What Financial Planners
Need To Know About
Code Sec. 199A
Matthew Ottemann
McGrath North Law Firm
• Signed December 22, 2017
• Significant business and individual
tax changes
• We’ll focus on Sec. 199A
Tax Cuts and Jobs Act
(TCJA)
For Individuals
• Rate Changes:
• Increase in Standard Deduction
• Eliminates Personal Exemptions
• Itemized Deduction for State & Local
Taxes Is Limited to $10,000
Summary Of Key Changes
Previous Rates 10% 15% 25% 28% 33% 35% 39.6%
↓
New Rates 10% 12% 22% 24% 32% 35% 37%
For Individuals
• New Loans: Mortgage Interest Is Only
Deductible On Debt Up To $750K
• Eliminates Deduction On
Miscellaneous Itemized Deductions
• Medical Expenses: Deductible If
Exceed 7.5% of AGI (Was 10%)
• Itemized Deduction for Casualty and
Theft Losses Was Suspended
Summary Of Key Changes
For Individuals
• Moving Expenses: Eliminated Deduction
for Job-Related Moving Costs
• Alimony: Not Deductible By Paying
Spouse; Not Taxable To Receiving
• Starting In 2019: No Penalty For Failure
To Obtain Minimum Health Coverage
Summary Of Key Changes
For Individuals
• AMT Exemptions: Increased
– Fewer people impacted
• Estate and Gift Tax Exemption: Raised
To $11.18 M Per Person
• Overall Limitation On Itemized
Deductions Was Suspended
Summary Of Key Changes
For Businesses
• Corporate Rates Reduced
– Flat 21%
• Tax Rate on C corp. income
distributed to shareholders
– 48% pre-TJCA
– 36.8% post-TJCA
Summary of Key Changes
For Businesses
• Dividends Received Deduction
– 80% to 65% (Own At Least 20%)
– 70% to 50% (Own Less Than 20%)
• Corporate AMT Repealed
Summary of Key Changes
For Businesses
• NOL Deduction Modified
– Eliminated 2 year Carryback (except
certain farming)
– Carried forward indefinitely
• Limit on business interest deduction
– 30% of Adjusted taxable income
Summary of Key Changes
For Businesses
• New fringe benefit rules
– Eliminates 50% deduction for business-
related entertainment
– Deduction for transportation fringe
benefits denied to employers
• Increased Sec. 179 expensing
– Maximum $1 million
Summary of Key Changes
For Businesses
• Like-kind exchange treatment limited
– Only like-kind exchanges of real
property not held primarily for sale
Summary of Key Changes
• Without 199A
– C corp. dividend: 36.8% top rate
– Other entity: 37% top rate
• Allow owners of other entities to
participate in tax cut from TJCA
199A Motivation
• Effective for 2018-2025
• Taxpayers other than corporations
– Individual owners of sole
proprietorships, S corporations,
partnerships, LLCs, or rental properties
– S corporation, partnership or trust that
owns interest in entity
199A Basics
• Up to 20% Deduction
– Below the line – reduces taxable income
but not AGI
– Available regardless of whether
taxpayer itemizes or claims standard
deduction
• “Qualified Business Income”
• Earned in “Qualified Trade or
Business”
199A Basics
• Every trade or business is qualified,
except:
– Trade or business of performing
services as an employee
– For high wage individuals, specified
service trade or business
“Qualified Trade Or Business”
Wage Limitations:
• Taxable income over $157,500
($315,000 for joint filers)
• Exclusion from “specified service” is
phased in
• Full exclusion if taxable income is
$50K ($100K for joint) above
threshold
“Qualified Trade Or Business”
• Specified Service Trade Or Business
– Involving performance of services in the
fields of:
“Qualified Trade Or Business”
• Health • Law
• Accounting • Actuarial Science
• Performing Arts • Consulting
• Athletics • Financial Services
• Brokerage Services • Trading
• Investing / investment
management
• Dealing in securities,
partnership interests or
commodities
• Specified Service Trade Or Business
– And: Any trade or business where the
principal asset of such trade or business
is the reputation or skill of 1 or more of
its employees or owners
“Qualified Trade Or Business”
• Example:
– TP is an attorney who practices in a firm
operated as a partnership
– Earns $80K from law business
– $130K total taxable income
• Because TP’s total taxable income is
less than $157,500, TP can take a
$16K (80K x 20%) deduction from
business income.
“Qualified Trade Or Business”
• Net income or loss with respect to a
qualified trade or business
• Effectively connected with the
conduct of a business within the
United States.
• Not including certain investment
income, including
– Capital gain/loss
– Dividend income
“Qualified Business Income”
Does Not Include:
• Reasonable compensation paid to taxpayer
for services rendered to business
• Guaranteed payments paid to partner for
services rendered to business
“Qualified Business Income”
• Determined separately for each qualified
trade or business
• For taxpayers above prior wage threshold,
tentative deduction is 20% of QBI.
• Example:
– TP owns S corp, which allocates $30K QBI to TP
– TP owns P’ship, which allocates $60K QBI to TP
– TP’s tentative deduction is $6K from S corp. &
$12K from P’ship
Deductible Amount
• For taxpayers above prior wage
threshold, deduction (for each
qualified trade or business) is limited
to greater of:
– 50% of W-2 wages with respect to
qualified trade or business; or
– Sum of 25% of W-2 wages with respect
to the qualified trade or business +
2.5% of the unadjusted basis of
“qualified property”
199A Limitation
• W-2 wages
– Total wages paid by the qualified trade
or business
– For S corp. or partnership, use owner’s
allocable share of W-2 wages
• Example:
– P’ship pays $100K of total wages
– Owner A is allocated 40% of ordinary
income
– A must be allocated $40K of wages
199A Limitation
Basis Example
• TP owns rental property through LLC
• Rental income earned by LLC is
$800K
• LLC pays no wages
• TP’s share of unadjusted basis of
property is $10 Million
• Limitation: $250,000 ($10M x 2.5%)
199A Limitation
In Total
• Deductible QBI for each business are
determined separately and added together
• Sum is subject to second limitation, which
is equal to excess of:
– Taxable income for the year, minus
– Sum of net capital gain + aggregate qualified
cooperative dividends
Additional 199A Limitation
In Total
• Example
– TP has $120K of QBI
– $100K L-T Net Capital Gain
– $40K Deductions
• 199A Deduction is Lesser of:
– $24,000 (20% x $120,000)
– $16,000 (20% x $80,000, excess of $180,000
Taxable Income - $100,000 Net Cap. Gain)
Additional 199A Limitation
AMT Implications
• 199A Deduction for AMT Purposes =
199A Deduction for Regular Tax
Additional Points
Deduction Allowance
• Allowed Only for Income Taxes
– Chapter 1 of IRC
• Not reduce self-employment tax
• Not reduce net investment income
• Not allowed in determining NOL
deduction
Additional Points
1. Executive Compensation
• If corporation owns LLC or other pass
through entity, may award ownership
interests to executive
– Potentially allow 199A deduction for
executive
• For existing entities, restructure
compensation to non-wage
Issues / Planning Opportunities
2. Potential Conversion To Pass-
Through
• Many entities are already structured
as pass-through entities
• For existing C corporations, may
provide basis for conversion
Issues / Planning Opportunities
3. Increased Exposure To Penalty
• Prior Law: 20% Penalty On Substantial
Understatement Of Tax
– 10% of tax required to be shown on return
– Or $5,000, whichever is greater
• If claim 199A deduction, lower threshold
for Substantial Understatement Penalty:
– 5% of tax required to be shown on return
– Or $5,000, whichever is greater
Issues / Planning Opportunities
4. “Trade Or Business”
• “Trade or Business” is not defined for
Sec. 199A purposes
• Most common use: Sec. 162 (Deduction
for ordinary and necessary expenses)
• Precedents:
– TP must act “with continuity and regularity”
– Primary purpose: For income or profit
Issues / Planning Opportunities
4. “Trade Or Business”
• May rental activity qualify?
• IRS Notice 2019-7: Safe Harbor
• Yes, if:
– Separate accounting records for each
enterprise
– 250 or more hours of services are
performed with respect to enterprise
– Records to document services
Issues / Planning Opportunities
5. Allocation Among Businesses
• Example: Group of commonly controlled
companies
• All employees are in 1 mgmt. company
• None of the operating companies hold
significant qualified property
• Can W-2 wages be allocated to
operating companies?
Issues / Planning Opportunities
5. Allocation Among Businesses
• Requirements:
– Same person, or group, must own 50% or
more of each trade or business
– 50% ownership is met for a majority of the
tax year
– All income is reported on returns with the
same tax year
– None of the trades or business is a
specified service trade or business
Issues / Planning Opportunities
5. Allocation Among Businesses
• Requirements:
– Two of three factors must be met:
a) Provide products and services that are the
same or customarily offered together (e.g.
gas station and car wash)
b) Share facilities or centralized business
elements
c) Operated in coordination with one or more
of the businesses in the group
Issues / Planning Opportunities
6. PEO / Employee Leasing Firm
• Example: Employees are leased through
a Professional Employer Organization
(PEO) or Employee Leasing Firm
• Employee of PEO or client
Issues / Planning Opportunities
7. Shareholder Compensation
• Example: X & Y own otherwise identical
businesses.
– No employees
– No qualified property
– $500,000 QBI before wages
– X operates as Sole Proprietorship
– Y operates as Wholly Owned S Corporation
Issues / Planning Opportunities
7. Shareholder Compensation
• X: Cannot Pay Wages, So W-2 Wage
Limitation = $0. No 199A Deduction.
• Y: Must Have Reasonable Wage
Compensation, So Pays Himself $80,000
Wages Per Year
– Tentative Deduction: $84,000 (20% X $420K)
– W-2 Limitation: $40,000
– 199A Deduction: $40,000
Issues / Planning Opportunities
7. Shareholder Compensation
• Second Example:
– Same, but X & Y each have $150K of QBI
– X: Entitled to $30K of 199A Deduction
(20% x $150,000)
– Y: Entitled To $14K of 199A Deduction
(20% x $70,000)
• So different results based on business
income
Issues / Planning Opportunities
8. Specified Service Business
• Many service businesses are not
specified
Issues / Planning Opportunities
• Specified Service Trade Or Business
– Involving performance of services in the
fields of:
Reminder:
“Qualified Trade Or Business”
• Health • Law
• Accounting • Actuarial Science
• Performing Arts • Consulting
• Athletics • Financial Services
• Brokerage Services • Trading
• Investing / investment
management
• Dealing in securities,
partnership interests or
commodities
• Specified Service Trade Or Business
– And: Any trade or business where the
principal asset of such trade or business
is the reputation or skill of 1 or more of
its employees or owners
Reminder:
“Qualified Trade Or Business”
8. Specified Service Business
Health
– Physicians, pharmacists, nurses, dentists,
veterinarians, physical therapists,
psychologists and other similar professionals
Not Including
– Health clubs / spas
– Research, testing, and manufacture and/or
sales of pharmaceuticals or medical devices
Issues / Planning Opportunities
8. Specified Service Business
Law
– Lawyers, paralegals, legal arbitrators,
mediators, and similar professionals
Not Including
– Printers
– Delivery services
– Stenography services
Issues / Planning Opportunities
8. Specified Service Business
Accounting
– Accountants, enrolled agents, return preparers,
financial auditors, and similar professionals
Issues / Planning Opportunities
8. Specified Service Business
Actuarial Science
– Actuaries and similar professionals
Issues / Planning Opportunities
8. Specified Service Business
Performing Arts
– Participate in the creation of performing arts,
such as actors, singers, musicians,
entertainers, directors, and similar
Not Including
– Maintenance and operation of equipment or
facilities for use in the performing arts
– Broadcast or disseminate video or audio to
public
Issues / Planning Opportunities
8. Specified Service Business
Consulting
– Provision of professional advice and counsel to
clients to assist the client in achieving goals
and solving problems.
– Includes advocacy with the intention of
influencing decisions made by a government or
governmental agency
– And attempts to influence legislators and other
government officials
Issues / Planning Opportunities
8. Specified Service Business
Consulting Does Not Include
– Sales or economically similar services
– Provision of training and educational courses
– Consulting services embedded in, or ancillary
to, the sale of goods or performance of
services (such as typical services provided by
a building contractor) if there is no separate
payment for the consulting services.
Issues / Planning Opportunities
8. Specified Service Business
Athletics
– Athletes, coaches, and team managers in
sports such as baseball, basketball, football,
soccer, hockey, martial arts, boxing, bowling,
tennis, golf, skiing, snowboarding, track and
field, billiards, and racing
Issues / Planning Opportunities
8. Specified Service Business
Athletics Does Not Include
– Maintenance and operation of equipment or
facilities for use in athletic events
– Broadcast or otherwise disseminate video or
audio of athletic events to the public
Issues / Planning Opportunities
8. Specified Service Business
Financial Services
– Managing wealth
– Advising clients with respect to finances,
– Developing retirement plans
– Developing wealth transition plans
– Advising on business purchases or restructuring
– Underwriting
– Client's agent in the issuance of securities
Issues / Planning Opportunities
8. Specified Service Business
Brokerage Services
– Arranges transactions between a buyer and a
seller with respect to securities for a
commission or fee
Not Including
– Real Estate Agents or Brokers
– Insurance Agents or Brokers
Issues / Planning Opportunities
8. Specified Service Business
Investing and Investment Management
– Investing, asset management, or investment
management services, including providing
advice with respect to buying and selling
investments
Not Including
– Directly managing real property
Issues / Planning Opportunities
8. Specified Service Business
Catch-All
– Any trade or business in which a person is paid
for endorsing products or services
– Any trade or business in which a person is paid
for the use of his or her image, name,
signature, etc.
– Payments for appearances
Issues / Planning Opportunities
9. Employee / Independent Contractor
• 199A Prohibits Employee From Taking 20%
Deduction
• Deduction Is Available To Contractors
• Workers May Want To Reclassify
Themselves As Contractors
Issues / Planning Opportunities
9. Employee / Independent Contractor
• Example:
– Manager of manufacturer earns $900K
annually
– Terminates employment and forms S corp.
– Manufacturer pays $900K to S corp.
– S corp. pays $300 K wages to Manager
– Manager’s 199A Deduction: Lesser of
• $120,000 (20% x $600,000)
• $150,000 (50% x $300,000)
Issues / Planning Opportunities
9. Employee / Independent Contractor
• Second Example:
– X, Y & Z are associates in accounting firm.
Each is married and is paid $250,000. Total
taxable income for each is less than $315,000.
– X, Y & Z may terminate their employment and
create partnership, which provides services to
firm.
– X, Y & Z each take $250,000 of income from
partnership and claim $50,000 199A deduction.
Issues / Planning Opportunities
9. Employee / Independent Contractor
• Prop. Regs.:
• Rebuttable Presumption: If person quits
jobs, and enters into contract to provide
substantially the same services, person is
still employee
• For 2 years
Issues / Planning Opportunities
10. Netting Of Losses
• If person has multiple QBI businesses
• One of which has a loss
• IRS Regs. provide method for netting
results together
– Complex calculation
Issues / Planning Opportunities
• Given TJCA changes, a C corporation may
lead to lower overall taxes.
– If corporation may qualify as “qualified small
business” under IRC 1202(d)
– If corporate stock was held until death and
receives fair market value basis step-up
Choice Of Entity
Questions
Matt OttemannPartner - McGrath North Law Firm
Member - American & Nebraska Bar Associations
- American Institute & Nebraska Society of CPA’s
- Omaha Estate Planning Council
- Board Member, Financial Planning Association
Creighton - College of Business 1999 (Summa Cum Laude)
- School of Law 2006 (Summa Cum Laude)
- Adjunct Faculty – Estate Planning (Business)
- Former Faculty – Estate and Gift Tax (Law)
Alabama - LL.M in Taxation 2010 (Magna Cum Laude & Valedictorian)
Matt specializes in taxation, estate planning, business planning, entity selection and
planning, and corporate business law. Matt has successfully represented clients in wide-
ranging situations plan for their estates, including with sophisticated gifting and entity
planning. Matt also works with numerous business owners, helping them successfully
plan for their exits.
Contact Info: [email protected] Website: www.McGrathNorth.com
(402) 633-9571
Presentation Disclaimer
This presentation should not be considered as legal, tax,business or financial advice. This presentation is intendedfor educational and informational purposes only. It isprovided with the understanding that while the author is apracticing attorney, neither he nor McGrath North has beenengaged by the attendee/reader to render legal advice orother professional service (unless a specific engagementagreement has been executed). If legal advice or otherexpert assistance is needed by the attendee/reader, theservices of a competent professional should be sought.
Matthew Ottemann402.633.9571
McGrath North Mullin & Kratz, PC LLO
First National Tower, Suite 3700 | 1601 Dodge Street | Omaha, NE 68102
www.mcgrathnorth.com
Thank You