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Qualified Business Income Deduction under IRC Section 199A

By Aaron Chaitovsky, Andy Tarquinio, Aaron Chaitovsky, CPA, Andy Tarquino, CPA .

Last August, the IRS issued proposed regulations under Section 199A of the Internal Revenue Code. Among the many uncertainties that existed under these new regulations was whether a franchisor, defined by the IRS as being 'in the business of selling franchises and also has company-owned locations that are considered a Specified Service Trade or Business (SSTB),' would themselves be considered an SSTB. Income from SSTBs does not generally qualify for the Section 199A deduction, unless the taxable income of their owners is below certain thresholds.

On January 18, 2019, the IRS finalized these regulations, making it clear that franchising income is eligible for the Section 199A deduction. Both the preamble to these final regulations (see page 75) and Example 12 (at the top of page 231) make it clear that a franchisor that is in the business of selling franchises that operate as an SSTB is not itself an SSTB.

For franchisors who also have company-owned locations that are an SSTB, this rule gets a little complicated. “IF” the franchisor operates BOTH the franchisor operations AND the company-owned locations as a single trade or business, to the extent the gross receipts from the SSTB portion exceed 10% of total gross receipts (for trade or business under $25M; 5% for trade or business over $25M), the gross receipts of the SSTB portion of the business will alter the whole enterprise and result in the entire operation being treated as an SSTB. In cases like these, the franchisor should consider whether to operate their (i) franchisor business and (ii) company owned locations – as TWO SEPARATE TRADES OR BUSINESSES. Whether or not, for tax purposes, you can operate as two separate trades or businesses, is facts and circumstances specific and can require you to take some specific actions.

In the final regulations, the IRS provided examples making it clear that franchising income is eligible for the Section 199A deduction. Citrin Cooperman’s Franchise Accounting & Consulting Practice professionals are committed to keeping you informed, and will provide updated information on this topic. If you have any questions regarding this regulation, or how it may affect you, please contact Aaron Chaitovsky or Andy Tarquinio.

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