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More businesses to qualify for 20% tax reduction under Treasury pass-through guidelines

The Treasury Department proposed investor-friendly regulations Wednesday that detail which companies and professionals are eligible to receive a 20% tax deduction by qualifying as pass-through entities.

Under the guidance, more businesses, or at least their owners, will qualify for a 20% reduction in taxes, according to Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center in Washington. "The Treasury opened more opportunities than we expected for investments to be tax-advantaged," he said.

The new provision, which was created by the Tax Cuts and Jobs Act, allows many owners of sole proprietorships, partnerships, trusts and S corporations to deduct 20% of their qualified business income. The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers.

Professionals like doctors and accountants are ineligible for the deduction because they're owners of "specified service" businesses.

In passing tax legislation last year, Congress "created some vague standards and then had a catch-all that invited the IRS to exclude other businesses from the 20% deduction," Mr. Rosenthal said. "But the IRS did not take the Congress up on that. They read the vague statutes narrowly and they limited the catch-all to a very narrow fact pattern."

Most hedge funds and private equity funds are pass-through entities and this proposal now gives them more investment opportunities, Mr. Rosenthal said. "If I were a hedge fund or private equity investor with a bunch of taxable individuals as the owners, because that's who benefits — taxable individuals, you have to have those at the end of your investment chain — I would be pleased that leasing operations, banking investments … there's a variety of businesses that can be eligible for the 20% discount for their owners if they're operated in a pass-through firm."

There will now be a 45-day comment period for interested parties to submit feedback, but Mr. Rosenthal doesn't expect any major changes. "The proposed regs tend to be the high water mark," he said. "Usually the Treasury and IRS becomes easier on taxpayers going forward after they hear complaints, not harder."