Final Rule Provides Guidance to Pass-Through Entities That Use a PEO
In a huge victory for the PEO industry, the Department of Treasury (Treasury) and the Internal Revenue Service (IRS) have issued a final rule which contains language clarifying that pass-through entities that use a PEO retain their eligibility for the 20 percent tax deduction contained in Section 199A of tax reform. NAPEO lobbied both the Treasury and IRS to clarify that pass-through entities that use a PEO remain eligible for this tax deduction.
Background
The tax reform bill signed by President Trump in 2017 created a new income tax deduction for certain types of business owners as a means of providing an even lower effective individual income tax rate. Specifically, this allows taxpayers to deduct, solely for federal income tax purposes, the “combined qualified business income amount” from a pass-through entity in an amount up to 20 percent of the taxpayer’s taxable income, after the deduction of any net capital gain.
PEO Impact
Because of the wording of the new law, some accountants and tax attorneys had indicated to their clients that are pass-through entities that a PEO relationship might conceivably jeopardize their eligibility for the 20 percent tax deduction. Specifically they stated that because they use a PEO, the client reports no W-2 wages. Because the new tax deduction is limited by the amount of W-2 wages paid, their concern/argument is that the only way the client can be certain of this deduction may be to end the PEO relationship and have the W-2 wages reported under the client’s tax identification number.
The Final Rule issued by the IRS and Treasury added additional language that helps clarify that the clients of PEOs that are not certified are also eligible for the 20 percent tax deduction. With the issuance of the final rule, NAPEO believes that the IRS and Treasury have made it clear that the clients of both certified and non-certified PEOs are eligible for the Section 199A 20 percent tax deduction.