Query: Jane is a partner in a partnership with a July 31 year end. What information does she use to calculate the Sec. 199A deduction she claims on her 2018 Form 1040, U.S. Individual Income Tax Return?
Short answer: Jane uses the information from her partnership Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., for the year ended July 31, 2018. It doesn’t matter that the K-1 includes months prior to the effective date of Sec. 199A because this provision applies to individuals for their tax years beginning after Dec. 31, 2017.
Now, the longer explanation:
P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA), added several new provisions to the tax code, many of which add complexity in terms of new calculations, interplay with other provisions and past tax decisions, and tax planning changes. Among these changes is new Sec. 199A potentially allowing a 20% deduction against qualified business income for certain noncorporate taxpayers. This provision consumes nine pages of the 185-page public law.
Guidance is needed to help understand and apply this new deduction. On Feb. 21, 2018, the AICPA submitted a letter to Treasury and the IRS requesting guidance on several topics including the definition of qualified business income. Hopefully, guidance will be issued before 2018 returns are filed, but estimated payments are due, and fiscal-year taxpayers need guidance as soon as possible. In the meantime, taxpayers and practitioners need to rely on the statute and legislative history for answers. One such area where it would be nice to get answers sooner rather than later is on how Sec. 199A applies to fiscal years. Following is this author’s explanation based on the statute and TCJA history.
Per Section 11011(e) of the TCJA and its committee reports, Sec. 199A applies to tax years beginning after Dec. 31, 2017. Sec. 199A(i) states that it does not apply to tax years beginning after Dec. 31, 2025. Thus, it is easy to see that calendar-year taxpayers can potentially claim this new deduction for eight years (2018 through 2025). The same should be true for fiscal-year taxpayers as well as for any taxpayer eligible for a Sec. 199A deduction who owns an interest in a fiscal-year entity.
Example: Assume Jane owns an interest in partnership P with a July 31 year end. What does Jane do when she receives her Schedule K-1 for P for its year ending July 31, 2018 — a year that includes five months of 2017 and seven months of 2018? Jane should do what she normally does — report this information on her 2018 Form 1040, including using all of it to compute her Sec. 199A deduction for 2018.
This is the most logical answer given that the Sec. 199A deduction is claimed by Jane and not P. Sec. 199A applies to tax years beginning after Dec. 31, 2017, which for Jane is her 2018 calendar-year income tax return. While it may seem odd that Jane’s 2018 return includes a Sec. 199A deduction based on P’s income data that includes five months of 2017, Jane’s final year of using P’s information for a Sec. 199A deduction will be from the Schedule K-1 for P’s year ended July 31, 2025. Thus, she does not use information for five months of 2025 (August through December) in calculating her eight years of Sec. 199A deduction. Altogether, Jane will claim a Sec. 199A deduction for a total of eight years of information from P.
This answer ties to the statute and legislative intent and makes sense in that Jane reports all of the July 31, 2018, Schedule K-1 information from P on her 2018 Form 1040.
Other possible answers don’t tie to the Code, the statute, or the committee reports. Consider two other possibilities and why they should not apply:
- Jane uses seven months of K-1 information for P’s year ended July 31, 2018, in calculating her Sec. 199A deduction for her 2018 return and then waits for her July 31, 2019, Schedule K-1 to get the last five months of 2018 data. Jane must miss the due date for her 2018 individual return under this approach, and the partnership must report monthly K-1 information to its partners. This approach seems contrary to the normal reporting of K-1 information by P’s partners.
- Jane waits until she gets her July 31, 2019, Schedule K-1 (P’s first year where all months occur after the Dec. 31, 2017, effective date) and doesn’t claim a Sec. 199A deduction based on her ownership in P until her 2019 individual return. This ignores the effective date of Sec. 199A and prevents Jane from claiming a Sec. 199A deduction for her partnership activity for a total of eight years. Some practitioners might think that this answer is correct because they remember how Sec. 199 (income attributable to domestic production activities) was implemented when it was added by the American Jobs Creation Act of 2004, P.L. 108-357, and then modified by the Gulf Opportunity Zone Act of 2005, P.L. 109-135. That amendment changed how the effective date worked for fiscal-year partnerships, S corporations, and trusts. The revised Sec. 199 effective date language stated that “in applying the effective date of the deduction under section 199, items arising from a taxable year of a partnership, S corporation, estate, or trust beginning before 2005 are not taken into account for purposes of [this section]” (Joint Committee on Taxation Rep’t JCX-88-05, p. 79). This approach also does not apply to Jane because this is not what Congress provided in Sec. 199A, despite awareness of how it wrote the Sec. 199 effective date language years ago.
Fiscal-year passthrough entities that must file for their year ending in 2018 prior to the release of the 2018 tax forms will have to determine per the statute what information is required by the noncorporate owners for their Sec. 199A deduction, unless the IRS provides that information (and forms) before the due date. Taxpayers also need guidance on how the W-2 wage information relevant to some business owners is computed for owners of partnerships and S corporations, including how the calendar-year reference in Sec. 199A(b)(4)(A) applies to reporting obligations of fiscal-year passthrough entities.
Taxpayers will need that information soon because, for example, the Form 1065, U.S. Return of Partnership Income, for a partnership with a year ending Jan. 31, 2018, is due April 15, 2018, with an extension available to Oct. 15, 2018. Hopefully, guidance will be available by that date for filing of returns of passthrough entities that ensures the owners have the necessary data to calculate their Sec. 199A deduction for 2018.
— Annette Nellen (email@example.com) is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, American Bar Association, and California State Bar, and chairs the AICPA Tax Executive Committee. She has written several articles on tax policy and reform and maintains the 21st Century Taxation blog.