The 20 Percent Pass-Through Deduction: Proposed Guidance and Its Impact on Trucking

When the Tax Cuts and Jobs Act (TCJA) became law on Dec. 22, 2017, there was interpretation of the law but little guidance on how taxpayers would implement the qualified business income (QBI) 20 percent pass-through deduction. After more than eight months, the IRS has finally issued proposed regulations. Initial commentary that Section 199A would be taxpayer favorable has been confirmed by the recently issued proposed regulations.

From the signing, the tax law left little doubt there would be significant tax benefits and reductions for trucking companies. The proposed regulations only further confirm trucking companies are among the winners with the new law. Companies structured as an S corporation, partnership, sole proprietorship, or trust will be permitted to deduct up to 20 percent of QBI resulting in a top federal tax rate of 29.6 percent. The deduction may be limited based on W-2 wages/fixed asset investment. However, given the labor and capital intensiveness of transportation, it is unlikely that these factors will limit the deduction. It is important to note that in situations where carriers work heavily with an owner-operator fleet and have little W-2 payroll or lease a significant portion of their equipment, the QBI deduction could be drastically limited or non-existent. Payments to owner-operators reported on Form 1099 will not count as W-2 wages for purposes of determining the QBI deduction.

The proposed regulations narrows the definition of Specialized Service Trade or Businesses (SSTB), which originally could have been interpreted to include trucking brokerage services, however, is now clearly not included as a SSTB. This is another win for the industry, as SSTBs are not permitted the 20 percent QBI deduction.

Many trucking companies operate utilizing multiple flow-through entities to manage liability risk. Often this structure includes a holding company that reports taxes for all related entities. The availability of the QBI deduction never appeared to be in question for this structure. However, trucking companies operating with entities in a brother-sister structure were unsure before the proposed regulations were issued if equipment leasing companies would be eligible for QBI deduction.

Furthermore, trucking companies that own terminals and other real estate in a tax flow-through structure which rent to an operating entity did not have certainty whether these separately owned rental business would be treated as part of the overall operations and fall within the QBI deduction parameters.

The proposed regulations provide for an aggregation of related businesses which could allow operating, logistic, and leasing entities to be treated as one company for purposes of Section 199A. The aggregation rule also eliminated the possible scenario of mismatching QBI in one entity and W-2 wages and fixed asset investments in another. Additionally, the proposed regulations state that self-rentals will be treated as trade or business allowing the QBI deduction to be taken.

For trucking company owners with individual taxable income less than $315,000 (MFJ), the SSTB and W-2/fixed asset investment limitation do not apply and the QBI deduction is fully allowed. The limitation fully applies and must be calculated once taxable income exceeds $415,000 (MFJ).

With the proposed regulations better framing the QBI deduction benefit for trucking companies, it solidifies the C corporation versus S corporation argument. While the C corporation federal tax rate was reduced to 21 percent, the all-in federal tax rate from income to dividend is 39.8 percent. With the QBI deduction available to trucking flow-through entities, the all-in federal tax rate is 29.6 percent; the same 10.2 percent S corporation tax benefit that existed under the old tax law. Under unique cases and business plans, there are situations where a C corporation could provide a deferred tax benefit that would result in a present value savings.

For questions on how these proposed regulations apply to you, please contact your KSM advisor.