On February 1, 2019, the IRS published a corrected version of their final regulations for Section 199A (available here).
The corrections include a handful of minor editorial tweaks. All helpfully flagged in the published document using revision marks. But one particular tweak makes sense to point out and discuss for many, many small businesses.
Do You Have Multiple Trades or Businesses?
That tweak? Well, as you may know if you’re reading this, you need to calculate the Section 199A deduction for each separate trade or business.
You can’t just add up the business profit from all your trades or businesses and multiply that sum by 20 percent even in the simplest case. Rather, you determine the profit of each trade or business, multiply just that trade or business’s profit by 20 percent, and then add up the individual trades’ or businesses’ deductions.
That requirement begs an obvious follow-up question: How do you or I determine whether one or more than one business exists?
The first version of final regulations published in mid-January suggested you needed to look at each situation carefully and apply a variety of tests.
But one important test? Do the activities keep separate books?
The Language Change: No Longer a Separate Requirement
But that “separate books” requirement dropped out of the corrected version which appeared in February.
Here’s the edit to that first language:
Section 1.446-1(d)(2) provides that no trade or business will be considered separate and distinct unless a complete and
separateseparable set of books and records is kept for such trade or business.
The revision added the underlined words and deleted the crossed-out word.
That’s interesting to me. And significant, I think, for three reasons.
No Requirement for Separate Books
The first obvious significance? You or your client don’t need separate books. You need separable books.
For example, to put this in terms of QuickBooks, the most popular small business accounting software program, you don’t need separate QuickBooks data files or separate QuickBooks Online subscriptions for each business.
Rather, you need to be able to set up your QuickBooks accounting records such that you can separate different trades or businesses.
My suggestion? I think you use your chart of accounts to allow for the required separation.
You would want different asset, liability and equity accounts for each trade or business. You would also want different income and expense accounts. (The different accounts should allow for “separable”-ness.)
An example? You would want separate bank accounts.
Another tip for QuickBooks users? I think you would want to use different invoice templates for each trade or business (probably showing different trade or business names).
A landscaper doing both maintenance and then design and wanting to treat these activities as separate and distinct trades or businesses might have one set of accounts for the maintenance business and another set of accounts for the design business.
Remember the Edit
Another significant thing, I suggest, you want to remember about all this?
I think you keep copies of the first draft and then the revised draft of the final regulations to document the editorial change.
If you ever find yourself in a discussion with an IRS auditor about whether you can within one QuickBooks file handle multiple trades or businesses? Hey, you want to point to this editorial change. You want to be able to back up the regulations require not “separate” books… but “separable” books.
No, I know. You can call me a scared-y cat on this. Because I am.
Separable Not Enough
One final thing to say here–though you probably already know this. You don’t create or prove separate trades or businesses merely by making the financial data separable.
The “separable” thing is necessary. It is not sufficient.
The IRS and Treasury set forth a number of other requirements.
For example, and here I quote, they “believe that multiple trades or businesses will generally not exist within an entity unless different methods of accounting could be used for each trade or business under §1.446-1(d).” You and I want to consider that.
Another thing to consider? While multiple trades or businesses can be conducted within one entity, a trade or business “cannot generally be conducted across multiple entities for tax purposes.”
And then this remark: In a discussion in Regulation 1.199A-5(c)(1)(iii), the IRS talks about a landscaping business that can’t treat its maintenance activities and design consulting activities as “separate” and then about a veterinarian who can treat the veterinary medicine practice as separate from a dog food business.
There, the IRS and Treasury say this about the dog food business,
Animal Care LLC also has separate employees who are unaffiliated with the veterinary clinic and who only work on the formulation, marketing, sales, and distribution of the organic dog food products. Animal Care LLC treats its veterinary practice and the dog food development and sales as separate trades or businesses for purposes of section 162 and 199A.
The way I read this? If you want to separate out activities into their own trades or businesses, you want things like “separate employees” and for the activities to be treated in the real world as “separate trades or businesses.”
I’ve got to get back to preparing tax returns. But two final quick comments.
First, if you are going to break-up the typical small business amalgam of activities into separate trades or businesses, I think you want to make sure the business owners have good accounting skills and systems. Many small businesses find a decent balance sheet hard to produce. I would imagine many more would find a “separable” requirement too difficult to achieve.
Second, if you do try this, I suggest you re-read (or read?) the final regulations’ discussions about how to account for and allocate income, expenses and assets between multiple trades or businesses. That information should help you channel the logic and thinking of the IRS and Treasury.
Other Related Resources
If you’re reading this discussion, you might also find this related blog post useful: Section 199A Trade or Business Concept Deconstructed.
This blog post might be useful too, if you’re still scrambling to make sense of the Section 199A complexity: Section 199A Qualified Business Income Deduction Danger Zones.