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Proposed 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 notice of proposed rulemaking, 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 has been lobbying since January of this year for Treasury and IRS to clarify that pass-through entities that use a PEO remain eligible for this tax deduction.


The tax reform bill signed by President Trump creates 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 have indicated to their clients that are pass-through entities that a PEO relationship might conceivably jeopardize the client’s eligibility for this new 20 percent tax deduction. Specifically the accountants are saying 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.


NAPEO Press Release on New Guidelines

Notice of Proposed Rulemaking

Relevant Text to PEOs in Notice of Proposed Rulemaking

Summary of Key Section 199A Regulations 

Section 199A FAQs