New Choices and Opportunities for Tax Savings
Are you a business owner curious about the new Section 199A deduction?
Although the deduction became effective on January 1, 2018, guidance on how it would be calculated was delegated to the Internal Revenue Service (IRS) by Congress. For months, tax professionals and their clients were only able to speculate based on the text of the statute and had no specific guidance to work with.
New Developments in August 2018
This shroud of uncertainty was lifted on August 8, 2018, when the IRS released proposed regulations that answered pressing questions about losses as well as how to account for multiple businesses. We can now more accurately project or estimate how much of a deduction you’re entitled to.
These new proposed regulations introduced many new options for you as a business owner. They also bring new pitfalls as an overabundance of options can lead to confusion without the help of an expert. The complexity of the 199A proposed regulations calls for careful, strategic planning with your estate planning and financial professionals. To help you prepare for a tax-optimizing discussion, here are the highlights you should be aware of before we dive in with more detail one-on-one:
If you own more than one qualifying non-specified service trade or business (non-SSTB), the decision of whether or not to aggregate the qualified business income (QBI) from each business provides you with an opportunity to deduct more depending on your specific circumstances. The great news is that the proposed regulations give you the choice, so if not aggregating makes your deduction larger, we can choose to not aggregate.
To keep individuals from buying properties for the purpose of gaining a larger deduction, the proposed regulations include a so-called anti-abuse rule excluding “property acquired at the end of the year” in the calculation of unadjusted basis immediately after acquisition if it was purchased within 60 days of the end of the tax year and sold soon after. If you’re thinking about investing in your business, make sure to consult with us and your tax professional so we can help you receive the largest possible deduction.
Clarification on Losses
Of course, everyone anticipates that business will generate profit, but that does not always happen. The new 199A regulations bring more clarity to the rules around how losses in one or more qualified trade or business are to be treated.
“Reasonable Method” Allocation
If you have multiple directly-controlled trades or businesses, you now have a new planning opportunity thanks to the “reasonable method” item allocation. If you operate multiple businesses, now is the time to make sure we can follow the rules and maximize your deduction.
There is an SSTB “taint” extending to trades or businesses over certain gross receipt thresholds. Luckily, the 199A proposed regulations narrow the definition of which businesses count as SSTBs. Non-SSTB businesses would do well to be extracted from SSTB as soon as possible — particularly if you can bypass the “taint” rule.
Unfortunately, the proposed regulations include a problematic rule for former employees with a new status (such as partners in a partnership or independent contractors) that are still being deemed employees for the purposes of 199A, which applies if they are providing substantially the same services to the former employer. This is presumably the case even if the new tax status is otherwise allowed under the tax laws. For example, a former employee who becomes a part owner in the business may be denied the 199A deduction even though she’s treated as an owner for all other non-199A purposes. This poor outcome may be overcome with proper planning and documentation. This is one area of the 199A which requires particular attention for affected people.
There is an additional anti-abuse rule about the treatment of multiple trusts to attempt to get around QBI limits. This is similar to the reciprocal trust doctrine you may have also heard us talk about in that the QBI deduction-maximizing arrangement will be disregarded if the economics of the trusts aren’t sufficiently different.
Underpayment of Tax Penalty
IRC § 6662 already imposes a 20% accuracy-related penalty on underpayments of tax attributable to, among other things, negligence or disregard of rules or regulations; and any substantial understatement of income tax. However, Section 199A lowered the threshold for when the 20% substantial understatement penalty kicks in from an understatement of the greater of 10% or $5,000 to the greater of 5% or $5,000 “in the case of any taxpayer who claims the deduction allowed under [IRC §] 199A.” The statute does not state that the understatement must specifically relate to the IRC § 199A deduction for this lower threshold to apply; it applies if the taxpayer merely claims the IRC § 199A deduction, regardless of whether the understatement arose out of the IRC § 199A deduction or some other reporting error.
The Time to Act Is Now!
These new proposed regulations fill in many missing details from the Tax Cuts and Jobs Act of 2017 that added the new deduction, but these rules are complex and easy to mishandle. It is imperative to get help as early as possible to obtain optimum results.
It’s time to review your situation and determine whether any changes need to be made to your entity or operations to take advantage of the new proposed regulations. If you own a business, you should contact us and your CPA immediately for an entity review.