what financial planners need to know about code …...• signed december 22, 2017 • significant...

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


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


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


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• Corporate AMT Repealed


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


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


For Businesses

• Like-kind exchange treatment limited

– Only like-kind exchanges of real

property not held primarily for sale


• 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


• Specified Service Trade Or Business

– Involving performance of services in the

fields of:


• Health • Law

• Accounting • Actuarial Science

• Performing Arts • Consulting

• Athletics • Financial Services

• Brokerage Services • Trading

• Investing / investment

management

• Dealing in securities,

partnership interests or

commodities


– 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


• 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.


• 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


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


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


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


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?



• 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



• 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


6. PEO / Employee Leasing Firm

• Example: Employees are leased through

a Professional Employer Organization

(PEO) or Employee Leasing Firm

• Employee of PEO or client


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



• 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



• 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


8. Specified Service Business

• Many service businesses are not

specified



– Involving performance of services in the

fields of:

Reminder:


• Health • Law

• Accounting • Actuarial Science

• Performing Arts • Consulting

• Athletics • Financial Services

• Brokerage Services • Trading

• Investing / investment

management

• Dealing in securities,

partnership interests or

commodities


– 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:



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



Law

– Lawyers, paralegals, legal arbitrators,

mediators, and similar professionals

Not Including

– Printers

– Delivery services

– Stenography services



Accounting

– Accountants, enrolled agents, return preparers,

financial auditors, and similar professionals



Actuarial Science

– Actuaries and similar professionals



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



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



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.



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



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



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



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



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



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


9. Employee / Independent Contractor

• 199A Prohibits Employee From Taking 20%

Deduction

• Deduction Is Available To Contractors

• Workers May Want To Reclassify

Themselves As Contractors



• 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)



• 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.



• 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


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


• 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

[email protected]

McGrath North Mullin & Kratz, PC LLO

First National Tower, Suite 3700 | 1601 Dodge Street | Omaha, NE 68102

www.mcgrathnorth.com

Thank You

what financial planners need to know about code …...• signed december 22, 2017 • significant...

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