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Proposed Regulation Has Favorable Loss Allocation

Published on: 14:23PM Aug 12, 2018

Under Section 199A, farmers will need to compute their qualified business income amount (QBIA) and in some cases this can be a loss.  If the farmer only has one business and it shows a loss, there is no deduction in the current year and that loss will carry forward to the following year as a "separate" item of qualified business income (QBI).  Here is an example (for purposes of the examples I will use QBIA as the Section 199A deduction):

Peter, a Schedule F farmer, incurs a loss of $200,000 during 2018.  There is no Section 199A deduction on this loss and the $200,000 loss carries forward to 2019.  In 2019, Peter has income of $120,000.  In this case, he now has a combined QBI loss of $80,000; there is no Section 199A deduction because of the carryforward of the taint on succeeding year income. The remaining QBI loss carries over to 2020.  In 2020, he shows income of $300,000.  In this case, his net QBI for the year is $220,000 and he should qualify for a $44,000 Section 199A deduction (assuming under the threshold and enough ordinary taxable income).

However, many of our farmers have multiple operations.  If one of these entities shows a loss, that loss must be netted against the income of the other entities. For farmers under the threshold amount, we simply net these numbers and multiply by 20% to arrive at the net Section 199A deduction.  However, if the farmer is over the threshold, then it gets more complicated. 

The proposed regulations calculate it differently from the way we originally thought it would work.

Assume Peter has a Schedule F and also has a custom harvesting business that he shows on a Schedule C.  The Schedule F has an income of $300,000 and the Schedule C shows a loss of $50,000.  The farm has total labor of $80,000 and the Schedule C has wages paid of $100,000 and no qualifying property for either entity.  Peter would take the $50,000 net Schedule C loss and reduce his Schedule F income to $250,000.  20% of this number is $50,000 but he is limited to $40,000 (the wage limit). 

In cases where there is a limit on the QBIA due to the wage or wage and qualified property limitation, the proposed regulation calculation will almost always result in a larger deduction than our old assumption.

Now, finally, Peter may elect to aggregate his Schedule C and F into "one" business for purposes of Section 199A.  In our example, this will result in a greater deduction.

Since Peter has elected to aggregate his C and F, his net income is $250,000 which results in a QBIA of $50,000.  His wage limit is now the combined wages of $180,000 times 50% or $90,000.  Therefore, he can deduct the full $50,000 of QBIA.  If Peter makes the election to aggregate these entities, he must follow this each year, but likely it will almost always result in a greater or equal deduction to not making the election (but I am sure there are cases will it will be less).

As I read the proposed regulations, they appear to be more favorable than I originally thought they would be, at least for farmers.  The AICPA and others will be responding to the IRS with comments and there are certainly items still to be addressed, but all-in-all, I have to give kudos to the IRS for doing a fairly good job for a very complicated tax provision.