1. Navigating Section 199A: New, Big, and Complex
Leon C. LaBrecque, JD, CPA, CFP®, CFA
LJPR Financial Advisors

2. Tax Cuts and Jobs Act: Tectonic Shift
Profound changes to business taxes
C-corp. rules changed
Pass-though rules changed (massively)
Small business changes
Depreciation changes
Interest changes
Loss deductions (NOL and Excess Losses) changed
Relevant remaining credits are R&D and low-income housing credit
Territorial tax
Deemed repatriation of accumulated foreign earnings
Individual taxes changed
Std. deduction increased
Itemized deductions limited
Child credit increased
Personal exemptions eliminated
AMT greatly reduced
Estate and gift changed
Estate and gift exemption amount doubled to $11.2M
Step-up basis retained
2/19/2019

3. Business Taxes: C-Corps
Giant change: rate is now flat 21%
Personal Service Corporations (C-corps) are taxed at the 21% flat rate!
Qualified small business (QSB) stock eligible for capital gain exclusion
100% exclusion
Non-service business (except engineers and architects)
$10M gain limit
QUESTIONS TO ASK:
Should I change my pass-through to a C-corp?
Is my service business over $315K(mfj) or $157.5K (all other) of income?
Can I use the QSB exemption?
Will I retain earnings in my trade or business?
2/19/2019

4. The Big Kahuna: §199A
Qualified Business Income (QBI deduction) for pass-throughs
Up to 20% of QBI can be deducted from taxable income
Deduction is from taxable income not AGI
Any non-C corp. is pass-through
2/19/2019

5. Why they did it
Top C corp. rate was dropped from 35% to 21% to make the US more competitive
Made C-corps more attractive than pass-through
20% deduction lowers maximum pass-through rate (non service business) to 29.6%
PSC C-corp. issues
§1202 issues
2/19/2019

6. Basic Rules: Pass-Through
Definition: All trade or businesses not C-corp:
S-Corp
Partnerships (LLC taxed as partnership)
Sole proprietorship
Trusts
Estates
REITs
MLPs
Entity-by-entity evaluation: each pass-though is separate
Annual basis
Deduction is from taxable income
Applies at the partner or shareholder level
C-corps that own pass-throughs can’t use the deduction
Does not reduce Net Investment Income Tax
Appears to be an itemized deduction under §§ and 63(b), but itemized limitations do not apply
2/19/2019

7. Rules Basic idea is that there is a deduction for the lesser of:
20% deduction of Qualified Business Income (QBI), or
20% of taxable ordinary income
Example: Sue has $100,000 profit (sch C) as a CPA. Taxable income is $88,000 (standard deduct.)
Deduction is $17,600
Service business exception
W-2 exception:
(50% of W-2 wages)
Unadjusted Basis exception:
(2.5% of unadjusted basis in qualified property + 25% of W-2 wages)
Income ‘exception to the exceptions’ on taxable income lower than $315K (mfj) or $157.5K (all others)
Income phase-out by $415,000 (mfj) or $207,500
2/19/2019

8. Specified Service Business
In general, 199A doesn't apply to specified service business (with income rule exceptions)
Health
Law
Accounting
Actuarial science
Performing arts
Consulting
Athletics
Financial services
Brokerage services
NOT engineering or architecture
Principal asset of trade or business is the reputation or skill or one or more owners or employees
Different from §1202(e)(3)(A), which doesn’t include owners
2/19/2019

9. Qualified Property Tangible; Depreciable;
Held by or used in trade or business at close of the year;
Used at any time for the production for QBI;
Not fully depreciated;
IRS to prescribe anti-abuse rules to manipulate depreciation period;
IRS to prescribe rules to property acquired in like-kind exchange;
Unadjusted basis is basis immediately after acquisition, unreduced by depreciation.
2/19/2019

10. Income Rule
If taxable income is under the stated thresholds, neither the W-2 rule, the unadjusted basis rule nor the specified service business rules apply
Phase-out if under threshold
Over phase-out, rules apply
Example: Thelma and Louis own a bump shop. It makes $325,000 of business income. They pay $100,000 in wages. Their taxable income is $310,000
QBI (.2 * $325K) = $65,000
W-2 limit (.5 * $100K) = $50,000
$65,000 deduction, W-2 doesn’t apply
2/19/2019

11. Pass-Through Income Exceptions
W-2 rules, property basis rule or service business rules do not apply.
Married filing joint: $315,000 of taxable income (24% bracket)
Married filing separately: $157,500
Single: $157,500
Child (including a kiddie tax child): $157,500
Non-grantor completed gift trust: $157,500
Non-grantor incomplete gift trust: $157,500
Estates: $157,500
2/19/2019

12. QBI exclusions REIT, Coop or publicly trade partnership dividends;
Reasonable compensation paid to the taxpayer;
Guaranteed payments under §707(c);
Payments to partner for services rendered to business;
Capital gains and losses;
Dividends or equivalents;
Interest income other than interest income properly allocable to a trade or business;
Foreign personal holding company income;
Annuity income;
Deductions or losses in regard to any preceding item.
2/19/2019

13. More QBI observations
Clearly favors intendent contractors over employees
§1231 gain is unclear is gain from property used in trade or business, net 1231 is treated as long-term capital gain (which is not used in QBI deduction). Guidance needed.
QBI losses are carried over.
QBI can’t create a NOL.
Sub-S basis apparently not reduced by QBI.
Reasonable compensation is S-corps will be an issue.
Guaranteed payments are not in the reasonable comp issue, for now.
‘Trade or business’ not defined anywhere despite multiple cites to the section.
Rental of one property can be a trade or business
Net-net-net leases?
2/19/2019

14. 2/19/2019

15. Pass-Through: The ‘Poor CPA’:
Gail is a single CPA, self-employed, earns net income from her practice of $150,000
Her taxable income is about $128,000
She gets a deduction of 20% of her taxable income, or $25,600
Being in a service business doesn’t matter, since she has income under $157,500
2/19/2019

16. Pass-Through: The ‘Rich CPA’:
Gail, from our previous example, gets a nice project on December 12, 2018 and her income goes up by $80,000, to $230,000
Her taxable income is about $208,000
She loses her deduction and is in a higher bracket
She made more than $207,500
Her bracket went way up (from 19.2%)
She can get the deduction back by:
Possibly using a 401(k) plan and employer contribution, she could put $55,000 ($61,000 if she’s over age 50).
She could make a charitable donation to her charity or to a donor advised fund.
Making the plan deduction saves her taxes on the deduction ($17,600) plus a QBI deduction of $27,724.
Bracket shifts from 32% through the level and down to 19.2%.
2/19/2019

17. Pass-Through: Real Estate Tycoon
You can get a QBI deduction on real estate if you have basis in the property (not fully depreciated)
2.5% of the unadjusted basis is limit
Example: Scrooge owns a property he bought in 2008 worth $5M. It generates about $400k of rental income
He will get a deduction for $80,000, since 20% of income is more than 2.5% of $5M
2/19/2019

18. Pass-Through: Splitting with Trusts
Suppose Scrooge owns some fully depreciated property worth $5M that generates $500K of income
No pass-through deduction, since it is fully depreciated
He sets up non-grantor trusts for each of his three nephews, spinning $100K each to them
They get pass-through, since the trusts get a $157,500 income exception
2/19/2019

19. Trusts Taxable Income Tax Rate (accumulated):
$0 - $ %
$2,551 - $9, %
$9,151 - $12, %
$12, %
Extra bracket to the $12,500 (possible $1,613 tax saving)
$157,500 QBI limitation (possible $11,655 tax effect)
$10,000 SALT
Grantor trusts merely pass through to grantor and trust rules don’t apply
NG (non grantor) trusts can be used to shift QBI to the trusts and utilize the income exclusion.
W-2
Unadjusted basis
Incomplete non-grantor (ING) might avoid state tax. (NINGs, SINGs and DINGs) (Not MI resident)
Can shift possible state taxes on investment income (not RE) by using a nontax situs
SALT limitation makes INGs more attractive
Stepped-up basis if incomplete gift
§643(f) anti-abuse rules
Substantially same grantor or grantors and substantially same beneficiary or beneficiaries, and
Principal purpose is avoidance of tax
H&W are one bennie or grantor
Contingents aren’t enough to be different
Independent purpose OK
2/19/2019

20. Pass-Through: Bigger Non-Service
Waldo runs a successful travel agency as a Sub-S corporation
He nets $800,000 in income
He pays wages of $120,000
He would get the lesser of 20% of $800,000 ($160,000) or 50% of W-2 wages ($60,000), $60,000
He could increase his deduction by paying himself so that 50% of total salaries equal 20% of QBI. Adding $142,500 to wages would generate a $132,500 QBI deduction
2/19/2019

21. Pass-Through: Shifting Debt
Bill and Melinda have rental real estate. It has a basis of $2M, is not fully depreciated and has gross annual rent of $100,000 and interest on a $1.5M note of $75,000
Net is $25,000; QBI deduction is $5,000
If they can pay off or refinance the debt, the QBI deduction goes up to $15,000
If they had bonds or cash, they could pay off the debt, save the $75,000 of interest (replacing the interest lost on the bonds) and garner a larger deduction.
If they used a pledged asset loan (or margin loan) with securities, they can still deduct the interest as investment interest.
2/19/2019

22. Accuracy-Related Penalty
Old rule on 20% accuracy related penalty was understatement exceeding 10% of tax or $5,000 for an individual
New rule: greater of 5% of tax or $5,000 in the case of a §199A Deduction
Excess of:
Required amount of tax to be shown on return, over:
Amount of tax actually shown on return
2/19/2019

23. What about… What is actually a specified service business?
What happens on tiered entities, like an LLC that owns other LLCs?
How do we net losses of one business from gains of another?
What if an entity has more than one clearly separate trade or business?
Is rental of real estate a trade or business?
What about §179 or bonus deprecation?
Unadjusted basis on §743(b) adjustments?
Are W-2 wages grouped in multiple trades or businesses?
Are all similar qualified businesses aggregated, or evaluated separately? Is there a De Minimus exclusion? Are there separate computations for service versus non-service activities?
If I have a mgt. company, is that an integral part of the trade or business, or separate?
What about 1245 gains and losses, retirement plan contributions to partners and sole proprietors and one-half the SE tax?
2/19/2019

24. QBI Wage Planning
Jim and Linda own a bakery. It is a sole proprietorship, making $200,000.
They have taxable income of $415,000
No employees
No Qualified Property
Not Specified Service Business
2/19/2019

25. QBI Wage Planning Situation 1: No QBI, over taxable income level:
20% of QBI ($40,000), or
> 50% of wages ($0) or 2 ½% of unadjusted basis ($0)
Situation 2: Form LLC, treat as partnership, pay Linda $50,000 guaranteed payment:
20% of QBI ($30,000), or
Situation 3: Form Sub-S, pay Linda $50,000 salary:
20% of QBI ($30,000) or
> 50% of wages ($25,000) or 2 ½% of unadjusted basis ($0)
QBI deduction of $25,000
Situation 4: Form Sub-S, pay Linda $57,142 salary (2/7 of QBI):
20% of QBI ($28,571) or
> 50% of wages ($28,571) or 2 ½% of unadjusted basis ($0)
QBI deduction of $28,571
Assume $50-$60K is reasonable comp
2/19/2019

26. QBI IC Planning
Mike (s) owns a moving company and pays his 2 workers on leased trucks $50,000 a year each as Independent Contractors
He has $250,000 of QBI
$300,000 of TI
No QBI deduction (no W-2)
Converts ICs to employees (assume he negotiates FICA)
QBI deduction lesser of:
20% of $250,000, or
50% of $100,000
2/19/2019

27. QBI Income Modification
Charitable contributions:
Willard, is a CPA (m) with $300,000 QBI, $365,000 taxable income
QBI reduced by 50% (over the $315,000)
$30,000 QBI deduction
Makes $50,000 DAF donation:
QBI is still $300,000
No phase-out
Taxable is $315,000
QBI deduction of $60,000
Charitable deduction of $50,000 (assuming at least $24,000 of other itemized)
401(k):
Millicent, is a CPA (m) with $200,000 QBI, $265,000 taxable income. She contributes $24,500 to her 401(k) and hires her husband, Milt as her office manager for $25,000 a year. He puts $18,500 in his 401(k).
QBI deduction is $40,000 (under SB limits)
$43,000 deferred in 401(k) (taxed later)
Switch to Roth 401(k):
QBI goes up to $48,600
Taxable is $308,000
Roth 401(k) grows tax-free
Consider taking Milt off payroll
2/19/2019

28. QBI Income Modification
401(k) and other qualified plans to reduce income:
Employer contributions
Cash balance plans
Oil and gas IDC
Gifting of business interest to family members
Incurring gains to increase taxable income
Portfolio
property
Reducing guaranteed payments
Revise operating agreements
Segregating business lines (rental versus other)
Martial status
Single v. married
MFJ v. MFS?
Partnership employees to partners?
Full expensing to knock income down to levels?
Biz code important?
Depreciation schedules?
2/19/2019

29. Service business Under the income threshold, OK
Spinning off other non-service businesses
Real estate
Admin staff
Non-service products (dermatologist)
Royalties may be statutorily excluded
2/19/2019

30. Strategies Choice of entity: C-corp. versus pass-through
Choice of entity: Sole proprietorship v. Sub-S v. LLC/partnership
Employee v. IC (both sides)
Filing status (MFS v. MFJ)
Reducing/increasing TI
Reducing/increasing W-2
Trusts (NG)
Threshold
Income shift
Asset protection
Service Biz
2/19/2019

31. Pass-Through Planning Issues
Am I subject to the pass-through rules? (Not C-Corp.)
Am I subject to the service company rules?
Am I subject to the W-2 rules?
Is my income under the threshold?
Should I do something about my income?
We’re married and one of us has a pass-through. Are we better off filing separately?
Should we split off businesses to take better advantage of the new rules?
Should we split ownership to other members of our family or to trusts?
2/19/2019

32. 2/19/2019

33. More Note C-corp. rules are permanent and 199A sunsets
§1202 (QSBS) (acquired after 09/27/10, 100%)
2/19/2019

34. More Business Changes Under $25 million 3-year average gross revenue:
Cash basis
No debt restrictions
Inventory
Completed contract
Full expensing of non-real estate
Net operating losses: no carryback, limited carry-forward
New excess loss limitation
Entertainment deduction eliminated
Car depreciation changed:
Under 6,000 pound GVW
Over 6,000 pound GVW
Interest deduction limited
2/19/2019

35. Disclaimer
This presentation and these materials are provided for informational and educational purposes based upon publically available information from sources believed to be reliable. This presentation and these materials are provided with the understanding that the author/presenter is not engaged in rendering legal, accounting, or other professional services, and it is not intended to provide any basis for legal, accounting, or other professional services.
Due to the constantly changing nature of the subject, this outline should not be used as a resource for any tax or accounting opinion, or tax return position.
Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
COPYRIGHT ©2018, LJPR Financial Advisors

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©2018, LJPR Financial Advisors