☞☞ Effective for tax years after December 31, 2017

The corporate tax rate is a flat 21%. The I.R.C. § 1445(e) withholding tax on the sale of US real property interests is amended to reflect the high-est rate of tax in effect for the tax year under I.R.C. § 11(b).

The I.R.C. § 1561 limit on accumulated earn-ings credit for certain controlled corporations is amended to $250,000 [$150,000 if any compo-nent member is a service corporation described in I.R.C. § 535(c)(2)(B)].

Introduction

The Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-97, substantially changes how tax practitioners will advise taxpayers and file 2018 tax returns. This chapter reviews changes in busi-ness tax laws made by the TCJA. It also includes changes to certain tax-exempt entity provisions. This chapter is organized numerically by Inter-nal Revenue Code section. This chapter will be updated as guidance and regulations are issued.

This publication is produced by the Land Grant University Tax Education Foundation. The Land Grant University Tax Education Foun-dation is pleased to provide the National Income Tax Workbook to approximately 29,000 tax practi-tioners in tax schools taught in 32 states. The 2018 National Income Tax Workbook will provide a com-prehensive discussion of the TCJA and related guidance and regulations. Please visit our website at taxworkbook.com for more information about online courses and tax workshops near you.

Depreciation Limits on Automobiles and Computer Equipment . . . . . . . . . . . . . . . 51

Tax Year of Inclusion . . . . . . . . . 51Limit on Losses for Taxpayers

Other Than C Corporations . 52S Corporation Conversions

to C Corporations . . . . . . . . . 53Unrelated Business Taxable Income

Separately Computed . . . . . 53Unrelated Business Taxable Income

Increased by Disallowed Fringe Benefits . . . . . . . . . . . . . . . . . 54

Charitable Contribution Deduction for Electing Small Business Trusts . . . . . . . . . . . . . . . . . . . 54

Charitable Contributions and Foreign Taxes Impact Limit on Allowance of Partner’s Share of Loss . . . . . . . . . . . . . . . . . . . . . 54

Repeal of Technical Termination of Partnerships . . . . . . . . . . . . . 55

Definition of Substantial Built-In Loss on Transfer of a Partnership Interest . . . . . . . 55

Like-Kind Exchanges . . . . . . . . . 55Partnership Profits Interests Issued

or Held for Performance of Investment Services . . . . . . . 56

Certain Self-Created Property Is Not a Capital Asset . . . . . . 57

Expansion of Qualifying Beneficiaries of an Electing Small Business Trust . . . . . . . 57

Excise Tax on Excess Tax-Exempt Organization Executive Compensation . . . . . . . . . . . 57


Employer Credit for Paid Family and Medical Leave 25

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against any individual for opposing any practice prohibited by the policy.

A qualifying employee means any employee as defined in section 3(e) of the Fair Labor Stan-dards Act of 1938 who has been employed by the employer for 1 year or more, and who for the preceding year, had compensation that was not more than 60% of the compensation threshold for highly compensated employees under I.R.C. § 414(q)(1)(B)(i). The compensation threshold is $120,000 in 2018. The IRS will determine whether an employer or an employee satisfies the applicable requirements for an eligible employer or qualifying employee based on information that the employer provides.

Family and medical leave is defined as leave described in section 102 of the Family and Medi-cal Leave Act of 1993. It is leave for the following purposes:

☞■ Because of the birth of a son or daughter of the employee and to care for such son or daughter

☞■ Because of the placement of a son or daugh-ter with the employee for adoption or foster care

☞■ To care for the spouse, or a son, daughter, or parent, of the employee, if such spouse, son, daughter, or parent has a serious health condition

☞■ Because of a serious health condition that makes the employee unable to perform the functions of the position of such employee

☞■ Because of any qualifying exigency (as defined in regulations that the IRS will issue) arising out of the fact that the spouse, or a son, daughter, or parent of the employee is on covered active duty (or has been notified of an impending call or order to covered active duty) in the Armed Forces

☞■ To care for a covered servicemember who is the spouse, son, daughter, parent, or next of kin of the employee

If an employer provides paid leave as vaca-tion leave, personal leave, or other medical or sick leave, this paid leave is not family and medi-cal leave.

The employer can elect to not have the credit apply. The credit is allowed against AMT. The employer cannot take both a credit and a deduc-tion for amounts paid for family and medical leave.

Employer Credit for Paid Family and Medical Leave

I.R.C. § 45S; TCJA § 13403

☞☞ Generally effective for wages paid in tax years beginning after December 31, 2017, and before January 1, 2020

The TCJA establishes the I.R.C. § 45S credit for paid family and medical leave. Eligible employ-ers can claim a general business credit equal to 12.5% of the amount of wages paid to qualify-ing employees during any period in which the employees are on family and medical leave and the rate of payment under the program is 50% of the wages typically paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.

For hourly employees, the credit cannot exceed the employee’s regular hourly wage rate multiplied by the number of hours of leave taken. To calculate this limit for a nonhourly employee, the employer must prorate the employee’s wages to an hourly wage rate under regulations to be established by the IRS. The maximum amount of family and medical leave that may be taken into account for any employee each tax year is 12 weeks.

An eligible employer is one who has in place a written policy that allows all qualifying full-time employees not less than 2 weeks of annual paid family and medical leave, and who allows all less-than-full-time qualifying employees a propor-tionate amount of leave. The policy must require payment that is not less than 50% of the employ-ee’s regular wage rate. Leave paid for by a state or local government or required by state or local law is not included in the amount of family and medical leave provided by the employer.

To be an eligible employer, an employer must provide certain protections applicable under the Family and Medical Leave Act of 1993, regard-less of whether they otherwise apply. Specifically, the employer must provide paid family and medi-cal leave in compliance with a policy that ensures that the employer will not interfere with, restrain, or deny the exercise of, or the attempt to exercise, any right provided under the policy; and will not discharge or in any other manner discriminate



Repeal of Exclusion for Employee Achievement Awards

I.R.C. §§ 74, 274; TCJA § 13310

☞☞ Effective for amounts paid or incurred after December 31, 2017

The TCJA repeals the limit on the employer’s deduction for employee achievement awards. An employee achievement award is an item of tan-gible personal property given to an employee in recognition of either length of service or safety achievement and presented as part of a meaning-ful presentation.

The TCJA repeals the exclusions from gross income and wages. Thus, an employee achieve-ment award is included in the employee’s gross income and wages.

The TCJA also adds a definition of tangi-ble personal property that may be considered a deductible employee achievement award. It provides that tangible personal property does not include cash, cash equivalents, gift cards, gift cou-pons, or gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items preselected or preapproved by the employer); or vacations, meals, lodging, tickets to theater or sporting events, stocks, bonds, other securities, and other similar items. This defini-tion clarifies but does not change present law and guidance.

Contributions to Capital

I.R.C. § 118; TCJA § 13312

☞☞ Effective for contributions made after Decem-ber 22, 2017. However, the provision does not apply to any contribution made after December 22, 2017, by a governmental entity pursuant to a master development plan that has been approved prior to such date by a governmental entity.

A corporation’s gross income does not include contributions to capital. The term contributions to capital does not include

Credit for Prior-Year Minimum Tax Liability of Corporations

I.R.C. § 53; TCJA § 12002

☞☞ Generally effective for tax years beginning after December 31, 2017. Refundability is effective for a tax year of a corporation beginning in 2018, 2019, 2020, or 2021.

The minimum tax credit (MTC) of a corporation can be applied to offset regular tax liability in any tax year. In 2018, 2019, 2020, and 2021, the MTC may be refundable. The refundable portion of the MTC is 50% (100% in a tax year beginning in 2021) of the excess (if any) of the MTC for the tax year over the MTC that offsets regular tax liability for the tax year. In short tax years, the refundable credit amount is prorated based on the number of days in the tax year.

Repeal of Alternative Minimum Tax for Corporations

I.R.C. § 55; TCJA § 12001

☞☞ Effective for tax years beginning after December 31, 2017

The TCJA repeals the AMT for corporations. The TCJA also makes conforming changes to several other Code provisions to reflect the repeal of the corporate AMT.

Individual AMT

The TCJA does not repeal the AMT for individuals, but it increases the AMT exemption amount . See the “New Legislation—Individual” chapter in the 2018 National Income Tax Workbook for informa-tion about the increased exemption amount .


Modification of Limitation on Excessive Employee Remuneration 27

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Modification of Limitation on Excessive Employee Remuneration

I.R.C. § 162; TCJA § 13601

☞☞ Effective for tax years beginning after December 31, 2017. The provisions do not apply to remu-neration that is provided pursuant to a bind-ing contract that was in effect on November 2, 2017, and was not modified in any material respect on or after that date.

I.R.C. § 162(m) limits the allowable deduction for compensation paid to a covered employee of a publicly held corporation. The deduction is lim-ited to no more than $1,000,000 per year. The TCJA revises the definition of covered employee to include an individual who is the principal exec-utive officer or the principal financial officer at any time during the tax year.

Covered employees are also the three most highly compensated officers for the tax year (other than the principal executive officer or principal financial officer) who are required to be reported on the company’s proxy statement (the statement required under the Securities Exchange Act of 1934).

In addition, if an individual is a covered employee with respect to a corporation for a tax year beginning after December 31, 2016, the individual remains a covered employee for all future years. Thus, an individual remains a cov-ered employee with respect to compensation oth-erwise deductible for subsequent years, including for years during which the individual is no longer employed by the corporation and years after the individual has died.

The TCJA extends the applicability of sec-tion 162(m) to include all domestic publicly traded corporations and certain publicly traded foreign companies. The expanded definition of a publicly traded corporation may include cer-tain additional corporations that are not publicly traded, such as large private C or S corporations.

The TCJA also eliminates the exceptions for commissions and performance-based compensa-tion from the definition of compensation subject to the deduction limit. Thus, such compensation is included in determining the amount of com-pensation that exceeds the $1,000,000 limit.

1. any contribution in aid of construction or any other contribution as a customer or potential customer, and

2. any contribution by a governmental entity or civic group (other than a contribution made by a shareholder as such).

I.R.C. § 118, as modified, continues to apply to only corporations.

Denial of Deduction for Sexual Harassment or Sexual Abuse Settlements

I.R.C. § 162; TCJA § 13307


Under the TCJA, I.R.C. § 162(q) denies a deduc-tion for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

Settlements

See the “Individual Issues” chapter in the 2018 National Income Tax Workbook for a further dis-cussion of the taxation of settlements, fines, and penalties .

Denial of Deduction for Local Lobbying Expenses

I.R.C. § 162; TCJA § 13308

☞☞ Effective for amounts paid or incurred on or after December 22, 2017

The TCJA repeals the exception for amounts paid or incurred related to lobbying local coun-cils or similar governing bodies, including Indian tribal governments. Thus, the general disallow-ance rules applicable to lobbying and political expenditures apply to costs incurred related to such local legislation.



The TCJA requires government agencies (or entities treated as government agencies) to report to the IRS and to the taxpayer the amount of each settlement agreement or order entered into where the aggregate amount required to be paid or incurred to or at the direction of the govern-ment is at least $600 (or such other amount as the IRS may specify). The report must separately identify any amounts that are for restitution or remediation of property, or correction of non-compliance. The report must be made at the time the agreement is entered into, as determined by the IRS.

Government Penalties and Fines

See the “Individual Issues” chapter in the 2018 National Income Tax Workbook for a detailed dis-cussion of the disallowance of the deduction for government fines and penalties, and the specific requirements to qualify for the exceptions .

Business Interest Deduction Is Limited

I.R.C. § 163; TCJA § 13301


The deduction for business interest is limited to the sum of

1. business interest income,2. 30% of the adjusted taxable income of the

taxpayer for the tax year (but not less than zero), and

3. the floor plan financing interest of the tax-payer for the tax year.

By including business interest income and floor plan financing interest in the limitation, the rule operates to allow floor plan financing interest to be fully deductible and to limit the deduction for net interest expense (less floor plan financing interest) to 30% of adjusted taxable income. That is, a deduction for business interest is allowed to the full extent of business interest income and any floor plan financing interest. To the extent

Denial of Deduction for Certain Fines and Penalties

I.R.C. §§ 162, 6050X; TCJA § 13306

☞☞ The provision denying the deduction and the reporting provision are effective for amounts paid or incurred on or after December 22, 2017, except that they do not apply to amounts paid or incurred under any binding order or agree-ment entered into before such date. This excep-tion does not apply to an order or agreement requiring court approval unless the approval was obtained before such date.

With some exceptions (discussed later), the TCJA denies a deduction for any amount paid or incurred (whether by suit, agreement, or oth-erwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by the government or entity into the potential violation of any law.

This provision applies only where a govern-ment (or other entity treated in a manner similar to a government) is a complainant or investigator with respect to the violation or potential viola-tion of any law. It does not apply to payments made by one private party to another in a lawsuit between private parties. Even if a court enters a judgment or directs a result in a private dispute, the payment is not made “at the direction of a government” for purposes of this provision.

Several exceptions apply, and a deduction may be allowed for the following:

☞■ Amounts that constitute restitution (includ-ing remediation of property) for damage or harm that was caused by violation of any law or the potential violation of any law

☞■ Amounts that are paid to come into compli-ance with any law

☞■ Any amount paid or incurred as reimburse-ment to the government or entity for the costs of any investigation or litigation or amount paid or incurred pursuant to an order of a court in a suit in which no govern-ment or governmental entity is a party

☞■ Certain amounts paid as restitution for fail-ure to pay tax

☞■ Amounts paid or incurred as taxes due


Business Interest Deduction Is Limited 29

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5. For tax years beginning before January 1, 2022, any deduction allowable for deprecia-tion, amortization, or depletion

6. Other adjustments that the IRS may specify

Additionally, because the TCJA repeals the I.R.C. § 199 domestic production activities deduction effective December 31, 2017, adjusted taxable income is computed without regard to that deduction.

Business InterestBusiness interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Any amount treated as interest under the Internal Revenue Code is interest for pur-poses of the business interest limitation. It does not include investment interest.

Business Interest IncomeBusiness interest income means the amount of inter-est includable in the gross income of the taxpayer for the tax year that is properly allocable to a trade or business. It does not include investment income.

Corporation’s Interest Income and Expense

Because the I .R .C . § 163(d) investment interest limitation does not apply to corporations, a cor-poration does not have investment interest or investment income within the meaning of section 163(d) . Thus, a corporation’s interest income and interest expense are properly allocable to a trade or business, unless the trade or business is other-wise excluded from the application of the busi-ness interest limitation .

Floor Plan Financing InterestFloor plan financing interest is interest paid or accrued on floor plan financing indebtedness.

Floor Plan Financing IndebtednessFloor plan financing indebtedness means indebted-ness that is used to finance the acquisition of motor vehicles held for sale or lease and is secured by the acquired inventory. A motor vehicle is any of the following:

that business interest exceeds business inter-est income and floor plan financing interest, the deduction for the net interest expense is limited to 30% of adjusted taxable income. The interest limitation does not apply to certain small busi-nesses (discussed later).

Example 2.1 Calculating the Limitation

In 2020, Acme Corporation has $100,000 adjusted taxable income, $20,000 business interest income, and $120,000 business interest expense. Acme’s deduction for business interest is limited to $50,000, calculated as follows:

1. The deduction is allowed to the full extent of the $20,000 business interest income.

2. The remaining net interest expense is limited to 30% of adjusted taxable income [$120,000 business interest − $20,000 business inter-est income = $100,000 net interest expense, which is limited to $30,000 (30% × $100,000 adjusted taxable income)].

3. The allowable deduction is $50,000 [$20,000 + $30,000].

4. The $70,000 disallowed interest [$100,000 − $30,000] can be carried forward indefinitely.

DefinitionsFor purposes of calculating the limitation on the business interest deduction, the TCJA defines adjusted taxable income, business interest, busi-ness interest income, floor plan financing interest, and floor plan financing indebtedness.

Adjusted Taxable IncomeAdjusted taxable income means the taxable income of the taxpayer computed without regard to the following:

1. Any item of income, gain, deduction, or loss that is not properly allocable to a trade or business

2. Any business interest or business interest income

3. The amount of any NOL deduction under I.R.C. § 172

4. The amount of any deduction allowed under I.R.C. § 199A



purposes of the business interest limitation. Thus, an employee’s wages are not counted in the tax-payer’s adjusted taxable income for purposes of determining the limitation.

Electing Real Property Trade or Business An electing real property trade or business is not a trade or business for purposes of the business interest limitation, and at the taxpayer’s election, the business interest limitation does not apply to such trades or businesses. Once made, the elec-tion is irrevocable.

An electing real property trade or business means any trade or business that is described in I.R.C. § 469(c)(7)(C). A trade or business described in section 469(c)(7)(C) is a real property develop-ment, redevelopment, construction, reconstruc-tion, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or busi-ness. This definition is intended to include real property trades or businesses conducted by a cor-poration or a real estate investment trust (REIT). Operation or management of a lodging facility is a real property operation or management trade or business.

Definition

The definition of a real property trade or busi-ness refers only to the section 469(c)(7)(C) descrip-tion, and not to other rules of section 469 [such as the rule of section 469(c)(2) that passive activi-ties include rental activities or the rule of section 469(a) that a passive activity loss is limited under section 469] . Thus, the other rules of section 469 are not made applicable by this reference .

Electing Farming Business An electing farming business is not a trade or business for purposes of the business interest lim-itation, and at the taxpayer’s election, the busi-ness interest limitation does not apply to such trades or businesses. Once made, the election is irrevocable.

The term electing farming business means

☞■ a farming business as defined in I.R.C. § 263A(e)(4) that makes an election under this rule, or

☞■ Any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road

☞■ A boat☞■ Farm machinery or equipment

Deferred InterestThe limitation applies after the application of provisions that subject interest to deferral, capi-talization, or other limitations. Thus, I.R.C. § 163(j) applies to interest deductions that are deferred—for example, under I.R.C. § 163(e) or I.R.C. § 267(a)(3)(B)—in the tax year to which such deductions are deferred. Section 163(j) applies after I.R.C. § 263A is applied to capitalize inter-est and after, for example, I.R.C. § 265 or I.R.C. § 279 is applied to disallow interest.

CarryoverBusiness interest that is disallowed because of the business interest limitation can be carried forward indefinitely, subject to the restrictions applicable to partnerships described later.

Small Business Exemption The business interest limitation does not apply to a taxpayer that is not a tax shelter (prohibited from using the cash method of accounting) if the taxpayer meets the $25,000,000 gross receipts test (see the later discussion of the gross receipts test). For a sole proprietorship, the gross receipts test is applied as if the taxpayer was a corporation or partnership.

Exceptions for Certain Trades or Businesses The term trade or business does not include the following:

1. The trade or business of performing services as an employee

2. Any electing real property trade or business3. Any electing farming business4. The trade or business of the furnishing or sale

of certain utilities by regulated public utilities

EmployeeThe trade or business of performing services as an employee is not a trade or business for


Business Interest Deduction Is Limited 31

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c. a public service or public utility commis-sion or other similar body of any state or political subdivision, or

d. the governing or ratemaking body of an electric cooperative.

Interest expenses paid or incurred in such trades or businesses is not business interest sub-ject to the limitation and is generally deductible in the computation of taxable income.

Rules Applicable to Electing Businesses

See the discussion of I .R .C . § 168(g)(1)(F) in this chapter for the requirement that an electing real property trade or business use the alternative depreciation system . See the discussion of I .R .C . § 168(g)(1)(G) in this chapter for the requirement that an electing farming business use the alterna-tive depreciation system .

Application to PartnershipsThe business interest limitation is applied at the partnership level and any deduction for busi-ness interest is taken into account in determin-ing the partnership’s nonseparately stated taxable income or loss. The adjusted taxable income of each partner is determined without regard to the partner’s distributive share of any items of income, gain, deduction, or loss of the partnership. This amount is the “Ordinary business income or loss” reflected on Form 1065, U.S. Return of Partner-ship Income. The partner’s distributive share is reflected in box 1 of Schedule K-1 (Form 1065).

This rule is intended to prevent double count-ing. Without such a rule, the same dollars of adjusted taxable income of a partnership could generate additional interest deductions as the income passes through to the partners.

Example 2.2 No Double-Counting Rule

ABC is a partnership owned 50-50 by XYZ Corporation and an individual. ABC generates $200 of noninterest income. Its only expense is $60 business interest. ABC’s deduction for busi-ness interest is limited to 30% of adjusted taxable income, which is $60 ($200 × 30%). ABC deducts $60 of business interest and reports $140 ordi-nary business income.

☞■ any trade or business of a specified agricul-tural or horticultural cooperative as defined in I.R.C. § 199A(g)(2).

Under section 263A(e)(4), a farming business includes the trade or business of operating a nurs-ery or sod farm; or the raising or harvesting of trees bearing fruit, nuts, or other crops, or orna-mental trees (other than evergreen trees that are more than 6 years old at the time they are sev-ered from their roots). Treas. Reg. § 1.263A-4(a)(4) further defines a farming business as a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. Examples of a farming business include the trade or business of operat-ing a nursery or sod farm; the raising or harvest-ing of trees bearing fruit, nuts, or other crops; the raising of ornamental trees (other than evergreen trees that are more than 6 years old at the time they are severed from their roots); and the rais-ing, shearing, feeding, caring for, training, and management of animals. A farming business also includes processing activities that are normally incident to the growing, raising, or harvesting of agricultural or horticultural products. A farming business does not include contract harvesting of an agricultural or horticultural commodity grown or raised by another taxpayer, or merely buying and reselling plants or animals grown or raised by another taxpayer.

Regulated Public UtilityCertain regulated public utilities are not a trade or business for purposes of the business interest limitation and the business interest limitation does not apply to such trades or businesses. Spe-cifically, it does not apply to the trade or business of the furnishing or sale of

1. electrical energy, water, or sewage disposal services;

2. gas or steam through a local distribution sys-tem; or

3. transportation of gas or steam by pipeline if the rates for such furnishing or sale have been established or approved by a. a state or political subdivision of a state, b. any agency or instrumentality of the

United States,



2. 30% of the adjusted taxable income of the partnership.

Example 2.3 Limit Increased by Excess Taxable Income

The facts are the same as in Example 2.2 except ABC has only $40 business interest. As in Exam-ple 2.2, ABC has a $60 limit on its interest deduc-tion. The limit exceeds ABC’s business interest by $20 ($60 − $40). ABC’s excess taxable income is $66.67 [($20 ÷ $60) × $200]. XYZ’s distribu-tive share of the excess taxable income from ABC Partnership is $33.33. XYZ’s deduction for net business interest is limited to 30% of the sum of its adjusted taxable income plus its distributive share of the excess taxable income from ABC Partner-ship. XYZ can deduct $10 [30% × ($0 + $33.33)]. XYZ has an interest deduction disallowance of $15 ($25 − $10).

Partnership CarryforwardsThe amount of any business interest that is not deductible by a partnership because of the busi-ness interest limitation is not treated as business interest paid or accrued by the partnership in the succeeding tax year and is treated as excess busi-ness interest that is allocated to each partner in the same manner as the non-separately stated tax-able income or loss of the partnership.

If a partner is allocated any excess business interest from a partnership under this rule, the excess business interest is treated as business interest paid or accrued by the partner in the next succeeding tax year in which the partner is allo-cated excess taxable income from the partner-ship, but only to the extent of the excess taxable income. Thus, the partner can deduct its share of the partnership’s excess business interest in any future year, but only against excess taxable income attributed to the partner by the partner-ship whose activities gave rise to the excess busi-ness interest carryforward. Any such deduction requires a corresponding reduction in excess tax-able income.

Any portion of the excess business interest remaining after the carryforward is treated as business interest paid or accrued in succeeding tax years, subject to the same limitations. For pur-poses of applying this rule, excess taxable income allocated to a partner from a partnership for any

XYZ’s distributive share of ABC’s ordinary business income is $70 ($140 ÷ 2). XYZ has $0 net taxable income from its other operations. None of its net income is attributable to interest income. XYZ has a $25 business interest expense, which is not included in its calculation of net tax-able income.

In the absence of any special rule, the $70 taxable income from XYZ’s distributive share of ABC’s income would allow XYZ to deduct up to an additional $21 of interest ($70 × 30%) and only $4 would be disallowed ($25 − $21). As a result, XYZ’s $100 share of ABC’s adjusted tax-able income would generate $51 ($30 + $21) of interest deductions, which exceeds the 30% limi-tation. If XYZ was a pass-through entity rather than a corporation, additional deductions might also be available at each tier.

The double counting rule provides that XYZ’s adjusted taxable income is computed without regard to the $70 distributive share from the part-nership. As a result, XYZ has $0 adjusted taxable income. XYZ’s deduction for business interest is limited to $0 (30% × $0), which results in a $25 deduction disallowance.

Each partner’s adjusted taxable income is increased by the partner’s distributive share of the partnership’s excess taxable income (defined later). Thus, the limit on the amount allowed as a deduction for business interest is increased by a partner’s distributive share of the partnership’s excess taxable income. This allows a partner to deduct additional interest expense the part-ner may have paid or incurred to the extent the partnership could have deducted more business interest. For this purpose, a partner’s distribu-tive share of partnership excess taxable income is determined in the same manner as the part-ner’s distributive share of the partnership’s non-separately stated taxable income or loss.

The term excess taxable income means, with respect to any partnership, the amount that bears the same ratio to the partnership’s adjusted tax-able income as

1. the excess (if any) of 30% of the adjusted taxable income of the partnership over the amount (if any) by which the business inter-est of the partnership, reduced by floor plan financing interest, exceeds the business inter-est income of the partnership bears to


Temporary 100% Bonus Depreciation for Certain Business Assets 33

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S Corporations and Shareholders Rules similar to those for partnerships apply to an S corporation and its shareholders. However, the partnership rules on carryforwards do not apply to S corporations and their shareholders.

Temporary 100% Bonus Depreciation for Certain Business Assets

I.R.C. § 168; TCJA § 13201

☞☞ The amendments made by this section apply to property acquired and placed in service after September 27, 2017. Property is not treated as acquired after September 27, 2017, if the tax-payer entered into a written binding contract for its acquisition before September 28, 2017. The amendments made by this section apply to spec-ified plants planted or grafted after September 27, 2017.

The I.R.C. § 168(k) bonus depreciation is increased and extended as follows:

☞■ 100% for property placed in service after September 27, 2017, and before January 1, 2023

☞■ 80% for property placed in service after December 31, 2022, and before January 1, 2024




The following different dates apply for certain aircraft and certain long-production-period property:

☞■ 100% for property placed in service after September 27, 2017, and before January 1, 2024


tax year is not taken into account for any business interest other than excess business interest from the partnership until all excess business interest for the tax year and all preceding tax years has been treated as paid or accrued.

Basis AdjustmentsThe adjusted basis of a partner in a partnership interest is reduced (but not below zero) by the amount of excess business interest allocated to the partner even though the carryforward does not give rise to a partner deduction in the year of the basis reduction. However, the partner’s deduction in a future year for interest carried for-ward does not reduce the partner’s basis in the partnership interest.

Special Rule for DispositionsIf a partner disposes of a partnership interest, the partner’s basis in the partnership interest is increased immediately before the disposition by the excess (if any) of the amount of the basis reduc-tion over the portion of any excess business inter-est allocated to the partner that has previously been treated as business interest paid or accrued by the partner (i.e., excess interest expense that has been deducted by the partner against excess taxable income of the same partnership). The basis increase also applies to transfers of the part-nership interest (including transfers upon death) in a transaction in which gain is not recognized in whole or in part. No deduction is allowed for any excess business interest resulting in a basis increase.

Carryovers in Corporate Transactions Carryovers of disallowed business interest to tax years ending after the date of distribution or transfer are included in the list of items that are carried over under I.R.C. § 381 to a distributee or transferee corporation for distributions in I.R.C. § 332 liquidations or for certain transfers under I.R.C. § 361. But carryovers of disallowed inter-est are treated as items of prechange loss that are subject to the I.R.C. § 382 limitation. As a con-forming change, a loss corporation is defined to include a corporation with a carryover of disal-lowed interest.



By extending the placed-in-service deadline for qualified property, the TCJA: (1) eliminates the 2018 and 2019 phasedown of the section 280F $8,000 first-year depreciation increase for passen-ger automobiles that are qualified property and (2) extends the increased depreciation limit to December 31, 2026. The depreciation limits for passenger automobiles are discussed later.

The TCJA makes numerous conforming amendments to make section 168 consistent with these and other changes. As a conforming amend-ment to the repeal of corporate AMT, the TCJA repeals the election to accelerate AMT credits in lieu of bonus depreciation.

Application to Used PropertyBonus depreciation is allowed if the original use begins with the taxpayer or the taxpayer acquires property that was not used by the taxpayer at any time prior to the acquisition. To prevent abuses, the additional first-year depreciation deduction applies only to property purchased in an arm’s-length transaction. It does not apply to property received as a gift or from a decedent.

In the case of trade-ins, like-kind exchanges, or involuntary conversions, it applies only to any money paid in addition to the traded-in property or in excess of the adjusted basis of the replaced property. It does not apply to property acquired in a nontaxable exchange such as a reorganiza-tion; or to property acquired from a member of the taxpayer’s family, including a spouse, ances-tors, and lineal descendants, or from another related entity as defined in I.R.C. § 267.

It also does not apply to property acquired from a person who controls, is controlled by, or is under common control with, the taxpayer. Thus, it does not apply, for example, if one member of an affiliated group of corporations purchases property from another member, or if an individ-ual who controls a corporation purchases prop-erty from that corporation.

ExclusionsThe TCJA excludes from the definition of quali-fied property certain public utility property and property of certain businesses that have floor plan financing indebtedness, and such property is not eligible for bonus depreciation. Specifically, it excludes any property that is primarily used in the trade or business of the furnishing or sale of




The section 168(k) bonus depreciation for plants bearing fruits and nuts is increased and extended as follows:

☞■ 100% for a plant that is planted or grafted after September 27, 2017, and before Janu-ary 1, 2023

☞■ 80% for a plant that is planted or grafted after December 31, 2022, and before Janu-ary 1, 2024




Phasedown

To qualify for the new phasedown of bonus depreciation and the I .R .C . § 280F increased limit on the depreciation deduction for certain pas-senger automobiles, the property must be both acquired and placed in service after September 27, 2017 . If the property was acquired before Sep-tember 28, 2017, and placed in service after Sep-tember 27, 2017, the new rules do not apply . The Consolidated Appropriations Act (the Appropria-tions Act), 2018, Pub . L . No . 115-141, clarifies that for longer-production-period property and cer-tain aircraft acquired before September 28, 2017, and placed in service in 2018, 50% applies to the entire adjusted basis, and if placed in service in 2019, 40% applies to the entire adjusted basis .


Modifications of Treatment of Certain Farm Property 35

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Modifications of Treatment of Certain Farm Property

I.R.C. § 168; TCJA § 13203

☞☞ Effective for property placed in service after December 31, 2017, in tax years ending after such date

The TCJA shortens the recovery period from 7 to 5 years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming busi-ness, if the original use of the asset commences with the taxpayer and it is placed in service after December 31, 2017.

The TCJA also repeals the required use of the 150% declining balance method for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property). The 150% declining balance method will continue to apply to any 15-year or 20-year property used in the farming business to which the straight-line method does not apply, or to property for which the taxpayer elects the use of the 150% declining balance method.

For these purposes, the term farming business means a farming business as defined in I.R.C. § 263A(e)(4). Thus, a farming business is a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horti-cultural commodity (e.g., the trade or business of operating a nursery or sod farm; the raising or harvesting of trees bearing fruit, nuts, or other crops; the raising of ornamental trees other than evergreen trees that are more than 6 years old at the time they are severed from their roots; and the raising, shearing, feeding, caring for, training, and management of animals). A farming business includes processing activities that are normally incident to the growing, raising, or harvesting of agricultural or horticultural products. A farming business does not include contract harvesting of an agricultural or horticultural commodity grown or raised by another taxpayer, or merely buying and reselling plants or animals grown or raised by another taxpayer.

1. electrical energy, water, or sewage disposal services;

2. gas or steam through a local distribution sys-tem; or

3. transportation of gas or steam by pipeline.

Such property is excluded if the rates for such furnishing or sale have been established or approved by a state or political subdivision thereof, by any agency or instrumentality of the United States, by a public service or public utility commission or other similar body of any state or political subdivision thereof, or by the governing or ratemaking body of an electric cooperative.

In addition, the TCJA excludes from the defi-nition of qualified property any property used in a trade or business that has had floor plan financ-ing indebtedness, unless the taxpayer with such trade or business is not a tax shelter prohibited from using the cash method and is exempt from the interest limitation rules in TCJA § 13301 (discussed earlier) by meeting the small business gross receipts test of I.R.C. § 448(c) (discussed later).

Film, Television, and Theater ProductionsThe TCJA expands the definition of qualified property eligible for the additional first-year depreciation allowance to include qualified film, television, and live theatrical productions placed in service after September 27, 2017, and before January 1, 2027, for which a deduction otherwise would have been allowable under I.R.C. § 181 without regard to the dollar limitation or termi-nation of that section. For purposes of this provi-sion, a production is considered placed in service at the time of initial release, broadcast, or live staged performance (i.e., at the time of the first commercial exhibition, broadcast, or live staged performance of a production to an audience).

Transition RuleA transition rule provides that for a taxpayer’s first tax year ending after September 27, 2017, the taxpayer can elect to apply a 50% allowance instead of the 100% allowance.



provide an ADS recovery period for the 15-year qualified improvement property.

Thus, qualified improvement property placed in service after December 31, 2017, should be generally depreciable over 15 years (see the ear-lier discussion of a technical correction) using the straight-line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than 3 years after the date the building was first placed in service, or made to a restaurant build-ing. Restaurant building property placed in ser-vice after December 31, 2017, that does not meet the definition of qualified improvement property is depreciable over 25 years as nonresidential real property, using the straight-line method and the midmonth convention.

As a conforming amendment, the TCJA replaces the references in I.R.C. § 179(f) to quali-fied leasehold improvement property, qualified restaurant property, and qualified retail improve-ment property with a reference to qualified improvement property. Thus, for example, the provision allows section 179 expensing for quali-fied improvement property without regard to whether the improvements are property subject to a lease, placed in service more than 3 years after the date the building was first placed in ser-vice, or made to a restaurant building. Restaurant building property placed in service after Decem-ber 31, 2017, that does not meet the definition of qualified improvement property is not eligible for section 179 expensing.

The TCJA also requires a real property trade or business electing out of the limitation on the deduction for interest (discussed earlier) to use ADS to depreciate any of its nonresidential real property, residential rental property, and quali-fied improvement property. A real property trade or business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, man-agement, leasing, or brokerage trade or business. A mortgage broker who is a broker of financial instruments is not in a real property trade or busi-ness for this purpose.

The TCJA shortens the ADS recovery period for residential rental property from 40 years to 30 years.

Farm Depreciation

See the “Agricultural and Natural Resource Issues” chapter in the 2018 National Income Tax Workbook for a detailed discussion of deprecia-tion of farm assets .

Applicable Recovery Period for Real Property

I.R.C. §§ 168, 179; TCJA § 13204

☞☞ Effective for property placed in service after December 31, 2017

The TCJA eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, and replaces them with qualified improvement property. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service, except for any improvement expense that is attributable to

1. enlargement of the building, 2. any elevator or escalator, or 3. the internal structural framework of the

building. [I.R.C. § 168(e)(6)]

Under the TCJA, the statutory language for I.R.C. § 168(e)(3)(E) does not include qualified improvement property, leaving it as nonresiden-tial real property [39-year MACRS and not sub-ject to bonus depreciation or some other class of property (e.g., a property with 15-year MACRS)]. However, according to the Conference Commit-tee Report, qualified improvement property was intended to be 15-year property, qualifying for bonus depreciation. It is expected that Congress will provide a technical correction designating the property class life as 15 years and including qualified improvement property as property that is eligible for 100% bonus depreciation. Quali-fied improvement property is depreciated on the straight-line method. The text of the TCJA fails to


Modification of Net Operating Loss Deduction 37

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can deduct an $80,000 NOL in 2019. Southside cannot deduct the remaining $15,000 ($95,000 − $80,000) in 2019, but it can carry forward the NOL indefinitely.

The TCJA also repeals the 2-year NOL carry-back and special carryback provisions and allows a taxpayer to indefinitely carry forward an NOL. A taxpayer can carry back farming losses 2 years. A farming loss is the lesser of

1. the amount that would be the NOL for the tax year if only income and deductions attribut-able to farming businesses [as defined in sec-tion 263A(e)(4)] are taken into account, or

2. the amount of the NOL for the tax year.

A farming loss for any tax year is treated as a separate NOL and is taken into account after the remaining portion of the NOL for the tax year. Property and casualty insurance companies are still subject to the 2-year carryback and 20-year carryforward.

A taxpayer who is entitled to the 2-year carry-back can elect not to apply the 2-year carryback to such loss year. The election must be made in a manner prescribed by the IRS and must be made by the due date (including extensions of time) for filing the taxpayer’s return for the tax year of the NOL. The election is irrevocable.

Disaster Losses

Notwithstanding the amendments made to the NOL deduction and the repeal of the deduction for personal casualty losses, the TCJA retains the present-law 3-year carryback for the portion of the NOL for any tax year that is a net disaster loss subject to section 504(b) of the Disaster Tax Relief and Airport and Airway Extension Act of 2017, Pub . L . No . 115-63 (i .e ., a net disaster loss arising from Hurricanes Harvey, Irma, or Maria) . See the “New Legislation—Additional” chapter in the 2018 National Income Tax Workbook for a discus-sion of net disaster losses .

Use of Alternative Depreciation System for Electing Farming Businesses

I.R.C. § 168; TCJA § 13205


The TCJA requires a farming business (defined earlier) electing out of the limitation on the deduction for interest to use ADS to depreciate any property with a recovery period of 10 years or more (e.g., property such as single-purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements).

Modification of Net Operating Loss Deduction

I.R.C. § 172; TCJA § 13302

☞☞ The limitation on losses applies to losses aris-ing in tax years beginning after December 31, 2017. The limitation on carryovers applies to net operating losses arising in tax years ending after December 31, 2017.

The net operating loss (NOL) deduction is lim-ited to 80% of taxable income (computed with-out regard to the NOL deduction). The limitation does not apply to a property and casualty insur-ance company. Specifically, the TCJA limits an NOL to the lesser of

☞■ the aggregate of the NOL carryovers to that year, plus the NOL carrybacks to that year; or

☞■ 80% of taxable income, computed without the NOL deduction.

Example 2.4 NOL Limitation in Carryover Year

Southside Corp. is a calendar-year taxpayer. In 2018, Southside had a $95,000 NOL that is car-ried forward to 2019. In 2019, Southside has $100,000 taxable income and no other NOL carryovers. Southside’s 2019 NOL deduction is limited to $80,000 ($100,000 × 80%). Southside



Change in Method of AccountingThe application of this provision is treated as a change in the taxpayer’s method of accounting for purposes of I.R.C. § 481, initiated by the tax-payer, and made with the consent of the IRS. The provision is applied on a cutoff basis to research or experimental expenditures paid or incurred in tax years beginning after December 31, 2021, and there is no adjustment under section 481(a) for research or experimental expenditures paid or incurred in tax years beginning before January 1, 2022.

Expensing Depreciable Business Assets

I.R.C. § 179; TCJA § 13101

☞☞ Effective for property placed in service in tax years beginning after December 31, 2017

Section 179 Maximum AmountThe TCJA increases the maximum amount a taxpayer may expense under section 179 to $1,000,000 and increases the phaseout thresh-old amount to $2,500,000. Thus, it provides that the maximum amount a taxpayer may expense for tax years beginning after 2017 is $1,000,000 of the cost of qualifying property placed in ser-vice for the tax year. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $2,500,000. The $1,000,000 and $2,500,000 amounts are indexed for inflation.

Sport Utility VehiclesSection 179(b)(6) is amended make the $25,000 per-vehicle limit on the cost of an SUV eligible for section 179 expensing adjustable for inflation in tax years beginning after December 31, 2018.

Qualified Real PropertyThe TCJA expands the definition of section 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodg-ing [I.R.C. § 1245(a)(3)]. The TCJA also expands

Amortization of Research and Experimental Expenditures

I.R.C. § 174; TCJA § 13206

☞☞ Effective for amounts paid or incurred in tax years beginning after December 31, 2021

Amounts defined as specified research or experi-mental expenditures must be capitalized and amortized ratably over a 5-year period, begin-ning with the midpoint of the tax year in which the specified research or experimental expendi-tures were paid or incurred. Specified research or experimental expenditures that are attribut-able to research that is conducted outside of the United States (which includes Puerto Rico and US possessions) must be capitalized and amor-tized ratably over a period of 15 years, beginning with the midpoint of the tax year in which such expenditures were paid or incurred.

Definition of Research and Experimental ExpendituresThe term specified research or experimental expendi-tures means research or experimental expendi-tures that are paid or incurred by the taxpayer in connection with the taxpayer’s trade or business. Specified research or experimental expenditures subject to capitalization include expenditures for software development. Specified research or experimental expenditures do not include expen-ditures for land or for depreciable or depletable property used in connection with the research or experimentation but do include the depreciation and depletion allowances of such property. Also excluded are exploration expenditures incurred for ore or other minerals (including oil and gas).

Retirement, Abandonment, or DispositionIn the case of retired, abandoned, or disposed property for which specified research or experi-mental expenditures are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal. The taxpayer must continue to amortize the expen-ditures over the remaining amortization period.


Qualified Business Income Deduction 39

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2. W-2 wage limit3. Specified service business limit

20%-of-Income LimitThe deduction cannot exceed 20% of taxable income less net capital gain [as defined in I.R.C. § 1(h)]. Special rules apply to qualified REIT income, qualified publicly traded partnership income, and qualified cooperative dividends.

Example 2.5 20%-of-Income Limit

Brandon Marx earned $100,000 qualified busi-ness income as a sole proprietor. He sold some land and recognized $50,000 long-term capi-tal gain. Brandon claimed $25,000 in itemized deductions, and his taxable income was $125,000 ($100,000 + $50,000 − $25,000). His taxable income adjusted for the net capital gain was $75,000 ($125,000 − $50,000). Brandon’s deduc-tion is the lesser of $20,000 ($100,000 × 20%) or $15,000 ($75,000 × 20%). Brandon’s deduction is limited to $15,000.

W-2 Wage LimitFor taxpayers with taxable income above a cer-tain threshold, the deduction is additionally lim-ited to the greater of

1. 50% of the W-2 wages with respect to the qualified trade or business; or

2. 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisi-tion of all qualified property (defined later).

The threshold amount is $157,500 ($315,000 MFJ). The threshold is indexed for inflation for tax years beginning after 2018. Thus, taxpayers below the threshold amount are not subject to the W-2 wage limit. The wage limit applies fully for a taxpayer with taxable income that exceeds the threshold amount plus $50,000 ($100,000 for MFJ). For taxpayers with taxable income that is more than the threshold amount but less than the threshold amount plus $50,000 ($100,000 for MFJ), the wage limit is phased in (see the later discussion of the W-2 wage limit phasein).

the definition of qualified real property eligible for section 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service:

☞■ Roofs☞■ Heating, ventilation, and air-conditioning property

☞■ Fire protection and alarm systems☞■ Security systems

The TCJA also replaces the references in I.R.C. § 179(f) to qualified leasehold improve-ment property, qualified restaurant property, and qualified retail improvement property with a ref-erence to qualified improvement property. See the earlier discussion of qualified improvement property.

Repeal of Domestic Production Activities Deduction

I.R.C. § 199; TCJA § 13305

☞☞ The provision is effective for noncorporate tax-payers and for certain rules applicable to agri-cultural and horticultural cooperates provided in I.R.C. § 199(d)(3)(A) and (B) for tax years begin-ning after December 31, 2017. The provision is effective for C corporations for tax years begin-ning after December 31, 2018.

The TCJA repeals the deduction for income attributable to domestic production activities.

Qualified Business Income Deduction

I.R.C. § 199A; TCJA § 11011

☞☞ Generally effective for tax years beginning after December 31, 2017, and before January 1, 2026

Generally, a taxpayer other than a corporation can deduct 20% of qualified business income (defined later) from a partnership, S corporation, or sole proprietorship. The following three limita-tions may reduce or eliminate the deduction:

1. 20% of income limit



it is fully depreciated because the depreciable period for qualified property is the later of the last day of the last full year of the applicable recovery period or 10 years after the date the property is first placed in service.

Example 2.7 W-2 Wage Limit—Wages

Wilma Wolde is subject to the W-2 wage limit. She does business as a sole proprietorship. Wilma conducts a widget-making business using rented equipment. The business had two employees in 2020 and paid $100,000 in wages. The limit on the deduction in 2020 is the greater of

1. 50% of W-2 wages ($50,000), or2. the sum of 25% of W-2 wages ($25,00) plus

2.5% of the unadjusted basis of qualified property ($0).

Thus, the limit on Wilma’s deduction is $50,000.

Example 2.8 W-2 Wage Limit— Depreciable Property

Wesley Winters is subject to the W-2 wage limit. He does business as a sole proprietorship. Wesley conducts a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The limit on the deduction in 2020 is the greater of

1. 50% of W-2 wages ($0), or2. the sum of 25% of W-2 wages ($0) plus 2.5%

of the unadjusted basis of the machine imme-diately after its acquisition.

Thus, the limit on Wesley’s deduction is $2,500 [$100,000 × .025].

Real Estate Investors

See the “Business Issues” chapter in the 2018 National Income Tax Workbook for a discussion of the QBI deduction for real estate investors .

Taxable Income

The taxpayer’s taxable income determines whether the taxpayer exceeds the threshold . Taxable income includes income and deductions of the taxpayer and his or her spouse (if filing a joint return) . In some cases, business income may exceed the threshold, but the taxpayer’s other deductions can reduce taxable income below the threshold .

Qualified PropertyFor purposes of the W-2 wage limit, qualified property means tangible property that is subject to depreciation under I.R.C. § 167. It must be

1. held by, and available for use in, the qualified trade or business at the close of the tax year; and

2. used in the production of qualified business income.

In addition, the depreciable period must not end before the close of the tax year. The depre-ciable period with respect to qualified property of a taxpayer means the period beginning on the date the property is first placed in service by the tax-payer and ending on the later of the date that is 10 years after that date, or the last day of the last full year in the applicable recovery period that would apply to the property under I.R.C. § 168 [without regard to section 168(g)].

Depreciable Property

For purposes of the W-2 wage limit test, the basis of depreciable property is its unadjusted basis immediately after acquisition . Depreciation deductions do not reduce basis .

Example 2.6 Depreciable Period

On January 1, 2015, Great Bear Manufacturing Co. purchased a piece of machinery for $20,000. Great Bear depreciates the machinery over 5 years (2015 to 2019). In 2021, Great Bear can include the $20,000 unadjusted basis of the machinery in its calculation of the W-2 wage test even though



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of the difference between the two amounts as the excess of the taxable income of the taxpayer over the threshold amount bears to $50,000 ($100,000 MFJ).

Example 2.9 W-2 Wage Limit PhaseIn

Henry and Wanda Rogers file a joint return on which they report taxable income of $400,000. Wanda has a qualified trade or business that is not a specified service business and does not own any qualified property. Wanda’s 20% of the qualified business income with respect to the business is $15,000. Wanda’s share of wages paid by the business is $20,000, and her 50% share of the W-2 wages of the business is $10,000. The $15,000 amount is reduced by 85% [($400,000 − $315,000) ÷ $100,000] of the difference between $15,000 and $10,000, or $4,250 (85% × $5,000). Henry and Wanda take a $10,750 deduction ($15,000 − $4,250).

Additional Examples

See the “Business Issues” chapter in the 2018 National Income Tax Workbook for additional examples of applying the QBI limits and calculat-ing the QBI deduction .

Acquisitions, Dispositions, and Short Tax YearsProperty that is sold and is no longer available for use in the trade or business is not taken into account in determining the W-2 wage limit. The IRS is directed to provide regulations that apply to a short tax year or a year where the taxpayer acquires, or disposes of, the major portion of a trade or business or the major portion of a sepa-rate unit of a trade or business during the tax year.

For a taxpayer with a short tax year that does not contain a calendar year ending during such short tax year, the following amounts are treated as the W-2 wages of the taxpayer for the short tax year:

Definition of WagesThe term W-2 wages means the total wages sub-ject to wage withholding, elective deferrals [as defined in I.R.C. § 402(g)(3)], and deferred com-pensation paid by the qualified trade or business with respect to employment of its employees dur-ing the calendar year ending during the tax year of the taxpayer. Deferred compensation includes compensation deferred under I.R.C. § 457, and the amount of any designated Roth contributions [as defined in I.R.C. § 402A]. W-2 wages does not include any amount that is not properly alloca-ble to qualified business income. It also does not include any amount that is not properly included in a return filed with the Social Security Adminis-tration on or before the sixtieth day after the due date (including extensions) for such return.

Leased Employees

Presumably, wages of leased employees are included in the definition of W-2 wages .

Phasein of W-2 Wage LimitThe W-2 wage limit applies fully for a taxpayer with taxable income greater than the threshold amount plus $50,000 ($100,000 MFJ). The appli-cation of the wage limit phases in for a taxpayer with taxable income greater than the threshold amount but not more than the threshold amount plus $50,000 ($100,000 MFJ).

For a taxpayer with taxable income within the phasein range, the wage limit applies as follows: With respect to any qualified trade or business, the taxpayer compares (1) 20% of the taxpayer’s qualified business income from the qualified trade or business with (2) the greater of 50% of the W-2 wages with respect to the qualified trade or business or 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property. If the amount determined under (2) is less than the amount determined under (1) (that is, if the wage limit is binding), the taxpayer’s deductible amount is the amount deter-mined under (1) reduced by the same proportion



2. Any dividend, income equivalent to a dividend, or payment in lieu of dividends described in I.R.C. § 954(c)(1)(G) [but this exclusion does not apply to any amount described in I.R.C. § 1385(a)(a)]

3. Any interest income other than interest income that is properly allocable to a trade or business

4. Certain I.R.C. § 954(c)(1)(C) and (D) com-modity gain or loss or foreign currency gain or loss (applied by substituting “qualified trade or business” for “controlled foreign corporation”)

5. Certain items of income, gain, deduction, or loss taken into account under section 954(c)(1)(F) notional principal contracts

6. Any amount received from an annuity that is not received in connection with the trade or business

7. Any item of deduction or loss properly allo-cable to an amount described in any of the preceding clauses

Puerto Rico

Although QBI must be effectively connected to a trade or business in the United States, special rules apply to Puerto Rico . For a taxpayer with QBI from sources within the commonwealth of Puerto Rico, if all such income is taxable under section 1 for such tax year, then for purposes of determining the qualified business income of such taxpayer, the term United States includes the Commonwealth of Puerto Rico .

Reasonable Compensation and Guaranteed Payments Qualified business income does not include rea-sonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business, any guaranteed payment described in I.R.C. § 707(c) paid to a partner for services ren-dered with respect to the trade or business, and to the extent provided in regulations, any payment described in I.R.C. § 707(a) to a partner who is not acting in his or her capacity as a partner for services rendered with respect to the trade or business.

1. Only those wages paid during the short tax year to employees of the qualified trade or business

2. Only those elective deferrals [within the meaning of section 402(g)(3)] made during the short tax year by employees of the quali-fied trade or business

3. Only compensation actually deferred under section 457 during the short tax year with respect to employees of the qualified trade or business

Amounts that are treated as W-2 wages for a tax year are not treated as W-2 wages of any other tax year.

The IRS is required to provide guidance applying rules similar to the rules of I.R.C. § 179(d)(2) to address acquisitions of property from a related party, as well as in a sale-lease-back or other transaction as needed to carry out the purposes of the W-2 wage limit. The IRS is directed to provide rules to determine the unad-justed basis immediately after acquisition of qual-ified property acquired in like-kind exchanges or involuntary conversions. The IRS is also directed to provide antiabuse rules.

Qualified Business IncomeThe term qualified business income (QBI) means the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business (defined later) of the taxpayer. It does not include any qualified REIT dividends or qualified publicly traded partnership income. The Appropriations Act (discussed later) repeals the exclusion of qualified cooperative dividends from QBI of a qualified trade or business and reduces QBI with respect to income received from cooperatives.

Qualified items of income, gain, deduction, and loss means items of income, gain, deduction, and loss to the extent such items are effectively con-nected with the conduct of a trade or business in the United States and are included or allowed in determining taxable income for the tax year.

The following are not taken into account as a qualified item of income, gain, deduction, or loss:

1. Any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss



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Qualified Trade or Business The QBI for a tax year is the net amount of quali-fied items of income, gain, deduction, and loss relating to any qualified trade or business of the taxpayer. A qualified trade or business is any trade or business other than a specified service trade or business, or the trade or business of perform-ing services as an employee. Thus, for taxpayers with income above a certain threshold (see the later discussion of the phasein of the specified ser-vice business limit), QBI does not include income from a specified service trade or business.

The term specified service trade or business means any trade or business that is described in I.R.C. § 1202(e)(3)(A) other than engineering and architecture, or which would be so described if the term employees or owners was substituted for employees. A specified trade or business also means the performance of services that consist of investing and investment management, trad-ing, or dealing in securities [as defined in I.R.C. § 475(c)(2)], partnership interests, or commodi-ties [as defined in section 475(e)(2)].

Services described above include health; law; accounting; actuarial science; performing arts; consulting; athletics; financial services; broker-age services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities; and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.

A similar list of service trades or businesses is provided in I.R.C. § 448(d)(2)(A) and Treas. Reg. § 1.448-1T(e)(4)(i). For purposes of section 448, Treasury regulations provide that the per-formance of services in the field of health means the provision of medical services by physicians, nurses, dentists, and other similar health care professionals. The performance of services in the field of health does not include the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient. For example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or con-ditioning to their customers [Treas. Reg. § 1.448-1T(e)(4)(ii)].

Sole Proprietorship

Partnership payments and S corporation reason-able compensation are not QBI . Payments made by a sole proprietorship or a single-member LLC treated as a disregarded entity appear to be included in QBI .

Example 2.10 QBI Items Allowed in Taxable Income

In a tax year, a qualified business has $100,000 of ordinary income from inventory sales, and makes an expenditure of $25,000 that is required to be capitalized and amortized over 5 years. Under applicable tax rules, the qualified business income is $95,000 ($100,000 − $5,000 current-year ordinary amortization deduction). The QBI is not reduced by the entire amount of the capital expenditure, only by the amount deductible in determining taxable income for the year.

QBI LossIf the net amount of QBI from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business in the next tax year. Similar to a qualified trade or business that has a qualified business loss for the current tax year, any deduction allowed in a subsequent year is reduced (but not below zero) by 20% of any carryover qualified business loss.

Example 2.11 QBI Loss

Theodore Trudeau has $20,000 QBI from quali-fied business A and a qualified business loss of $50,000 from qualified business B in 2018. Theo-dore is not permitted a deduction for 2018 and has a carryover qualified business loss of $30,000 to 2019. In 2019, Theodore has $20,000 QBI from qualified business A and $50,000 QBI from qualified business B. To determine the deduc-tion for 2019, Theodore reduces the 20% deduct-ible amount determined for the $70,000 QBI from qualified businesses A and B by 20% of the $30,000 carryover qualified business loss. Theo-dore’s deduction for 2019 is $8,000 [($70,000 × 20%) – ($30,000 × 20%)].



PhaseIn of Specified Service Business LimitIf the taxpayer’s taxable income is less than the $157,500 threshold ($315,000 MFJ), then the specified service trade or business limit does not apply and the business is treated as a qualified trade or business. The exclusion from the defi-nition of a qualified business for specified ser-vice trades or businesses is fully phased in for a taxpayer with taxable income greater than the threshold amount plus $50,000 ($100,000 MFJ). For a taxpayer with taxable income within the phasein range, the exclusion applies as follows: if, for any tax year, the taxable income of any tax-payer is less than the sum of the threshold amount plus $50,000 ($100,000 MFJ), then the limit is phased in by a percentage equal to the ratio of (1) the taxable income of the taxpayer for the tax year greater than the threshold amount over (2) $50,000 ($100,000 MFJ). Thus, the phasein ranges are as follows:

☞■ Single: between $157,500 and $207,500☞■ MFJ: between $315,000 and $415,000

Example 2.12 PhaseIn of Specified Service Business Limit

Tanya Taylor is an accountant who files a joint return. She and her husband have taxable income of $350,000, of which $200,000 is attributable to an accounting sole proprietorship after pay-ing wages of $100,000 to employees. Tanya has an applicable percentage of 65% [1 – (350,000 – 315,000) ÷ $100,000]. In determining includable QBI, Tanya takes into account 65% of $200,000, or $130,000. In determining the includable W-2 wages, Tanya takes into account 65% of $100,000, or $65,000. Tanya calculates the deduction by taking the lesser of 20% of $130,000 ($26,000) or 50% percent of $65,000 ($32,500). Tanya takes a deduction for $26,000.

Deduction against Taxable IncomeThe 20% deduction is not allowed in computing adjusted gross income, and instead it is allowed as a deduction reducing taxable income. Thus, for example, the provision does not affect limitations based on adjusted gross income. The deduction is available to both nonitemizers and itemizers. The deduction applies only to income tax. For

For purposes of the similar list of services in section 448, Treasury regulations provide that the performance of services in the field of the perform-ing arts means the provision of services by actors, actresses, singers, musicians, entertainers, and similar artists in their capacity as such. The per-formance of services in the field of the performing arts does not include the provision of services by persons who themselves are not performing art-ists (e.g., persons who may manage or promote such artists, and other persons in a trade or busi-ness that relates to the performing arts). Similarly, the performance of services in the field of the performing arts does not include the provision of services by persons who broadcast or other-wise disseminate the performance of such artists to members of the public (e.g., employees of a radio station that broadcasts the performances of musicians and singers) [Treas. Reg. § 1.448-1T(e)(4)(iii)].

For purposes of the similar list of services in section 448, Treasury regulations provide that the performance of services in the field of consulting means the provision of advice and counsel. The performance of services in the field of consult-ing does not include the performance of services other than advice and counsel, such as sales or brokerage services, or economically similar ser-vices. For purposes of the preceding sentence, the determination of whether a person’s services are sales or brokerage services, or economically simi-lar services, is based on all the facts and circum-stances of that person’s business. Such facts and circumstances include, for example, how the tax-payer is compensated for the services provided (e.g., whether the compensation for the services is contingent upon the consummation of the trans-action that the services were intended to effect) [Treas. Reg. § 1.448-1T(e)(4)(iv)].

Multiple Lines of Business

A business may conduct activities and use quali-fied property in both a qualified trade or busi-ness and a specified service or business . See the “Business Entities” chapter and the “Business Issues” chapter in the 2018 National Income Tax Workbook for a discussion of allocating assets and services to specific business units, spinning or splitting off entities, and grouping activities .



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Application to Trusts and EstatesTrusts and estates are eligible for the 20% deduc-tion. Rules similar to the rules under I.R.C. § 199(d)(1)(B)(i) (as in effect on December 1, 2017) for the apportionment of W-2 wages apply to the apportionment between fiduciaries and beneficiaries of W-2 wages and the apportion-ment of unadjusted basis of qualified property for purposes of the W-2 wage limit.

Agricultural or Horticultural CooperativesThe TCJA gave specified agricultural or horticul-tural cooperatives a deduction in an amount equal to 20% of the gross income of a specified agricul-tural or horticultural cooperative, less qualified cooperative dividends paid during the tax year. The deduction for cooperatives was not limited to 20% of taxable income. Thus, Congress uninten-tionally provided a potentially higher deduction for a farmer who sells to a cooperative.

Effective for tax years after December 31, 2017, the Consolidated Appropriations Act (the Appropriations Act), 2018, Pub. L. No. 115-141, modifies the deduction for qualified business income of a specified agricultural or horticultural cooperative under I.R.C. § 199A(g) to instead provide a deduction for qualified production activities income (QPAI) of a specified agricul-tural or horticultural cooperative that is similar to the deduction for QPAI under former I.R.C. § 199.

The Appropriations Act replaces the QBI deduction for a specified agricultural or horticultural cooperative with a deduction that is 9% of the lesser of the cooperative’s QPAI or its taxable income [determined without regard to the cooperative’s section 199A(g) deduction and any deduction allowable under I.R.C. § 1382(b) and (c), relat-ing to patronage dividends, per-unit retain alloca-tions, and nonpatronage distributions].

The deduction is limited to 50% of the W-2 wages paid by the cooperative. Wages do not include any amount not properly allocable to domestic production gross receipts (DPGR).

For oil-related QPAI, the deduction is reduced by 3% of the least of the cooperative’s oil-related QPAI, its QPAI, or taxable income [determined without regard to the cooperative’s section 199A(g) deduction and any deduction allowable under section 1382(b) and (c)]. For this

purposes of determining alternative minimum taxable income under I.R.C. § 55, QBI is deter-mined without regard to any adjustments under I.R.C. §§ 56 through 59.

Application to Partnerships and S CorporationsThe deduction is applied at the partner or share-holder level, and each partner or shareholder must take into account such person’s allocable share of each qualified item of income, gain, deduction, and loss. Each partner or shareholder is treated as having W-2 wages and unadjusted basis immediately after acquisition of qualified property for the tax year in an amount equal to such person’s allocable share of the W-2 wages and the unadjusted basis immediately after acqui-sition of qualified property of the partnership or S corporation for the tax year (as determined under regulations prescribed by the IRS).

A partner’s or shareholder’s allocable share of W-2 wages is determined in the same manner as the partner’s or shareholder’s allocable share of wage expenses. A partner’s or shareholder’s allocable share of the unadjusted basis imme-diately after acquisition of qualified property is determined in the same manner as the partner’s or shareholder’s allocable share of depreciation. For an S corporation, an allocable share is the shareholder’s pro rata share of an item.

Partnership and S Corporation Allocations

See the “Business Issues” chapter in the 2018 National Income Tax Workbook for a comprehen-sive discussion and examples of allocations from a partnership to its partners and from an S corpora-tion to its shareholders .

Example 2.13 Partner’s Share of Wages

Paul Peterson is a partner in ABC Partnership. ABC allocates to Paul a deductible amount of 10% of wages paid by ABC to its employees for the tax year. Paul must be allocated 10% of the W-2 wages of the partnership for purposes of cal-culating the W-2 wage limit.



For a specified agricultural or horticultural cooperative that is a partner in a partnership, rules like the rules applicable to a partner in a partnership under section 199A(f)(1) apply. For a tax-exempt cooperative subject to tax on its unre-lated business taxable income, the Appropria-tions Act substitutes unrelated business taxable income for taxable income where applicable.

The section 199A(g) deduction is determined by only considering items that are attributable to the actual conduct of a trade or business.

The Appropriations Act further provides that an eligible patron that receives a qualified pay-ment from a specified agricultural or horticultural cooperative is allowed a deduction for the tax year in which the payment is received. The deduction is an amount equal to the share of the coopera-tive’s deduction for QPAI that is proportional to the QPAI to which such payment is attributable. The cooperative must identify the deduction in a written notice mailed to the patron. Thus, the cooperative’s section 199A(g) deduction is allo-cated among its patrons based on the quantity or value of business done with or for such patron by the cooperative. The patron’s deduction cannot exceed the patron’s taxable income for the tax year [determined without regard to the deduction but after taking into account the patron’s other deductions under section 199A(a)].

A qualified payment is any amount that

1. is described in paragraph (1) or (3) of section 1385(a) (i.e., patronage dividends and per-unit retain allocations),

2. is received by an eligible patron from a speci-fied agricultural or horticultural cooperative, and

3. is attributable to QPAI with respect to which the cooperative is allowed a deduction.

An eligible patron is a taxpayer other than a corporation, or another specified agricultural or horticultural cooperative. For this purpose, corpo-ration does not include an S corporation.

Finally, the cooperative cannot reduce its income under section 1382 for any deduction allowable to its patrons under this rule [i.e., the cooperative must reduce its deductions allowed for certain payments to its patrons in an amount equal to the section 199A(g) deduction allocated to its patrons].

purpose, oil-related QPAI for any tax year is the portion of QPAI attributable to the production, refining, processing, transportation, or distribu-tion of oil, gas, or any primary product thereof.

In general, QPAI is equal to DPGR reduced by the sum of: (1) the cost of goods sold that are allocable to such receipts; and (2) other expenses, losses, or deductions that are properly allocable to such receipts. DPGR generally are gross receipts of the cooperative that are derived from any lease, rental, license, sale, exchange, or other dis-position of any agricultural or horticultural prod-uct that was manufactured, produced, grown, or extracted by the cooperative in whole or in signif-icant part within the United States. The coopera-tive is treated as having manufactured, produced, grown, or extracted in whole or significant part any agricultural or horticultural products mar-keted by the cooperative if such items were manufactured, produced, grown, or extracted in whole or significant part by its patrons. DPGR do not include any gross receipts of the cooperative derived from property leased, licensed, or rented by the taxpayer for use by any related person. In addition, DPGR do not include gross receipts that are derived from the lease, rental, license, sale, exchange, or other disposition of land.

The Appropriations Act limits the definition of a specified agricultural or horticultural cooperative to organizations to which part I of subchapter T applies that (1) manufacture, produce, grow, or extract in whole or significant part any agricul-tural or horticultural product; or (2) market any agricultural or horticultural product that their patrons have manufactured, produced, grown, or extracted in whole or significant part. The definition no longer includes a cooperative solely engaged in the provision of supplies, equipment, or services to farmers or other specified agricul-tural or horticultural cooperatives.

All members of an expanded affiliated group are treated as a single corporation, and the deduc-tion is allocated among the members of the expanded affiliated group in proportion to each member’s respective amount, if any, of QPAI. In addition, for purposes of determining DPGR, if all the interests in the capital and profits of a partnership are owned by members of a single expanded affiliated group during the entire tax year, the partnership and all members of such group are treated as a single taxpayer.



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QPAI with respect to which a deduction is allow-able to the cooperative under former section 199 for a tax year of the cooperative beginning before January 1, 2018. Such qualified payment remains subject to former section 199 and any section 199 deduction allocated by the cooperative to its patrons related to such qualified payment may be deducted by such patrons in accordance with former section 199. In addition, no deduction is allowed under section 199A for such qualified payments.

QBI for Cooperatives

See the “Agricultural and Natural Resource Issues” chapter in the 2018 National Income Tax Work-book for a further discussion and examples of the deduction for cooperatives and their patrons .

Accuracy-Related PenaltyThe I.R.C. § 6662(d)(1) accuracy-related penalty applies to the section 199A deduction. For pur-poses of determining a substantial underpayment of income tax under the accuracy-related penalty, a substantial underpayment exists if the amount of the understatement exceeds the greater of 5% (not 10%) of the tax required to be shown on the return or $5,000.

Qualified REIT Dividends and Publicly Traded Partnership IncomeA taxpayer can claim a deduction for 20% of the taxpayer’s aggregate amount of qualified REIT dividends and qualified publicly traded partnership income for the tax year. Qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend. Qualified publicly traded partnership income means (with respect to any qualified trade or business of the taxpayer), the sum of (1) the net amount of the taxpayer’s allocable share of each qualified item of income, gain, deduction, and loss [that are effectively connected with a US trade or business and are included or allowed in determining tax-able income for the tax year and do not constitute excepted enumerated investment-type income,

The IRS is directed to issue regulations under section 199A(g), including regulations that pre-vent more than one cooperative taxpayer from being allowed a deduction with respect to the same activity (i.e., the same lease, rental, license, sale, exchange, or other disposition of any agri-cultural or horticultural product that was manu-factured, produced, grown, or extracted in whole or in significant part in the United States). In addi-tion, the IRS is directed to issue regulations that address the proper allocation of items of income, deduction, expense, and loss for purposes of determining QPAI (like the former section 199 regulations).

The Appropriations Act repeals the section 199A special deduction for qualified coopera-tive dividends. In addition, it repeals the rule that excludes qualified cooperative dividends from QBI of a specified trade or business. The Appro-priations Act also clarifies that items of income excluded from qualified items of income, and thus excluded from QBI, do not include any amount described in section 1385(a)(1) (i.e., patronage dividends). Accordingly, QBI of a qualified trade or business includes any patronage dividend, per-unit retain allocation, qualified written notice of allocation, or any other similar amount received from a cooperative, provided such amount is oth-erwise a qualified item of income, gain, deduc-tion, or loss [i.e., such amount is (1) effectively connected with the conduct of a trade or busi-ness within the United States, and (2) included or allowed in determining taxable income for the tax year].

For any qualified trade or business of a patron of a specified agricultural or horticultural coop-erative, the deductible amount determined under section 199A(b)(2) for such trade or business is reduced by the lesser of (1) 9% of the amount of QBI with respect to such trade or business as is properly allocable to qualified payments received from such specified agricultural or horticultural cooperative, or (2) 50% of the amount of W-2 wages with respect to such qualified trade or busi-ness that are properly allocable to such amount.

The Appropriations Act clarifies that the repeal of section 199 for tax years beginning after December 31, 2017, does not apply to a qualified payment received by a patron from a specified agricultural or horticultural cooperative in a tax year beginning after December 31, 2017, to the extent such qualified payment is attributable to



The TCJA modifies the special rule for costs incurred by persons other than the taxpayer in connection with replanting an edible crop for human consumption following loss or damage due to casualty. Under the TCJA, with respect to replanting costs paid or incurred after Decem-ber 22, 2017, but no later than a date that is 10 years after such date, for citrus plants lost or dam-aged due to casualty, replanting costs may also be deducted by a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50% in the replanted citrus plants at all times during the tax year in which the replanting costs are paid or incurred, and such other person holds any part of the remaining equity interest; or (2) such other person acquires all of the tax-payer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land.

Production Period for Beer, Wine, and Distilled Spirits

I.R.C. § 263A; TCJA § 13801

☞☞ Effective for interest costs paid or accrued after December 31, 2017 and before January 2, 2020

The TCJA excludes the aging periods for beer, wine, and distilled spirits from the production period for purposes of the uniform capitalization (UNICAP) interest capitalization rules. Thus, producers of beer, wine, and distilled spirits can deduct interest expenses (subject to any other applicable limitation) attributable to a shorter production period.

Micro-Breweries, Wineries, and Distilleries

See the “Business Issues” chapter in the 2018 National Income Tax Workbook for a discussion of the new excise tax and other tax laws that apply to micro-breweries, wineries, and distilleries .

and not including the taxpayer’s reasonable com-pensation, guaranteed payments for services, or (to the extent provided in regulations) section 707(a) payments for services] from a publicly traded partnership not treated as a corporation; and (2) gain recognized by the taxpayer on dis-position of its interest in the partnership that is treated as ordinary income (for example, by rea-son of I.R.C. § 751).

Choice of Entity and Filing Status

The new QBI deduction may impact a taxpayer’s choice of business entity and a taxpayer’s choice of filing status . See the “Business Entity Issues” chapter in the 2018 National Income Tax Work-book for comprehensive examples of how the QBI deduction affects choice of business entity; and see the “Individual Issues” chapter for a discus-sion of how the QBI deduction may affect choice of filing status .

Reduction in Dividends Received Deduction

I.R.C. § 243; TCJA § 13002


The 70% dividends received deduction is reduced to 50%. The 80% dividends received deduction for 20% or more owned corporations is reduced to 65%. Thus, the maximum tax on dividends is 10.5% (50% of the top corporate rate of 21%), and 7.35% (35% of the top corporate rate of 21%) for 20% or more owned corporations.

Expensing of Costs of Replanting Citrus Plants

I.R.C. § 263A; TCJA § 13207

☞☞ Effective for costs paid or incurred after Decem-ber 22, 2017


Small Business Accounting Method Reform and Simplification 49

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income-producing factor. In addition, a tax shel-ter cannot use the cash method.

In addition, the TCJA exempts certain tax-payers from the requirement to keep inventories. Specifically, taxpayers that meet the $25,000,000 gross receipts test are not required to account for inventories under I.R.C. § 471. They can use a method of accounting for inventories that either (1) treats inventories as non-incidental materials and supplies (deductible in the tax year in which they are first used or are consumed in the taxpay-er’s operations), or (2) conforms to the taxpayer’s financial accounting treatment of inventories. The taxpayer’s financial accounting treatment of inventories is determined by reference to the method of accounting used in the taxpayer’s applicable financial statement. If the taxpayer does not have an applicable financial statement, it is determined by reference to the method of accounting used in the taxpayer’s books and records prepared in accordance with the taxpay-er’s accounting procedures. For a sole proprietor-ship, the $25,000,000 gross receipts test is applied as if the sole proprietorship is a corporation or partnership.

The TCJA expands the exception for small taxpayers from the uniform capitalization rules and any producer or reseller that meets the $25,000,000 gross receipts test is exempted from the application of I.R.C. § 263A. The TCJA retains the exemptions from the uniform capital-ization rules that are not based on a taxpayer’s gross receipts.

Finally, the TCJA expands the exception for small construction contracts from the requirement to use the percentage-of-completion method. Contracts within this exception are those con-tracts for the construction or improvement of real property if the contract

1. is expected (at the time such contract is entered into) to be completed within 2 years of commencement of the contract, and

2. is performed by a taxpayer that (for the tax year in which the contract was entered into) meets the $25,000,000 gross receipts test.

A taxpayer who fails the $25,000,000 gross receipts test is not eligible for any of the excep-tions (i.e., from the accrual method, from keeping inventories, from applying the UNICAP rules, or from using the percentage-of-completion method) for such tax year.

Small Business Accounting Method Reform and Simplification

I.R.C. §§ 263A, 448, 460, and 471; TCJA § 13102

☞☞ The TCJA provisions that expand the types of tax-payers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the UNICAP rules apply to tax years beginning after December 31, 2017. The provision to expand the exception for small construction contracts from the requirement to use the percentage-of-completion method applies to contracts entered into after December 31, 2017, in tax years end-ing after such date.

The TCJA expands the types of taxpayers that may use the cash method of accounting. Under the TCJA, the cash method of accounting may be used by taxpayers, other than tax shelters, that sat-isfy the gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. The gross receipts test allows taxpayers with annual average gross receipts that do not exceed $25,000,000 for the 3-prior-tax-year period to use the cash method. The $25,000,000 amount is indexed for inflation for tax years beginning after 2018.

The TCJA expands the types of farming C corporations (and farming partnerships with a C corporation partner) that may use the cash method to include any farming C corporation (or farming partnership with a C corporation part-ner) that meets the $25,000,000 gross receipts test.

The TCJA retains the exceptions from the required use of the accrual method for quali-fied personal service corporations and taxpay-ers other than C corporations. Thus, qualified personal service corporations, partnerships without C corporation partners, S corporations, and other pass-through entities can use the cash method without regard to whether they meet the $25,000,000 gross receipt test, if the use of such method clearly reflects income. Consistent with present law, the cash method generally may not be used by taxpayers, other than those that meet the $25,000,000 gross receipts test, if the pur-chase, production, or sale of merchandise is an



3. a facility or portion thereof used in connec-tion with any of the above items.

Thus, the TCJA repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business (and the related rule applying a 50% limit to such deductions).

Allowable Expenses

The TCJA restrictions on deducting entertain-ment expenses do not apply to the expenses for which I .R .C . § 274(e) authorizes a deduction . These include (with some exceptions), expenses for goods, services, and facilities, to the extent that the expenses are treated as wages to the employee; certain substantiated expenses paid or incurred by the taxpayer, in connection with the performance of services for another person under a reimbursement or other expense allowance arrangement; expenses for recreational, social, or similar activities (including facilities therefor) pri-marily for the benefit of employees (other than employees who are highly compensated employ-ees); and expenses directly related to business meetings of the taxpayer’s employees, stockhold-ers, agents, or directors .

Transportation BenefitsThe TCJA disallows a deduction for expenses associated with providing any qualified transpor-tation fringe benefits [as defined in I.R.C. § 132(f)] to employees of the taxpayer. Except as is neces-sary to ensure the safety of an employee, the TCJA disallows a deduction for any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.

Food and Beverage ExpensesTaxpayers may still generally deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after December 31, 2017, and until December 31, 2025, the TCJA expands this 50% limitation to expenses of the

Application of the TCJA provisions to increase the types of taxpayers eligible to use the cash method, exempt certain taxpayers from the requirement to keep inventories, and expand the exception from the UNICAP rules is a change in the taxpayer’s method of accounting for pur-poses of I.R.C. § 481. Application of the excep-tion for small construction contracts from the requirement to use the percentage-of-completion method is applied on a cutoff basis for all simi-larly classified contracts [there is no adjustment under section 481(a) for contracts entered into before January 1, 2018].

Accounting Methods

See the “Business Issues” chapter in the 2018 National Income Tax Workbook for a further discussion of the qualified personal service cor-poration exception, other exemptions from appli-cation of the uniform capitalization rules, and the choice of accounting methods .

Entertainment, Transportation, and Food and Beverage Expenses

I.R.C. § 274; TCJA § 13304

☞☞ Generally effective for amounts paid or incurred after December 31, 2017. However, for expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer, amounts paid or incurred after December 31, 2025, are not deductible.

Entertainment ExpensesThe TCJA provides that no deduction is allowed with respect to

1. an activity generally considered to be enter-tainment, amusement, or recreation;

2. membership dues with respect to any club organized for business, pleasure, recreation, or other social purposes; or


Tax Year of Inclusion 51

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The TCJA also removes computer or periph-eral equipment from the definition of listed prop-erty. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.

Tax Year of Inclusion

I.R.C. § 451; TCJA § 13221

☞☞ Effective for tax years beginning after December 31, 2017. For income from a debt instrument with OID, it applies to tax years beginning after December 31, 2018.

The TCJA revises the rules associated with the timing of the recognition of income. Specifically, it provides that an accrual method taxpayer rec-ognizes income no later than the tax year in which the income is taken into account as revenue in an applicable financial statement or another finan-cial statement under rules specified by the IRS. Thus, an accrual method taxpayer with an appli-cable financial statement will include an item in income under I.R.C. § 451 upon the earlier of when the all events test is met or when the tax-payer includes such item in revenue in an appli-cable financial statement.

For example, any unbilled receivables for partially performed services must be recognized to the extent the amounts are included in income for financial statement purposes. Similarly, for a contract that contains multiple performance obli-gations, the taxpayer must allocate the transac-tion price in accordance with the allocation made in the taxpayer’s applicable financial statement.

Recognition of Income

The provision does not revise the rules associated with when an item is realized for federal income tax purposes and, accordingly, does not require the recognition of income in situations where the federal income tax realization event has not yet occurred . For example, the provision does not require the recharacterization of a transaction from sale to lease, or vice versa, to conform to how the transaction is reported in the taxpayer’s applicable financial statement .

employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid until December 31, 2025, are subject to the 50% limit. After Decem-ber 31, 2025, employers cannot deduct these expenses. Specifically, after December 31, 2025, an employer cannot deduct

☞■ any expense for the operation of an employer-operated eating facility described in section 132(e)(2);

☞■ any expense for food or beverages, including under section 132(e)(1), associated with an employer-operated eating facility; or

☞■ any expense for meals described in I.R.C. § 119(a).

Depreciation Limits on Automobiles and Computer Equipment

I.R.C. § 280F; TCJA § 13202

☞☞ Effective for property placed in service after December 31, 2017, in tax years ending after such date

The TCJA increases the I.R.C. § 280F depre-ciation limits that apply to listed property. For passenger automobiles placed in service after December 31, 2017, and for which the additional first-year depreciation deduction under I.R.C. § 168(k) is not claimed, the maximum amount of allowable depreciation is $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recov-ery period [Rev. Proc. 2017-29, Table 3, 2017-14 I.R.B. 1065]. The limits are indexed for inflation for passenger automobiles placed in service after 2018. For vehicles that are qualifying property for which bonus depreciation is allowed, $8,000 is added to the applicable placed-in-service year limit. See the earlier discussion of the extension of bonus depreciation.



year of receipt if such income is also deferred for financial statement purposes. For advance pay-ments received for a combination of services, goods, or other specified items, the TCJA allows the taxpayer to allocate the transaction price in accordance with the allocation made in the taxpayer’s applicable financial statement. The deferred advance payment is included in gross income if the taxpayer ceases to exist.

The application of these rules is a change in the taxpayer’s method of accounting for purposes of I.R.C. § 481. If a taxpayer is required by this provision to change its method of accounting for its first tax year beginning after December 31, 2017, such change is treated as initiated by the taxpayer and made with the consent of the IRS. For income from a debt instrument with OID, the related section 481(a) adjustment is taken into account over 6 tax years.

Limit on Losses for Taxpayers Other Than C Corporations

I.R.C. § 461; TCJA § 11012

☞☞ Effective for tax years beginning after December 31, 2017, and before January 1, 2026

The I.R.C. § 461(j) limit on excess farm losses of certain non–C corporation taxpayers does not apply, and any excess business loss of the tax-payer for the tax year is not allowed. The term excess business loss means the excess (if any) of the aggregate deductions of the taxpayer for the tax year that are attributable to trades or businesses of such taxpayer (determined without regard to whether such deductions are disallowed for such tax year under this rule), over the sum of

1. the aggregate gross income or gain of such taxpayer for the tax year that is attributable to such trades or businesses, plus

2. $250,000 ($500,000 for MFJ).

For tax years beginning after December 31, 2018, the $250,000 ($500,000 MFJ) amount is adjusted for inflation.

For a partnership or S corporation, the rule applies at the partner or shareholder level. Each partner’s distributive share and each S corpo-ration shareholder’s pro rata share of items of income, gain, deduction, or loss of the partnership

The term applicable financial statement means

1. a financial statement that is certified as being prepared in accordance with generally accepted accounting principles and is a. a 10-K (or successor form), or annual state-

ment to shareholders, required to be filed by the taxpayer with the United States Securities and Exchange Commission; or

b. certain audited financial statement of the taxpayer that are used for credit purposes; reporting to shareholders, partners, or other proprietors, or to beneficiaries; or any other substantial nontax purpose;

2. certain financial statements that are made on the basis of international financial reporting standards and are filed by the taxpayer with an agency of a foreign government; or

3. certain financial statements filed by the tax-payer with any other regulatory or govern-mental body specified by IRS.

The rule does not apply to taxpayers without an applicable or other specified financial state-ment. Thus, accrual method taxpayers without an applicable or other specified financial state-ment will continue to determine income inclu-sion under the all events test, unless an exception permits deferral or exclusion.

For accrual method taxpayers with an appli-cable financial statement, the section 451 income recognition rules must be applied before apply-ing the special rules for OID, market discount on bonds, discounts on short-term obligations, OID on tax-exempt bonds, and stripped bonds and stripped coupons. Thus, for example, to the extent amounts are included in revenue for finan-cial statement purposes when received (e.g., late-payment fees, cash-advance fees, or interchange fees), such amounts generally are includable in income at such time in accordance with the gen-eral recognition principles under section 451.

The TCJA provides an exception for any item of gross income in connection with a mort-gage servicing contract.

The TCJA also codifies the current deferral method of accounting for advance payments for goods, services, and other specified items under Rev. Proc. 2004-34, 2004-22 I.R.B. 991. Accrual method taxpayers can elect to defer the inclusion of income associated with certain advance pay-ments to the end of the tax year following the tax


Unrelated Business Taxable Income Separately Computed 53

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3. all the owners on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on December 22, 2017.

Under this provision, if an eligible terminated S corporation makes a distribution of money, the accumulated adjustments account is allocated to the distribution, and the distribution is charge-able to accumulated earnings and profits in the same ratio as the amount of the accumulated adjustments account bears to the amount of the accumulated earnings and profits. Thus, instead of being charged first to accumulated earnings and profits and being taxed as a C corporation dividend, the cash distribution is allocated pro-portionately between the accumulated earnings and profits and the accumulated adjustments account.

Choice of Entity

See the “Business Entity Issues” chapter in the 2018 National Income Tax Workbook for a dis-cussion of when an S corporation may want to revoke its S election to take advantage of the new corporate tax rates .

Unrelated Business Taxable Income Separately Computed

I.R.C. § 512; TCJA § 13702

☞☞ Effective for tax years beginning after December 31, 2017. Under a special transition rule, NOLs arising in a tax year beginning before January 1, 2018, that are carried forward to a tax year beginning on or after such date are not subject to this provision and the organization’s unre-lated business taxable income (UBTI) is reduced by the amount of the NOL.

For an organization with more than one unrelated trade or business, the organization must first cal-culate UBTI separately for each trade or business, without regard for the I.R.C. § 512(b)(12) deduc-tion that applies for dioceses, religious orders, or conventions or associations of churches. The organization’s UBTI for a tax year is the sum of the amounts (not less than zero) computed for

or S corporation are taken into account by the partner or shareholder in the tax year of the part-ner or shareholder with or within which the tax year of the partnership or S corporation ends.

The IRS is directed to adopt additional reporting requirements as necessary to carry out the purposes of this rule.

This rule is applied after the application of I.R.C. § 469. Any loss that is disallowed under this rule is treated as a net operating loss carry-over in subsequent tax years under I.R.C. § 172. Under the TCJA, NOL carryovers generally are allowed for a tax year up to the lesser of the car-ryover amount or 80% of taxable income deter-mined without regard to the deduction for NOLs.

Excess Business Losses

See the “Agricultural and Natural Resource Issues” chapter in the 2018 National Income Tax Workbook for a discussion of the excess business loss rule and its application with the passive activ-ity loss and NOL rules .

S Corporation Conversions to C Corporations

I.R.C. §§ 481 and 1371; TCJA § 13543

☞☞ Effective December 22, 2017

Under the TCJA, any I.R.C. § 481(a) adjustment of an eligible terminated S corporation attribut-able to the revocation of its S corporation election is taken into account ratably during the 6-tax-year period beginning with the year of change. Thus, if an S corporation revokes its election, and it must change from the cash method to an accrual method, it can take any increased tax into account over a 6-year period. An eligible termi-nated S corporation is any C corporation that

1. is an S corporation before December 22, 2017;

2. during the 2-year period beginning on December 22, 2017, revokes its S corporation election under I.R.C. § 1362(a); and



Charitable Contribution Deduction for Electing Small Business Trusts

I.R.C. § 641; TCJA § 13542


The charitable contribution deduction of an elect-ing small business trust (ESBT) is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. AGI is computed in the same manner as in the case of an individual, except that the deductions for costs that are paid or incurred in connection with the administration of the trust and which would not have been incurred if the property were not held in such trust are allowed in the calculation of AGI. The percentage limitations and carryfor-ward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.

Charitable Contributions and Foreign Taxes Impact Limit on Allowance of Partner’s Share of Loss

I.R.C. § 704; TCJA § 13503

☞☞ Effective for partnership tax years beginning after December 31, 2017

A partner’s distributive share of partnership loss (including capital loss) is allowed only to the extent of the adjusted basis (before reduction by the current year’s losses) of the partner’s interest in the partnership at the end of the partnership tax year in which the loss occurred. The TCJA modifies the basis limitation on partner losses to provide that the limitation takes into account a partner’s distributive share of partnership chari-table contributions [as defined in I.R.C. § 170(c)] and taxes (described in I.R.C. § 901) paid or accrued to foreign countries and to possessions of the United States. Thus, the amount of the basis limitation on partner losses is decreased to reflect these items.

each separate unrelated trade or business, less the specific deduction allowed under section 512(b)(12). A NOL deduction is allowed only with respect to a trade or business from which the loss arose.

The result of this provision is that a deduc-tion from one trade or business for a tax year may not be used to offset income from a different unrelated trade or business for the same tax year. The provision does not prevent an organization from using a deduction from one tax year to offset income from the same unrelated trade or busi-ness activity in another tax year.

Tax Exempt Entities

See the “Business Entity Issues” chapter in the 2018 National Income Tax Workbook for a dis-cussion of new forms, procedures, and rules that affect tax-exempt entities .

Unrelated Business Taxable Income Increased by Disallowed Fringe Benefits

I.R.C. § 512; TCJA § 13703


UBTI includes any expenses paid or incurred by a tax-exempt organization for qualified transporta-tion fringe benefits [as defined in I.R.C. § 132(f)], a parking facility used in connection with quali-fied parking [as defined in I.R.C. § 132(f)(5)(C)], or any on-premises athletic facility [as defined in I.R.C. § 132(j)(4)(B)], if such amounts are not deductible under I.R.C. § 274.

UBTI

See the “Business Entity Issues” chapter in the 2018 National Income Tax Workbook for a fur-ther discussion of UBTI and the requirement to add certain disallowed fringe benefit expenses to UBTI .


Like-Kind Exchanges 55

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disposition by the partnership of all the partner-ship’s assets in a fully taxable transaction for cash equal to the assets’ FMV immediately after the transfer of the partnership interest.

Example 2.14 Substantial Built-In Loss

ABC Partnership has three taxable partners (part-ners A, B, and C). ABC has not made a section 754 election. ABC has two assets. Asset X has a $1,000,000 built-in gain. Asset Y has a $900,000 built-in loss. Pursuant to the partnership agree-ment, any gain on sale or exchange of asset X is specially allocated to partner A. The three part-ners share equally in all other partnership items, including in the built-in loss in asset Y.

In this case, partner B and partner C each have a $300,000 net built-in loss (one-third of the loss attributable to Asset Y) allocable to his partner-ship interest. Nevertheless, the partnership does not have an overall built-in loss, but a $100,000 net built-in gain of ($1,000,000 − $900,000).

Partner C sells his partnership interest to part-ner D for $33,333. Under the TCJA, the test for a substantial built-in loss applies both at the part-nership level and at the transferee partner level. If the partnership sold all its assets for cash at their FMV immediately after the transfer to D, then D would be allocated a $300,000 loss (one-third of the $900,000 built-in loss of asset Y). A substan-tial built-in loss exists under the partner-level test, and the partnership adjusts the basis of its assets accordingly with respect to D.

Like-Kind Exchanges

I.R.C. § 1031; TCJA § 13303

☞☞ Generally effective for exchanges completed after December 31, 2017. However, an excep-tion is provided for any exchange if the property disposed of by the taxpayer in the exchange is disposed of on or before December 31, 2017, or the property received by the taxpayer in the exchange is received on or before such date.

The TCJA modifies the provision providing for nonrecognition of gain in the case of like-kind exchanges by limiting its application to real property that is not held primarily for sale. It is intended that real property eligible for like-kind

In the case of a charitable contribution by the partnership, the amount of the basis limita-tion on partner losses is decreased by the part-ner’s distributive share of the adjusted basis of the contributed property. In the case of a chari-table contribution by the partnership of property whose FMV exceeds its adjusted basis, a special rule provides that the basis limitation on partner losses does not apply to the extent of the partner’s distributive share of the excess.

Repeal of Technical Termination of Partnerships

I.R.C. § 708(b); TCJA § 13504

☞☞ Effective for partnership tax years beginning after December 31, 2017

The TCJA repeals the I.R.C. § 708(b)(1)(B) rule providing for technical terminations of partner-ships. The provision does not change the present-law rule of section 708(b)(1)(A) that a partnership is considered to be terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.

Definition of Substantial Built-In Loss on Transfer of a Partnership Interest

I.R.C. § 743; TCJA § 13502

☞☞ Effective for transfers of partnership interests after December 31, 2017

In general, a partnership does not adjust the basis of partnership property following the transfer of a partnership interest unless either the partnership has made a one-time election under I.R.C. § 754 to make basis adjustments, or the partnership has a substantial built-in loss immediately after the transfer.

The TCJA modifies the definition of a sub-stantial built-in loss for purposes of I.R.C. § 743(d). Under this provision, in addition to the present-law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical



applicable partnership interest, or the taxpayer made a section 83(b) election with respect to an applicable partnership interest, the 3-year hold-ing period requirement for long-term capital gain still applies.

The amount of the taxpayer’s net long-term capital gain with respect to an applicable partner-ship interest that exceeds the amount of the net gain calculated as if a 3-year (not 1-year) hold-ing period applies is treated as short-term gain. In making this calculation, long-term capital losses are calculated as if a 3-year holding period applies.

For purposes of this rule, an applicable partner-ship interest is any interest in a partnership that, directly or indirectly, is transferred to (or held by) the taxpayer in connection with performance of services in any applicable trade or business (defined later). The services may be performed by the taxpayer or by any other related person or persons in any applicable trade or business. It is intended that partnership interests will be treated as transferred or held in connection with the performance of services even if the taxpayer also made contributions to the partnership, and the Treasury Department is directed to provide guidance implementing this intent.

However, an applicable partnership interest does not include any capital interest in a partner-ship giving the taxpayer a right to share in part-nership capital commensurate with the amount of capital contributed (as of the time the partner-ship interest was received), or commensurate with the value of the partnership interest that is taxed under section 83 on receipt or vesting of the partnership interest. For example, in the case of a partner who holds a capital interest in the partner-ship with respect to capital he or she contributed to the partnership, if the partnership agreement provides that the partner’s share of partnership capital is commensurate with the amount of capi-tal he or she contributed (as of the time the part-nership interest was received) compared to total partnership capital, the partnership interest is not an applicable partnership interest to that extent.

An applicable partnership interest does not include an interest in a partnership directly or indirectly held by a corporation. In Notice 2018-18, 2018-12 I.R.B., the Treasury Department and the IRS announced that they intend to issue regu-lations providing guidance on the application of I.R.C. § 1061. The regulations will provide

exchange treatment under present law will continue to be eligible for like-kind exchange treatment under the provision. For example, a like-kind exchange of real property includes an exchange of shares in a mutual ditch, reservoir, or irrigation company described in I.R.C. § 501(c)(12)(A) if at the time of the exchange such shares have been recognized by the highest court or stat-ute of the state in which the company is organized as constituting or representing real property or an interest in real property. Similarly, improved real estate and unimproved real estate are generally considered to be property of a like kind [Treas. Reg. § 1.1031(a)-1(b)].

Partnership Profits Interests Issued or Held for Performance of Investment Services

I.R.C. § 1061; TCJA § 13309


A profits interest in a partnership is the right to receive future profits in the partnership but does not generally include any right to receive money or other property upon the immediate liquidation of the partnership. A taxpayer receiving a profits interest for performing services is typically not taxed upon the receipt of the partnership interest.

The partner includes in income its distribu-tive share of partnership items of income and gain, including capital gain eligible for the lower tax rates. Thus, for an investment services part-nership with substantial income from long-term capital gains and qualified dividends, issuance of a profits interest for compensation entitles the partner to preferential tax rates (instead of ordi-nary income that would be paid on a manage-ment fee or other direct compensation).

The TCJA addresses this issue by character-izing certain gains from partnership profits inter-ests held in connection with the performance of investment services as short-term gains. Specifi-cally, the TCJA provides a 3-year holding period for certain net long-term capital gain on an applicable partnership interest, notwithstanding the rules of I.R.C. § 83 or any election in effect under section 83(b). Thus, if a taxpayer included an amount in income upon acquisition of an


Excise Tax on Excess Tax-Exempt Organization Executive Compensation 57

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Expansion of Qualifying Beneficiaries of an Electing Small Business Trust

I.R.C. § 1361; TCJA § 13541

☞☞ Effective January 1, 2018

A nonresident alien individual can be a potential current beneficiary of an electing small business trust (ESBT).

Excise Tax on Excess Tax-Exempt Organization Executive Compensation

I.R.C. § 4960; TCJA § 13602


New I.R.C. § 4960 imposes a 21% excise tax on remuneration paid by an applicable tax-exempt organization to a covered employee that exceeds $1,000,000 plus any excess parachute payment paid to the covered employee. The excise tax applies to an excess parachute payment, even if the covered employee’s remuneration does not exceed $1,000,000.

The following definitions apply:☞■ An applicable tax-exempt organization is an organization exempt from tax under I.R.C. § 501(a); an exempt farmers’ cooperative; a federal, state, or local governmental entity with excludable income; or a political organization.

☞■ A covered employee is an employee (including any former employee) of an applicable tax-exempt organization if the employee is one of the five highest-compensated employees of the organization for the tax year or was a covered employee of the organization (or a predecessor) for any preceding tax year beginning after December 31, 2016.

that the term corporation for purposes of section 1061(c)(4)(A) does not include an S corporation.

An applicable trade or business means any activ-ity (regardless of whether the activity is conducted in one or more entities) that consists in whole or in part of raising or returning capital, and either investing in (or disposing of) specified assets, identifying specified assets for investing or dis-position, or developing specified assets. Specified assets include securities, commodities, and real estate held for rental or investment. For purposes of the provision, real estate held for rental or invest-ment does not include, for example, real estate on which the holder operates an active farm.

Certain Self-Created Property Is Not a Capital Asset

I.R.C. § 1221; TCJA § 13314

☞☞ Applicable to dispositions after December 31, 2017

The TCJA amends I.R.C. § 1221(a)(3) to exclude the following from the definition of a capital asset:

☞■ A patent, invention, model, or design (whether or not patented)

☞■ A secret formula or process that is held either by the taxpayer who created the prop-erty or a taxpayer with a substituted or trans-ferred basis from the taxpayer who created the property (or for whom the property was created)

Thus, gains or losses from the sale or exchange of these assets does not receive capital gain treatment.



times the base amount. The base amount is the average annualized compensation includable in the covered employee’s gross income for the 5 tax years ending before the date of the employee’s separation from employment. Parachute payments do not include payments under a qualified retire-ment plan, a simplified employee pension plan, a simple retirement account, a tax-deferred annuity, or an eligible deferred compensation plan of a state or local govern-ment employer. They also do not include compensation paid to employees who are not highly compensated employees [within the meaning of I.R.C. § 414(q)].

International Tax

See the “New Legislation—Additional” chapter in the 2018 National Income Tax Workbook for a discussion of pertinent TCJA changes to interna-tional tax laws .

☞■ Remuneration is wages as defined for income tax withholding purposes but does not include any designated Roth contribu-tion. The definition of remuneration for this purpose includes amounts required to be included in gross income under I.R.C. § 457(f). However, remuneration of a cov-ered employee that is not deductible because of the $1,000,000 limit on deductible com-pensation is not taken into account for purposes of this provision. Compensation attributable to medical services of certain qualified medical professionals is exempted from the definitions of remuneration and parachute payment.

☞■ An excess parachute payment is the amount by which any parachute payment exceeds the portion of the base amount allocated to the payment. A parachute payment is a payment as compensation to (or for the benefit of) a covered employee if the payment is con-tingent on the employee’s separation from employment and the aggregate present value of all such payments equals or exceeds three


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