Copyright 2018, James M. McCarten, Burr & Forman LLP, all rights reserved

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1 Prepared for Stetson 2018 National Conference on Special Needs Planning and Special Needs Trusts Pre-Conference Tax Intensive St. Petersburg, Florida Wednesday, October 17, 2018 Presented by: James M. McCarten Partner Burr & Forman LLP Atlanta, Georgia Nashville, Tennessee 404/ (Atlanta, GA) 615/ (Nashville, TN)

2 Our Agenda 1. Rate Changes (and the implications). 2. The New Qualified Business Income ( QBI ) Deduction. 3. Other Tax Reform Changes Impacting Businesses. 4. Post-2017 Choice of Entity Considerations. 2

3 Tax Rates 1. Corporate Tax Rate %. Down from 35%. No More PSC penalty rate. 2. Capital Gain and Qualifying Dividends 15% or 20%. The change occurs at $426,700. 3

4 Tax Rates 3. Individual Tax Rates: Between $82,500 and $157, % Down 1% (look at income level breaks) Between $157,500 and $200, % A surprising increase of 4% Between $200,000 and $500, % For most of this group, an increase of 2% For those over $416,000 to $500,000, no change Over $500, % A decrease of 2.6% 4

5 Comparing Total Tax Burdens Type of Entity and Income Distributed* A corporation distributing 100% of its after-tax net income A corporation distributing 50% of its after-tax net income No corporate earnings distributed S corporations, partnerships or sole proprietorships (all passthru Gorin 2018, reproduced with permission. Total Tax Rate If Individual in Top Bracket Total Tax Rate If Individual in Modest Tax Bracket 47.3% 40.8% 36.7% 33.4% 26.0% 26.0% 34.6% to 45.8% 27.4% to 46.2% 5

6 The Qualified Business Income ( QBI ) deduction. The Pass-Thru Business Rate Equalizer Qualifying for this deduction constitutes a large part of post small business tax planning. The deduction is only available to the owners of pass-through businesses, including estates and trusts. The deduction is 20% of the qualified income from a trade or business passed thru to an entity s owners. There are limitations once an owners taxable income exceeds $157,500 for singles, $315,000 for married filing jointly. The income from certain businesses, Specified Service Trades or Businesses ( SSTBs ), does not qualify if an owner s taxable income exceeds the above thresholds. 6

7 1. IRS created acronyms: The Language of QBI QBI - qualified business income; RPE - relevant pass-thru entity; SSTB - specified service trade or business; UBIA - unadjusted basis immediately after acquisition; PTP - publicly traded partnerships; REIT - real estate investment trust. 2. An additional defined term: Threshold Amount 7

8 A Conceptual Overview 1. Start with the taxpayer s Threshold Amount. To determine if exclusions or limitations apply. 2. Calculate the QBI, including applicable exclusions and/or limitations, for each separate trade or business the taxpayer is deemed to participate in. QBI Aggregation rules are conceptually similar to passive loss grouping rules. Losses from a qualified trade or business ( QTB ) are first netted against positive QBI of other QTBs. Then carried forward to reduce the QBI in subsequent year(s). 8

9 A Conceptual Overview of the QBI Deduction 3. Total all of the separate trade or business QBIs and multiply by 20%. 4. Add 20% of qualified REIT dividends and 20% of qualified publicly traded partnership income. 5. Equals the allowable QBI deduction. 9

10 The First Step 1. Calculate the QBI for each QTB. Aggregation rules are discussed separately, but impact this calculation. 2. Is the QBI SSTB included because the taxpayer s taxable income is below the applicable Threshold Amount. 3. If Threshold Amount surpassed, calculate the applicable limitation for each QTB: The 50% Wage Limitation (allocable W-2 wages) or The 25% Wage plus 2 ½% UBIA of Qualified Property Limitation. 4. This determines the QBI for each separate QBT. 10

11 Exclusions 1. Specified Service Trades or Businesses. Health, Law, Accounting, Actuarial Sciences, Performing Arts, Consulting, Athletics, Financial Services, Brokerage or where Principal Asset is Reputation or Skill or an employee. 2. These SSTBs are not QBTs if the taxpayer s taxable income exceeds the applicable Threshold Amount. 3. If taxpayer s taxable income is less than the applicable Threshold Amount, the SSTB is aqtb. 4. Applicable Threshold Amounts: Single, estate or trust --- $157,500. Married filing joint --- $315,000. For each, there is a small additional phase out amount of taxable income. 11

12 Multiple QTBs 1. The Aggregation Election. Each owner of a QTB makes its own election. The election is irrevocable once made. Pass-thru entities are not allowed to aggregate, must report each QTB separately. 2. Aggregation is available when a single person or group, directly or indirectly, owns 50%ofeach QTB being aggregated. Can be QTBs in same RPE or different RPEs. The QTB cannot be an SSTB (a separate rule applies). 12

13 Multiple QTBs 3. To aggregate, the QTBs must meet 2 of 3 tests. Offer same products or services (or are customarily offered together), Share facilities or certain centralized core business elements, or Be operated in coordination with or reliance upon one or more businesses within the aggregated group. 4. The QTBs must be related for a majority of the tax year. Proposed Regulations provide examples of the 2 of 3 tests with a few unexpected results. 5. Year-to-year consistency and annual disclosure are required. 13

14 Limitations on QBI Deduction 1. Limitations only apply when the taxpayer s taxable income exceeds the applicable Threshold Amount. 2. The first limitation is 50% of wages allocable to the QTB. Wages subject to withholding, elective deferrals and many fringe benefits are included. Must allocate between QTBs when more than one is operated within a single entity. Independent Contractor payments do not count. Prop. Regulations allow amounts paid when leasing employees to count as wages. 14

15 The 2.5% of UBIA Limit 1. This limitation combines 25% of wages plus 2.5% of UBIA of Qualified Property. 2. The wages rules from previous slide apply. 3. The unadjusted basis immediately after acquisition ( UBIA ) of Qualified Property. Qualified Property is depreciable property. Must be used at any time during the year in the QTB for the production of income. The 2.5% is calculated on acquisition cost, not tax basis. Improvements to property are treated as separate items of property. 15

16 The 2.5% of UBIA Limit II 1. Accountants full employment UBIA is available for the QBI calculation until the later of: 10 years, or Last full year of its applicable recovery period; i.e., depreciable life. A new depreciation-type schedule will have to be maintained by RPEs. 2. Acquisition cost means the RPE ignores how handled otherwise (i.e., Section 179 expensing, bonus depreciation). 3. Like kind property acquired in an exchange uses UBIA cost and period of exchanged property. 4. No UBIA increase available from 754 elections. 16

17 More On SSTBs 1. SSTBs and their special aggregation rules. RPE is not engaged in a specified service, but provides 80% or more of its products or services to an SSTB will itself be treated as an SSTB when the RPE and SSTB share 50% or more common ownership. Where RPE and SSTB are 50% commonly owned but less than 80% of RPE s goods/services are provided to the SSTB, all income will be QBI except the portion provided to SSTB. Incidental aggregation occurs when 95% of combined receipts are SSTB receipts. 17

18 More On SSTBs II 2. Where RPE has QBI and less than 10% of gross receipts are SSTB receipts, the QBT is not treated as an SSTB. If gross receipts exceed $25M, the SSTB s gross receipts must be less than 5%. 3. Reputation and skill of employee as an SSTB is restricted to: Endorsement receipts. Receipts from the use of image, likeness, name, trademark or other symbols (think Prince). Appearance receipts. Not Jim s Beachside Bar & Grill. 18

19 Special Rules for Trusts 1. The QBI Threshold Amount is $157,500 for trusts. Calculated before the DNI deduction. 2. Trust calculates QBI items and then allocates between trust and beneficiaries based on amount of DNI reported by each. 3. An anti-abuse rule. If a significant purpose of using a trust is obtaining the QBI deduction, the trust will not be respected. The Trust is not respected only for QBI deduction. When is a purpose significant? 4. These are the QBI specific rules, new regs. under 643(f) must also be examined. 19

20 643(f) Prop. Regulations 1. These also address the use of multiple trusts and create anti-abuse rules with a broader reach. Proposed only so not effective until adopted in final. 2. The prop. regs. provide that 2 or more trusts will be combined and treated as a single trust if: The trusts have substantially the same grantor(s) and primary beneficiary(ies), and A principal purpose for multiple trusts is the avoidance of tax. The principal purpose of tax avoidance will be presumed when creating multiple trusts results in a significant income tax benefit unless a significant non-tax purpose could not have been achieved without multiple trusts. Carefully analyze the examples provided in the prop. regs. 20

21 Other Important QBI Rules to Know 1. RPEs must report sufficient information about each of its QPTs for each owner to calculate her QBI deduction. The cost of return preparation has increased. Items to report for each QTB include income, deductions, SSTB (or not), relevant wage and UBIA amounts. No detail from RPE equals no QBI deduction for owners. 2. A QBI specific penalty. Section 6662 understatement of tax penalty applies where an understatement of tax attributable to QBI deduction exceeds the greater of $5,000 or 5% of the true tax due. 21

22 Some Final QBI Observations 1. There is a significant difference between the QBI of S corps and partnerships. In an S corp., QBI is calculated on income less owner salary. Partnership QBI is not similarly reduced. 2. No item of capital gain, long and short term, qualifies as an item of QBI, including 1231 gain. But 1231 depreciation recapture is ordinary income so it is included. 3. Use of centralized management companies is treated just like the employee leasing rule for the wage limitation. ButifallocatedtoanSSTBwillonlyprovideaQBIbenefitif taxpayer s taxable income is below the Threshold Amount. 22

23 The Second Tier of Important Changes 1. The complete elimination of the deduction for entertainment expenses. No deduction if related to entertainment, amusement or recreational activities. Applies to all business taxpayers (C corps., S corps., LLC s, partnerships and sole proprietors). 2. Increases in Section 179 Expensing and additional first-year depreciation. Section 179 now applies for $1,000,000 of acquired depreciable property and does not sunset. Additional 1 st year depreciation increases from 50% to 100%, but does sunset. 23

24 The Second Tier of Important Changes 3. Other business changes will not have much practical impact on professional practices. 4. Important personal tax changes. The limitation on the deductibility of state and local taxes. Itemized deductions are no longer available. 24

25 Choice of Entity Factors 1. Individual Income Tax Rates. 2. Applicable Capital Gain and Qualified Dividend Rates. 3. The 3.8% Net Investment Income ( NII ) Tax. 4. The 3.8% Medicare Tax on Wages and Self- Employment Income (over the social security minimum). 5. Corporate Tax Rates, Including the Repeal of the Corporate AMT. 6. The Two Layers of Tax on Income from C Corporations Versus One Layer for Pass-Thru Entities. 7. Deferral of the Second Layer of Tax by C Corporations. 25

26 Choice of Entity Factors II 8. The Ability of Owners to Utilize Business Losses on Personal Returns (though now limited to $250K for singles and $500K for married taxpayers). 9. The QBI Deduction. 10. The Limit on Individual Deductions for State and Local Taxes. 11. Passive Activity Losses. 12. A Realistic Exit Strategy: Asset Sale or Sale of Equity. 13. The Potential Benefit of Providing Services as a Sole Proprietor, through a Disregarded Entity or as the Sole Owner of an S Corporation. 26

27 THE END. Thank you for your kind attention. James M. McCarten (404) sought for specific _1 situations.