Tax Planning for Law Firms Under the 2017 Tax Act Revisited: The Effects of the Proposed Regulations American Bar Association Section of Taxation

Transcription

1 Tax Planning for Law Firms Under the 2017 Tax Act Revisited: The Effects of the Proposed Regulations American Bar Association Section of Taxation Wednesday, September 26,

2 Presenters Morgan L. Klinzing, Pepper Hamilton, LLP Philadelphia, PA, Robb A. Longman, Longman & Van Grack, LLC Bethesda, MD, J. Robert Turnipseed, Armbrecht Jackson, LLC Mobile, AL,

3 Overview Section 199A Introduction Choice of Entity Definitions of Trade or Business as it Applies to Law Firms Calculation of the Deduction Employee/Independent Contractor Issues Aggregation of Trades or Businesses Restructuring for Non-Equity Partners Defining a SSTB Examples 3

4 Section 199A Introduction

5 Section 199A 20% deduction for certain income of pass-through entities including sole proprietorships through Maximum deduction is 20% of the qualified business income (QBI ). 5

6 Section 199A The General Rule for 199A The 199A deduction amount is equal to the lesser of the following: (1) the taxpayer s combined qualified business income amount, or (2) 20% of the excess of (i) the taxpayer s taxable income for the taxable year, over (ii) the taxpayer s net capital gain for such taxable year. This calculation is subject to a number of exclusions and limitations, which has added a great deal of complexity to this provision. 6

7 Qualified Business Income QBI is the net amount of qualified income, gain deduction and loss with regards to a qualified trade or business. Must be effectively connected to US trade or business Included or allowed in determining taxable income. 7

8 QBI Exclusions Qualified Business Income does not include the following: Investments-dividends, interest capital gains. Compensation paid to an owner for services rendered with respect to the trade or business. Guaranteed payments Reasonable Compensation Payment to a partner for services rendered W-2 Income 8

9 Limitations to 20% Deductions The 20% deduction is limited to a cap equal to the greater of: 50% of W-2 wages paid, or 25% of W-2 wages paid plus 2.5% of the original basis of Qualified Property W-2 wages could have a larger effect on S-Corps as opposed to partnerships. Partnerships do not pay W-2 Wages to partners. Guaranteed payments under IRC Section 707(c), if paid, are not included (until otherwise stated by IRS) as W-2 wages, but also not included in QBI. Payments for services covered by IRC Section 707(a) are also not included as W-2 wages or QBI. 9

10 Exception to Wage Limitation Taxpayers whose taxable income is less than the threshold amount do not have to follow the wage limits. Threshold amount is defined in Section 199A(e)(2) as $157,500 or 200% of such amount ($315,000) in the case of a joint return. For taxpayers with QBI falling in between $207,500 and $415,000, there is a phase out of the wage limits which must be calculated in order to determine the proper deduction. 10

11 Reasonable Compensation Applies to S-Corporations. S-Corporation must pay shareholders who provide services to the company as an employee, in a reasonable amount. Concern that reasonable compensation could have been applied to partnerships. Regulations provide that reasonable compensation will continue to only be applied, in the context of Section 199A to entities taxed as S-Corporations. If the S-Corporation fails to pay its shareholder employees a salary, the amount of reasonable compensation that would be applicable will still be deducted from QBI. 11

12 Choice of Entity

13 Entity Tax Choices C-Corporation S-Corporation Partnership Sole Proprietor Limited Liability Company C-Corporation S-Corporation Partnership Sole Proprietor 13

14 Comparison of C-Corp and Pass-Through C-Corporation Tax Rate 21% Dividend 20%+3.8%=23.8 State and Local Tax Deduction is allowed Pass Through (20% Deduction Allowed) Tax Rate 29.6% (Individual Level) Dividend 0 State property taxes deductible, local income tax are not deductible. 14

15 Financial Comparison of C-Corp and Pass Through C Corp. C Corp. (No distribution) Pass Through (Active) Pass-thru (No 199A) Taxable income $ $ $ $ Entity level tax ($210.00) ($210.00) ($0.00) ($0.00) Net distribution $ $ $ $ % deduction ($200.00) Individual tax ($180.80) ($0.00) ($290.60) ($370.00) After-tax cash $ $ $ $ Effective tax rate 39.8% 21.0% 29.6% 37.0% 15

16 Benefits of Pass Through Potential to get the 20% deduction depending upon individual s net income. No double taxation. Pass through of losses (hopefully none). Flexibility of distributions and tax benefits. 16

17 Cons of Pass Through No deferral Reasonable Compensation for S-Corps which is not eligible for the 20% deduction. Issues on non-equity partners and payments of such (guaranteed payments are not eligible for 20% deduction. Non-deductibility of local income taxes. 17

18 Pros of C-Corps Currently lower tax rates at the corporate level. Potential for deferred compensation. 18

19 Cons to C-Corps Tax Rate may increase. Double Taxation. 19

20 Definitions of Trade or Business as it Applies to Law Firms

21 Trade or Business Definition Code Section 199A(d) provides a definition of qualified trade or business but only provides what is NOT included it does not contain a specific definition of what is a trade or business. The regulations point us toward Section 162(a) for the definition of a trade or business as it relates to Section 199A. Section 162 does not provide a definition, but significant amounts of case law have established a definition for trade or business as it relates to Section 162. Trade or business definition as it relates to Section 162 is as follows: Primary purpose to make a profit. Practiced by individual with continuity and regularity, See Comm. V. Groetzinger. Specifically included for 199A is rental or licensing of tangible or intangible property that may not generally fall under Section

22 Businesses not Included in Definition of Qualified T or B-- Specified Services Section 199A(d) excludes specified service trade or businesses from the definition of qualified trade or business for purposes of Section 199A. That includes the following industries: Health Providers Legal Accounting-includes services provided by enrolled agents. Actuarial Science Performing Arts Financial Services Brokerage Services Other service professionals where the business is based upon a specialized skill of one or more of the owners. 22

23 Specified Services Business For owners of excluded businesses with income less than $157,500 for single taxpayers, or $315,000 for taxpayers filing joint returns, the specified services exclusion does not apply and they are entitled to full 20% deduction. There is a phase out for owners with income between $157,000 and $207,500 for single taxpayers, and $315,000 and $415,000 for married taxpayers filing jointly. Owners in excess of $207,500 for single taxpayer and $415,000 for joint taxpayers are not entitled to claim the 20% deduction. 23

24 What Qualifies as a Law Firm Law firms are clearly included within the definition of specified service business. What is included in the actual trade or business of a law practice? Performance of the services of the field of law Includes not just services from lawyers, but also paralegals, legal arbitrators, mediators and other similar professions. Exclusions from regulations printers, delivery services or stenography services. 24

25 Fine Line of What is a Legal Service Real estate attorney who do not just practice real estate law, but also offer title insurance etc. Tax lawyers who provide services that can also be offered by other professionals cannot escape because of the accounting services exemption. Attorney who provide collection services-look to the service provided. 25

26 Calculation of the Deduction

27 Examples showing the Calculation of 199-A Deduction A, is unmarried and owns and operates a solo practitioner law firm. He is taxed as a sole proprietorship. The business generated $100,000 in net taxable income from operations in A has no capital gains or losses. A s total taxable income for 2018 is $81,000. The business s QBI is $100,000. A s Section 199A deduction for 2018 is equal to $16,200, the lesser of 20% of A s QBI from the business ($100,000 x 20% = $20,000) and 20% of A s total taxable income for the taxable year ($81,000 x 20% = $16,200). 27

28 Examples showing the Calculation of 199-A Deduction B and C are married and file a joint tax return. B earned $500,000 in wages as an employee. C owns 100% of the shares of X, an S corporation that provides legal services. X generated $100,000 in net income. X paid C $150,000. B and C s total taxable income is $270,000. B s and C s wages are not considered to be income from a trade or business for purposes of the Section 199A deduction. Because X is an S corporation, its QBI is determined at the S corporation level. X s QBI is $100,000, the net amount of its qualified items of income, gain, deduction, and loss. The wages paid by X to C are considered to be a qualified item of deduction for purposes of determining X s QBI. The section 199A deduction with respect to X s QBI is then determined by C, X s sole shareholder, and is claimed on the joint return filed by B and C. B and C s Section 199A deduction is equal to $20,000, the lesser of 20% of C s QBI from the business ($100,000 x 20% = $20,000) and 20% of B and C s total taxable income for the taxable year ($270,000 x 20% = $54,000). 28

29 EMPLOYEE/INDEPENDENT CONTRACTOR ISSUES 29

30 Employee Wages that Are Part of the Trade or Business All Common law Employees of the Company. Following rules of former Section 199. Separate reporting requirements for each business under 199A. 30

31 Employee vs. Independent contractor Employees receive a W-2, therefore, their wages are included in restrictions of the deduction. Employer pay a portion of the FICA for the employee. Independent contractors receive a an employer does not pay FICA on their behalf. 25 part test to determine if someone is an employee of independent contractor. Major indications focus on control employer has over the worker. 31

32 Former Employee Presumption Employees are not eligible for the Section 199A deduction. Section 530 rules that limits IRS from imposing employment tax liabilities against employers for misclassification of employees will not apply to employees attempting reclassification for Section 199A purposes. If an employee should have been classified as an employee, Proposed Reg 1.199A-5(d)(3) provides that for purposes of Section 199A the improperly classified employee will be treated as an employee. The reg is not intended to change the definition or application of the definition of an employee or independent contractor, but to provide presumptions that individuals substantiate their status. There is a presumption that if at one point in time an individual was treated as an employee by an employer, that individual will continue to be an employee even if they are treated as an independent contractor. 32

33 Employee to Independent Contractor The benefits can add up on each end assist could allow for larger deductions for business. Provides a benefit to those employees who could now be entitled to 20% deduction. Employee will be required to show that the relationship has changed between the employer and employee to make the employee and independent contractor. The requirement is there regardless of the reg, but the reg can increase the compliance cost for the employee. 33

34 Trade or Business of Performing Services as an Employee Associates C and D Law Firm 2 LLP Payment for services 1.199A-5(d)(3)(ii) Example 2. C was an attorney for Law Firm and had income below $315k. Law Firm terminates its employment relationship with C. C and other former associates form a new partnership, Law Firm 2, which contracts to perform legal services for Law Firm. Are payments deductible? What if Law Firm 2 becomes a partner in Law Firm LLP? 34

35 Aggregation of Businesses

36 Aggregation Of Businesses General Rule: Each trade or business is a separate trade or business for purposes of applying the calculations relating to W2 wages and qualified property. Reg. Section 1.199A-4(a). Most of the comments received by the IRS requested using grouping rules found in Reg. Section regarding passive activity losses. IRS rejected utilizing Section 469 Rules for Aggregation purposes, but did recognize that in certain situations aggregation would be appropriate. 36

37 Aggregation Of Businesses New aggregation rules found in Reg. Section 1.199A-4(b). Rule provides that trades or businesses may be aggregated for purposes of applying the calculations under Reg. Section 1.199A-1(d)(2)(iv) If the taxpayer can demonstrate the following: 1. Same persons or group of persons, directly or indirectly, owns 50% or more of each trade or business to be aggregated; 2. Ownership exists for the majority of the taxable year for which the businesses would be aggregated; 3. Items attributable to each trade or business to be aggregated are reported on returns within the same taxable year; 4. None of the trades or businesses to be aggregated are a specified service trade or business; and 5. The trade or business to be aggregated satisfies at least two of the following factors: a. The trade or businesses provide products and services that are the same or are customarily offered together; b. The trade or businesses share facilities or share a significant centralized business elements, such as personal, accounting, legal, manufacturing, purchasing, human resources, or information technology resources; and c. The trade or businesses are operated in coordination with, or reliance upon, one or more of the businesses in the aggregated group. 37

38 Aggregation Of Businesses The option to aggregate is optional, and is not mandatory upon individuals or relevant pass through entities (RPE). Multiple owners of an RPE need not aggregate in a same manner. Regulations contain family attribution rules, which allows for attribution of ownership by spouses, children, grandchildren, and parents. 38

39 Aggregation Of Businesses Reporting rules are found in Reg. Section 1.199A-4(c). Rules require consistency of reporting in taxable years, but allows for adding of trades or businesses where certain requirements are met, or for removing a trade or business from aggregation if it no longer qualifies. Where aggregation will be done by a taxpayer, the individuals must attach a statement to their returns which requires specific information regarding the aggregation. The Rules specifically provides that the IRS may disaggregate the individuals T or B without such statement.

40 Aggregation Rules: Relevance to Law Practices? Aggregation is of limited relevance for law practices due to the exclusion of specified service trades or businesses. Main purpose of aggregation to increase W2 wages or qualified property for the calculations under Section 199A(b)(2). But the wages/qualified property limitation does not apply if the taxpayer s taxable income is less than $157,500 for individuals, or $315,000 for joint return SAME LIMITATION AS FOR SPECIFIED SERVICES BUSINESSES. Could aggregate non-specified service trades or businesses for purposes of 20% deduction into a single trade or business for purposes of the W-2 wage and qualified property computations, but the specified service industry will have to be calculated separately. Aggregation Rules will have no impact on the new rules in the regulations relating to specified service trades or businesses, which are now likely to include all related trades or businesses for purposes of calculating the specified service trade or business limitations on QBI.

41 Restructuring for Non-Equity Partners

42 Restructuring for Non-Equity Partners Many law firms have equity and non-equity partners. Non-equity partner s compensation typically is considered a guaranteed payment under 707(c). What is a guaranteed payment? Payment made to partner for services or for use of capital, determined without regard to the income of the partnership. Reg (c). Under Section 199A(c)(4), neither W-2 wages or guaranteed payments qualify as Qualified Business Income for purposes of the 20% deduction. Non-equity partners are typically the partners within a specified service T or B who would qualify under the income limitations to claim the 20 percent deduction (i.e., under $157,500 single or $315,000 joint). Key Point finding ways to structure the business such that the payments to non-equity partners are considered distributions by the partnership, and therefore considered QBI for 199A deduction. 42

43 Restructuring for Non-Equity Partners (cont d) What are the options? Option Number 1--Distribute equity to non-equity partners. Likely the easiest option, and would require little to no amendments to current operating structure. Little to no chance of IRS challenge, and full 199A deduction on distributions. Problem fitting them into existing partner compensation structure, as these younger partners will likely receive less due to less clientele/origination. Increased risk because payments based solely on profits of the partnership. No profits=no payments. Full SECA taxes borne by new partners, and allocation of phantom income. 43

44 Restructuring for Non-Equity Partners (cont d) Option Number 2--Change partnership agreement to provide for priority income allocations and cash flow distributions in lieu of guaranteed payments. Structured properly, this may allow for full 199A deduction. Would increase risk to NEPs, and also greater possibility of IRS challenge under 704(c) regulations. Full SECA taxes borne by new partners, and allocation of phantom income. Complexity of calculations of allocations/capital accounts Proposed Regulations under Section 707(a) and 707(c) (REG ) require significant entrepreneurial risk in order for an allocation to be treated as a partner s distributable share. However, it is unclear whether these proposed regulations will be made final, so there is not yet any definitive guidance. 44

45 Restructuring for Non-Equity Partners (cont d) Option Number 3 Priority income allocation to NEPs, with a minimum guaranteed distribution where profits are insufficient for payments. Are the minimum distributions considered guaranteed payments? Maybe see Example 2 of Reg (c). Where net profits exceed guaranteed payment, the payments should be treated as distributive share. See PLR Less risk on the NEP than Option 2 due to minimum guaranteed payment. The 2015 Proposed Regulations on Section 707(a) and (c) would have revised Example 2 from Reg (c) to treat the entire minimum distribution as a guaranteed payment. However, it is unclear whether these proposed regulations will be made final, so there is not yet any definitive guidance. 45

46 Restructuring for Non-Equity Partners--(cont d) Impact of New 199A regulations Did anything change in the regulations regarding how the IRS would treat guaranteed payments? The Answer is no, and the IRS really didn t address the issue. The only references to guaranteed payments are found in Reg. Section 1.199A-3(b)(1)(ii) and (2)(ii)(l). Those provisions simply note guaranteed payments will not be considered as QBI, and accordingly will not be entitled to the deduction. Rules note that the partnership deduction associated with the guaranteed payment will be taken into account in computing QBI if the deduction is properly allocable to the T or B and is deductible.

47 Restructuring for Non-Equity Partners--(cont d) Impact of New 199A regulations Additionally, the new Regulations addressed Section 707(a) payments made to a partner who engages in a transaction with the Partnership, other than in his or her capacity as a partner. The only references to 707(a) payments are found in Reg. Section 1.199A-3(b)(2)(ii)(J). Those provisions simply note 707(a) payments will not be considered as QBI, and accordingly will not be entitled to the deduction. No assistance provided in the regs to determine WHEN the payments will be considered as 707(a) payments.

48 Restructuring for Non-Equity Partners--(cont d) Impact of 2015 Proposed Regulations under 707(a) and (c) Proposed Reg , issued on July 23, 2015, is the major regulation in this area. Makes a distinction between 707(a)(2)(A) disguised payments for services, and 707(c) guaranteed payments the first applies to arrangements in which distributions to the service provider depend on an allocation of an item of income, and the latter applies to amounts whose payments are unrelated to PS income. 707(a)(2)(A) issue: payments received by a partner where he or she has insufficient entrepreneurial risk. Will be considered as disguised payment for services under Section 707(a)(2)(A). Guaranteed payments issue: major revision to Example 2 in Reg (c). Eliminates the wait and see approach.

49 Restructuring for Non-Equity Partners--(cont d) Impact of 2015 Proposed Regulations under 707(a) and (c) Are these proposed regulations effective? Not yet. Effective as of date of final regulations. Congress requested additional comments on these proposed regulations, and regulations have been delayed for two years since change of administrations. Regulations were put into long term action status. Regs have now been put on calendar for final rules status, so IRS will either finalize or withdraw soon. Unclear if these regulations will ever be effective, but certainly indicative of IRS s position on Section 707(a)(2)(A) and 707(c).

50 Restructuring for Non-Equity Partners (cont d) Result? Consider changing the way distributions are made to NEPs. Because the 199A proposed regulations do not address the issue, the prior law under Section 707(c) and the regulations and IRS rulings will apply to determine when a payment should be considered a guaranteed payment versus a profit distribution. Firms which have treated the payments as guaranteed payments should consider amending their operating agreements to treat payments to non-equity partners as preferred profit distributions. Where a firm does not wish to give the NEPs a priority profits distribution, it should consider treating NEPs as employees subject to W-2 wages, instead of as a GP. More advantageous to the NEPs due to reduction of FICA payments. Point treating payments as guaranteed payments to the NEP is the least beneficial way to treat the payments.

51 Specified Service Trade or Business

52 Effect of Being a SSTB Unless an exception applies, none of the items of a SSTB are taken into account in determining QBI. Exceptions include individuals with income below the threshold or de minimis SSTB activities. If a flow through entity is in a SSTB, then none of the income from that trade or business that flows through is QBI, regardless of whether the owner participates in the business. 52

53 Defining What is Included in a SSTB De Minimis Rule Services or Property Provided to a SSTB Business is Incidental to a SSTB 53

54 Defining What is Included in a SSTB De Minimis Rule Gross receipts of $25MM or less: business is not a SSTB if less than 10% of the gross receipts are attributable to a SSTB. Gross receipts over $25MM: business is not a SSTB if less than 5% of the gross receipts are attributable to a SSTB. In determining the % attributable to a SSTB, any activity that is incident to the actual performance of services in that field is considered the performance of a SSTB. 54

55 Defining What is Included in a SSTB De Minimis Rule Partner A Partner B Can you combine legal services with another business? Is it feasible from a business perspective? Business Planning LLP Legal Services Business Services 9.9% Gross Receipts 90.1% Gross Receipts 55

56 Defining What is Included in a SSTB Services or Property Provided to a SSTB A SSTB includes any business with 50% common ownership that provides 80% or more of its property or services to a SSTB. Ownership: direct and indirect, within the meaning of 267(b) nd 707(b) Is crack and pack still alive? 56

57 Defining What is Included in a SSTB Services or Property Provided to a SSTB Legal Services Partner A Law Firm LLP Admin Services Partner B 1.199A-5(c)(2)(iv) Example. Law firm is a partnership that provides legal services to clients, owns its own office building and employs its own administrative staff. Law firm divides into 3 partnerships. Partnership 1 performs legal services. Partnership 2 owns the office building and rents it to Partnership 1. Partnership 3 provides administrative services to Partnership 1 in exchange for fees. 57

58 Defining What is Included in a SSTB Services or Property Provided to a SSTB Partners A and B Pship 1 Legal Services Admin Services Rent Partners A and B Pship 3 Partners A and B Pship 2 Law firm divides into 3 partnerships. Partnership 1 performs legal services. Partnership 2 owns the office building and rents it to Partnership 1. Partnership 3 provides administrative services to Partnership 1 in exchange for fees. Admin Services 58

59 Defining What is Included in a SSTB Business is Incidental to a SSTB A non-sstb will be considered part of a SSTB if: (1) a non-sstb has 50% common ownership with a SSTB, (2) the non-sstb and SSTB shares expenses, and Expenses include wages and overhead. (3) the gross receipts of the non-sstb are no more than 5% of the combined gross receipts of the non-sstb and the SSTB. 59

60 Defining What is Included in a SSTB Business is Incidental to a SSTB Result? Example provided in regulations is pretty clear that splitting off non-legal businesses to take advantage of 199A deduction will not work in most situations. Complexity of structures that may satisfy the rules would negate the possible tax savings for owners of SSTB. Example setting up a separate management company, which manages multiple firms (in order to reduce ownership below 50%). 60

61 Anti-Avoidance Rules for Multiples Trusts As part of the 199A regulation package, Treasury also issued Prop. Reg. Section 1.643(f)-1. Threshold amount for 199A deduction is determined at the trust level. Concerned that taxpayers would circumvent the threshold amount by dividing assets among multiple trusts, each of which would claim its own threshold amount. Under the proposed reg, if (1) two or more trusts have substantially the same grantor, (2) substantially the same beneficiary, and (3) were formed with a principal purpose of avoiding FIT, then such trusts will be treated as a single trust. Applies to trusts entered into or modified on or after August 16,

62 Examples

63 Example One Law firm A has two partners. Law Firm A contract with other attorney who are hired as Of Counsel. Each of these Of Counsel attorneys has their own law firm. The Of Counsel attorney are paid an hourly rate. Each Of Counsel Attorney has their own office, but is allowed to use Law Firm A s office when working with Law Firm A s clients. How will Of Counsel Attorneys be treated for employee/independent contractor issues? What is Of Counsel Attorney only works on Law Firm A Matters? What if Of Counsel Attorney becomes a non-equity partner, is paid in same manner as prior when Of Counsel Attorney? 63

64 Example Two Attorney B is new to Law Firm. Upon being hired, Attorney B request that he/she be treated as an independent contractor? Are there ways that Attorney B may be treated as an independent contractor? 64

65 Example Three Law Firm A has thirty lawyers, which are broken down as follows: 12 lawyers are full equity partners, and receive only their distributive share based on the firm s allocation formula for distribution of profits. 10 lawyers are non-equity partners, and receive set payments prior to any profits distributions to equity partners in exchange for their services, with a potential bonus at the end of the year depending on billable hours and production. 8 lawyers are associates, and are paid set wages reported on Form W-2, with a potential bonus at the end of the year depending on billable hours and production. 65

66 Example Four Tax Treatment? Equity partners: all payments made to the partners are considered distributions by the partnership, and accordingly entitled to the Section 199A deduction, but subject to the statutory caps ($157,500 single taxpayer, $315,000 jointly filed). Non-Equity Partners: all payments considered guaranteed payments under Section 707(c). No 20% deduction, AND the NEP pays full SECA on all payments received. Deductible by PS. Associates: treated as employees with W-2 wages, no deduction, pay ½ FICA on wages received (PS pays other ½). Deductible by PS. 66

67 Example Five What if the Firm changes its operating agreement to provide that NEPs will receive priority profit distributions instead of guaranteed payments? NEPs now able to utilize the 20% deduction from Section 199A. Still responsible for full SECA payments. Risk is that the firm does not have sufficient profits in any particular month, meaning that NEPs receive nothing. Can the operating agreement provide that missed profits payments to NEPs will be made up in future months where firm makes a profit? Can the operating agreement provide for advances of profits to the NEPs in months where no profit is made? Does the operating agreement have to require that the NEPs pay back any amounts received if the firm fails to make profits in the second half of the taxable year? Where will the line be drawn by the IRS that would pull this planning technique into Section 707(a)(2)(A)? NEPs now subject to phantom income allocations. 67

68 Example Six Same facts, but operating agreement provides that NEPs will receive a minimum guaranteed distribution each month of $10,000, irregardless of profits of the partnership. Result? This fact pattern falls under current Example 2 of Reg (c), which provides that whether this payment will be considered a guaranteed payment under 707(c) must be reviewed at the end of the taxable year. If payments exceed what would have been the partner s distributive share of profits (even as a priority distribution) at the end of the taxable year, then the excess would be considered a guaranteed payment, and 199A deduction not allowed for that amount. Likely a fairer result for the NEP (who will be much more dependent on monthly income than other partners) less risk of receiving payment. But riskiest planning structure for IRS due to proposed regs. New Example 2 in the regs would not allow this planning technique. 68

69 Example Seven Partners A and B Partners A and B Partnership 1 performs legal services. Pship 1 Legal Services Rent Pship 2 Partnership 2 owns the office building and rents 15% of the building to Partnership 1. Partnership 2 rents the remaining 85% of the building to unrelated third parties. Is a deduction allowed? 69

70 Example Eight Partners A and B Pship 1 Legal Services Admin Services Partners A, B, C, D Pship 3 Partners C and D Pship 2 Legal Services Admin Services Partnerships 1 and 2 perform legal services. Each partnership has different partners. Partnership 3 provides administrative services to Partnerships 1 and 2 in exchange for fees. Partnership 3 is owned by partners A, B, C and D. Admin Services 70