IRS Confirms that Banking Pass-through Income is Eligible for New 20% Tax Deduction

On August 8, 2018, the IRS issued 184 pages of proposed regulations related to the Qualified Business Income (QBI) deduction for pass-through entity income.  QBI deduction is part of the Tax Cuts and Jobs Act passed in December 2017. 

QBI deduction provides parity for pass-through entity shareholders for income they receive from partnerships, s-corporations, trusts and estates. Since C-corporations receive a substantial reduction in their corporate income tax rate (down to 21%), it is equitable to give pass-through entity shareholders a break on their income tax rates. QBI deduction provides a 20% tax deduction on pass-through entity income- with several limitations.

One significant limitation is for income from Specified Service Trade or Business (SSTB)

SSTB's are defined as:

"any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners...or any business which involves the performance of services that consist of investing and investing management, trading, or dealing with securities, partnership interests, or commodities." 

Previously there had been disagreement, or lack of certainty, on whether "financial services" includes traditional banking income. The new proposed regulation helps to clarify this question. 

The proposed regulation limits the definition of financial services to those typically performed by financial advisers and investment bankers. Additionally, the regulation identifies the provision of financial services to clients as: 

  • Managing wealth or advising clients with respect to finances
  • Developing retirement or wealth transition plans 
  • Advisory services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in title 11 or similar cases)
  • Raising financial capital by underwriting, or acting as the client's agent in the issuance of securities, and similar services

Ultimately, the new regulation limits the definition of financial services to include services provided by financial advisers, investment bankers wealth planners and retirement advisers and other similar professions. However, the regulation does not include taking deposits or making loans under the umbrella of "financial services." Therefore, traditional banking income from taking deposits or making loans is not considered an SSTB. 

This clarification of the QBI deduction removes one of the limitations to taking the deduction for banking pass-through income. There are other potential limitations, including the W-2 wage limitation, that will be expounded on in future newsletter articles. 

The application of the new QBI deduction rule is very complicated, so please consult with your professional tax adviser if you have questions on this rule.