New Section 199A Qualified Business Income Regulations: Definitions, Thresholds, Exclusions and Calculations

Transcription

1 New Section 199A Qualified Business Income Regulations: Definitions, Thresholds, Exclusions and Calculations FOR LIVE PROGRAM ONLY OCTOBER 18, 2018, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at ext.1 (or ext. 1). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x1 (or x1) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 New Section 199A Qualified Business Income Regulations October 18, 2018 David M. Lehn, Partner Withersworldwide, Greenwich, Conn. Richard S. LeVine, Special Counsel Withersworldwide, New Haven, Conn.

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 5 Planning for 199A Deductions Richard LeVine, David Lehn Withers Bergman LLP October 18, 2018

6 6 Agenda Overview Definitions Conclusions Flow Chart Examples Reporting Requirements Final Thoughts Q&A

7 7 Overview

8 8 The Section 199A Deduction A deduction of 20% of the net income from essentially any business other than most service businesses. Determine the business net income. Reduce the income by 20%. The 199A Deduction is a phantom deduction. No expense, no capital improvement, no cash outlay required. The 199A Deduction does not apply to C Corporations. For pass-through entities, the deduction is applied at the entity s owner level (member, partner, shareholder). Each owner takes into account their share of each entity item for 199A purposes The 199A Deduction is applied as a deduction to reduce Adjusted Gross Income in determining Taxable Income (may be important for certain computations or for certain states that compute tax on AGI). So it is after the determination of AGI, but it is not an Itemized Deduction.

9 9 Prior Section 199 Deduction A deduction of 9% of qualified domestic production activities income. Sale or lease of tangible personal property (intended to encourage manufacturing, etc), software, sound recordings, films, electricity, natural gas potable water Construction of real property in construction trade/business Engineering/architectural services in real estate construction Subject to a Wage limitation and a taxable income limitation No longer effective for years beginning after December 31, The new 199A is much broader in terms of types of income that qualify for a deduction (rental real estate business, other types of real estate income, any non-specified service business, etc.) and more than doubles the deduction (20% vs 9%).

10 10 The Complete formula of the 199A Deduction The 199A Deduction is the Combined Qualified Business Income Amount (CQBIA), which includes (i) For each Qualified Trade or Business (QTB), 20% of the Qualified Business Income (QBI) from the QTB, determined by the qualified items of income, gain, deduction or loss (but not excluded Qualified Items). QTB excludes Services as an Employee and, generally, Specified Service Trade or Business (SSTB). Excluded Qualified Items generally include capital, dividend, interest, other financial products, and certain partnership payments. The 20% amount for each such QTB is subject to a limitation which is the greater of the Wage Limitation or the Wage/Basis Limitation, In the case of certain taxpayers whose taxable income is less than the Threshold Amount, a QTB may include a Specified Service Trade or Business (SSTB) and the income from such SSTB may be QBI. Further, the Wage Limitation or the Wage/Basis Limitation may not apply. If such taxable income is more than the Threshold Amount but less than the Phase In amount, a portion of Qualified Business Income and limited by a portion of such Wage Limitation or Wage/Basis Limitation (ii) 20% of the aggregate qualified REIT dividends, and (iii) 20% of the aggregate qualified publicly traded partnership income. The 199A Deduction is limited to 20% of Taxable Income, excluding (i) net capital gain (but including net capital loss) and (ii) the 199A Deduction

11 11 Definitions

12 12 Definitions Qualified Trade or Business (QTB) Specified Service Trade or Business (SSTB) Qualified Business Income (QBI) Combined Qualified Business Income Amount ** Relevant Pass-Through Entity (RPE) W-2 Wage Limitation & Wage/Basis Limitation Wages, Unadjusted Basis (UBIA), Qualified Property Qualified REIT Dividend Qualified Publicly traded partnership income Qualified items of income, gain, deduction or loss from a Qualified Trade or Business Qualified Cooperative Dividends Threshold Amount ** It is possible to have a Combined Qualified Business Income Amount without having Qualified Business Income

13 13 Definitions Qualified Trade or Business Any trade or business other than: (i) a specified service trade or business or (ii) the trade or business of being an employee. In the case of a trade or business conducted through an S corporation or a partnership, the section 199A deduction is computed at the shareholder or partner level. Accordingly, an owner may have a single qualified trade or business conducted through multiple pass-through entities. The identification of qualified trades or businesses under section 199A will not necessarily follow the activity rules under section 469. No specific definition of trade or business is provided under section 199A (with one exception), instead following the section 162 definition. An exception is provided for the rental or licensing of tangible or intangible property to a commonly controlled business. If such activity is not otherwise a section 162 trade or business, it will be treated as a trade or business for purposes of section 199A.

14 14 Definitions Qualified Trade or Business Any trade or business unless excluded. Extremely broad No definition in the IRC exists for trade or business Courts Control, investment, effort and time devoted by taxpayer, opportunity for profit/loss, permanency, relationships with others, indicia of business When is there sufficient activity to be a trade or business? For example, if a business leases out real estate on a triple net lease, is the net lease situation a Qualified Trade or Business? May need to provide a work around to make a net lease NOT a net lease.

15 15 Definitions Specified Service Trade or Business Any trade or business involving the performance of services in the fields of: health, law, accounting, actuarial service, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or any trade or business which involves the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities.

16 16 Definitions Specified Service Trade or Business The SSTB limitation does not apply to individuals with taxable income below the threshold amount. A phase-in rule applies to individuals with taxable income within the phase-in range, allowing them to take into account a certain applicable percentage of QBI, W-2 wages, and UBIA of qualified property from an SSTB. No QBI, W-2 wages, or UBIA of qualified property from the SSTB may be taken into account by any individual whose taxable income exceeds the phase-in range, even if the item is derived from an activity that is not itself a specified service activity. If a relevant passthrough entity ( RPE ) conducts a SSTB, this limitation applies to any direct or indirect individual owners of the business, regardless of whether the owner is passive or participated in any specified service activity.

17 17 Definitions Specified Service Trade or Business De minimis rule Gross receipts of $25 million or less. For a trade or business with gross receipts of $25 million dollars or less for the taxable year, a trade or business is not an SSTB if less than 10 percent of the gross receipts of the trade or business are attributable to the performance of services. Gross receipts of greater than $25 million. For a trade or business with gross receipts of greater than $25 million for the taxable year, a trade or business is not an SSTB if less than 5 percent of the gross receipts of the trade or business are attributable to the performance of services. For purposes of determining whether the de minimus test is satisfied, the performance of any activity incident to the actual performance of services in the field is considered the performance of services in that field.

18 18 Definitions Specified Service Trade or Business Related Party Activity An SSTB includes any trade or business that provides 80 percent or more of its property or services to an SSTB if there is 50 percent or more common ownership of the trades or businesses. If a trade or business provides less than 80 percent of its property or services to an SSTB within the meaning of this section and there is 50 percent or more common ownership of the trades or businesses, that portion of the trade or business of providing property or services to the 50 percent or more commonly-owned SSTB is treated as a part of the SSTB. 50 percent or more common ownership includes direct or indirect ownership by related parties within the meaning of sections 267(b) or 707(b).

19 19 Definitions Specified Service Trade or Business Trade or Business Incidental to an SSTB A trade or business (that would not otherwise be treated as an SSTB) will be treated as incidental to and, therefore, part of the SSTB if: it has 50 percent or more common ownership with an SSTB, including related parties (within the meaning of sections 267(b) or 707(b)), has shared expenses with the SSTB, including shared wage or overhead expenses, and if the gross receipts of the trade or business represents no more than 5 percent of the total combined gross receipts of the trade or business and the SSTB in a taxable year.

20 20 Definitions Qualified Business Income The net amount of qualified items of income, gain, deduction and loss with respect to the qualified trade or business of the taxpayer. Items of income, gain, deduction and loss are qualified only to the extent that: they are included or allowed in the determination of the taxpayer s taxable income for the year and they are effectively connected with the conduct of a trade or business in the United States, including Puerto Rico.

21 21 Definitions Qualified Business Income - Qualified business income does not include: Capital items (gain or loss) Dividends Interest income, except if included in a trade or business Certain Commodities and Foreign Currency gains or losses or notional principal contracts income etc. Annuity income not part of a trade or business Reasonable Compensation that should have been paid to a Shareholder/Employee (but not Partner) Guaranteed payments of a partnership (use preferred profits interest) IRC 707(a) payment for services The concept is that the 199A Deduction is to be based on operating income.

22 22 Definitions Qualified Business Income Previously suspended losses are generally QBI in the year in which they are deducted. Typical suspended losses include the following: Section 465 at-risk losses; Section 469 passive activity losses; Section 704(d) basis limitations for partnership interests; and Section 1366(d) basis limitations for S corporations. Only applies to post-2017 taxable years

23 23 Definitions Qualified Business Income The treatment of section 1231 gains and losses was not specified in the statute, but the proposed regulations clarified that the treatment of such items depends on their ultimate classification in the hands of each taxpayer: For a taxpayer with net section 1231 gains, all such gains and losses are long-term capital gains and losses, and thus excluded from QBI. For a taxpayer with net section 1231 losses, all such gains and losses are ordinary gains and losses, thus included in QBI to the extent that all other requirements are satisfied. The proposed rules presumably extend to gains characterized as ordinary under section 1231(c) (five-year lookback rule). Interest income is subject to the following rules in determining QBI: To the extent it is properly allocable to a trade or business, such as interest received on accounts or notes receivable, or loans made by the trade or business, it is QBI. Interest income received on working capital, reserves, or similar accounts is not QBI.

24 24 Definitions Qualified Business Income Qualified items of income, gain, deduction or loss from a Qualified Trade or Business: U.S. Sourced Includes Partnership Hot Asset income (IRC 751) Excludes loss carryforwards from pre-2018 income years.

25 25 Definitions Qualified Business Income Fiscal-Year Relevant Passthrough Entities (RPE) Because section 199A is applied at the owner level for S corporations and partnerships, questions had been raised about the application of the provision for fiscal-year entities with calendar-year owners. The proposed regulations clarify that the taxpayer (S corporation shareholder or partner) takes items of QBI, UBIA, and W-2 wages of a passthrough entity into account for the taxable year of the taxpayer in which or with which the entity s taxable year ends. Accordingly, for an entity with a taxable year that began in the calendar year 2017 and ends in the calendar year 2018, all of the entity s items are taken into account in determining a calendar-year owner s QBI, UBIA, and W-2 wages for A Trust that allocates income to beneficiaries may be considered a RPE

26 26 Definitions Qualified Business Income Allocation of Items Among Directly-Conducted Trades or Businesses An individual or an RPE may directly conduct two or more trades or businesses. QBI must be determined for each qualified trade or business. RPEs with QBI must allocate the items of income, gain, deduction, and loss among the trades or businesses to which they are allocable using a reasonable method that is consistent with the purposes of section 199A. Allocation methods may vary from one item to the next, but must be consistently applied from year to year and must clearly reflect income. Suggested reasonable methods may include direct tracing, allocations based on gross income, or other methods, depending on the facts and circumstances of each trade or business.

27 27 Definitions Combined Qualified Business Income Amount Means the sum of: (i) the lesser of (a) 20% of the qualified business income of the taxpayer and (b) the W-2 Wage/Basis limitation of the taxpayer; plus (ii) 20% of all qualified REIT dividends of the taxpayer; plus (iii) 20% of all qualified publicly traded partnership income of the taxpayer.

28 28 Definitions Wage/Basis Limitation The Wage/Basis limitation is equal to the greater of: (i) 50% of the taxpayer s allocable share of the entities W-2 wages paid or (ii) the sum of (a) 25% of the W-2 wages allocated to the taxpayer plus (b) 2.5% of the unadjusted basis (immediately after acquisition) (UBIA) of all qualified property. If the taxpayer s taxable income is below the threshold amount, then the Wage/Basis limitation does not apply. The Wage/Basis limitation phases in for a taxpayer with taxable income in excess of the threshold amount. The Wage/Basis limitation is fully phased in for taxpayers who have taxable income of: (x) $315,000 + $100,000 for joint filers and (y) $157,500 + $50,000 for single filers. The Wage/Basis limitation does not apply to qualified REIT dividends or qualified publicly traded partnership income.

29 29 Definitions W-2 Wages Means the total wages subject to wage withholding, elective deferrals, and deferred compensation paid by the qualified trade or business with respect to employment of its employees during the calendar year ending during the tax year of the taxpayer. W-2 Wages do not include: (a) any amount that is not properly allocable to the qualified business income as a qualified item of deduction; and (b) any amount that was not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date (including extensions) for filing such return.

30 30 Definitions Notice Proposed revenue procedure provides three methods for calculating total W-2 wages: 1) Unmodified Box Method Lesser of: Total box 1 wages for all employees, or Total box 5 wages for all employees 2) Modified Box 1 Method Box 1 wages for all employees are adjusted by the following amounts: Subtract amounts included in box 1 that are not wages for Federal income tax withholding purposes (i.e. supplemental unemployment compensation benefits) Add amounts reported in box 12 that are properly coded D, E, F, G and SD, E, F, G, & S are 401(k), 403(b), 408(k)(6), 457(b), & 408(p) deferrals respectively 3) Tracking Wages Method Total amount of wages subject to Federal income tax withholding plus amounts reported in box 12 that are properly coded as D, E, F, G and S Method #1 is the least burdensome but methods #2 and #3 are more accurate

31 31 Definitions Unadjusted Basis Immediately After Acquisition (UBIA) - Means the initial basis of the qualified property in the hands of the individual or RPE, depending upon whether it was purchased or contributed. UBIA is determined without regard to any adjustments for any portion of the basis for which the taxpayer has elected to treat as an expense (for example, under Sec. 179 of the Code). Therefore, for purchased or produced qualified property, UBIA generally will be its cost as of the date the property is placed in service. For qualified property contributed to a partnership in a tax-free exchange for a partnership interest and immediately placed in service, UBIA generally will be its Adjusted basis in the hands of the contributing partner, and will not be changed by subsequent elective basis adjustments under Sections 734 or 743. For property inherited from a decedent and immediately placed in service by the heir, the UBIA generally will be its fair market value at the time of the decedent s death.

32 32 Definitions UBIA is allocated to partners and shareholders of RPEs as follows: For qualified property currently generating tax depreciation: The partner or shareholder s share of UB is the same proportion as their share of tax depreciation bears to the entity s total tax depreciation for that property. For qualified property not currently generating tax depreciation (such as for property that had been held for less than 10 years with shorter recovery period): For partners their share of UBIA is based on how gain would be allocated to them pursuant to sections 704(b) and 704(c) if the qualified property were sold for cash equal to its fair market value. For shareholders their share of UBIA is based on the ratio of shares held by them in the S corporation to total shares of the S corporation. Implications: Due to bonus depreciation and section 179 UBIA is likely to include significant amounts of fully depreciated property. Proper capital account maintenance will be critical to properly allocating UBIA of partnerships

33 33 Definitions Qualified Property Means tangible property of a character subject to depreciation: (i) is held by, and available for use in, the qualified trade or business at the end of the tax year; (ii) that is used in the production of qualified business income; and (iii) for which the depreciable period has not ended before the end of the tax year. An anti-abuse rule provides that property is not qualified property if it is acquired within 60 days of the end of the taxable year and disposed of within 120 days, without being used in the trade or business for at least 45 days

34 34 Definitions Depreciable Period Means, with respect to qualified property, the period beginning on the date the property is first placed into service and ending on the later of: (i) the date 10 years after such date; and (ii) the last day of the last full year of the applicable recovery period that would apply to the property under IRC 168(c) (without regard to 168(g)). Property acquired in a non-recognition event generally will be treated as two separate properties, the carryover portion (exchanged basis) and the new portion (excess basis) For the carryover portion, the depreciable period starts when the relinquished property was originally placed in service For the new portion, the depreciable period starts when the replacement property is placed in service

35 35 Definition Improvements to Qualified Property Treated as separate qualified property Date placed in service is beginning date

36 36 Definitions Threshold Amount This is the amount which causes the Wage/Basis limitation to be phased in and the specified service trade or business exclusion to be phased in, thus, if a taxpayer earns less than the applicable threshold amount, neither the Wage/Basis limitation nor the specified service trade or business exclusion apply. The threshold amount is: $157,500 for single filers; $315,000 for joint filers; and In each case adjusted for inflation. A non-employee (i.e. independent contractor, LLC owner, etc.) that is generating income through a SSTB will have Qualified Business Income if their Taxable Income is less than the Threshold Amount because the Specified Service rule is ignored in this circumstance.

37 37 Definitions Qualified REIT Dividends Means any dividend from a REIT received during the tax year which is not a capital gain dividend and is not qualified dividend income. Qualified Publicly Traded Partnership Income Means, with respect to any qualified trade or business of the taxpayer, the sum of: (i) the net amount of such taxpayer s allocable share of each item of income, gain, deduction and loss from a publicly traded partnership which is not treated as a corporation plus (ii) any gain recognized by the taxpayer upon the disposition of its interest in such publicly traded partnership to the extent such gain is treated as an amount realized from the sale or exchange of property other than a capital asset under IRC 751(a).

38 38 Definitions Qualified Cooperative Dividend Means any patronage dividend (as defined in IRC 1388(a)), any per-unit retain allocation (as defined in IRC 1388(f)) and any qualified written notice of allocation (as defined in IRC 1388(c)) or any similar amount received from an organization described in IRC 501(a) and/or IRC 1381 and/or an organization which is governed by the rules applicable to cooperatives before the enactment of subchapter T.

39 39 Definitions Applicable Percentage Amount Means the applicable percentage of qualified items of income, gain, deduction or loss and the W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property of the taxpayer allocable to such specified service trade or business shall be taken into account in computing the qualified business income, W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property of the taxpayer for the taxable year for purposes of applying this section. Applicable Percentage Means 100%, reduced (not below zero) by the percentage equal to the ratio of (i) the taxable income of the taxpayer for the year in excess of the threshold amount, bears to (ii) $50,000 ($100,000 in the case of a joint return).

40 40 Definitions Aggregation of Trade or Business An individual or RPE may be engaged in more than one trade or business. Unless the trades or businesses are aggregated, each trade or business is a separate trade or business for purposes of applying the Wage and Basis Limitations.

41 41 Definitions Aggregation of Trade or Business An individual may aggregate trades or businesses operated directly and the individual s share of QBI, W-2 wages, and UBIA of qualified property from trades or businesses operated through RPEs. Multiple owners of an RPE need not aggregate in the same manner. For those trades or businesses directly operated by the individual, the individual computes QBI, W-2 wages, and UBIA of qualified property for each trade or business before applying these aggregation rules. If an individual aggregates multiple trades or businesses, the individual must combine the QBI, W-2 wages, and UBIA of qualified property for all aggregated trades or businesses for purposes of applying the Wage and Basis Limitations.

42 42 Definitions Aggregation of Trade or Business Once an individual chooses to aggregate two or more trades or businesses, the individual must consistently report the aggregated trades or businesses in all subsequent taxable years. An individual may add a newly created or newly acquired (including through nonrecognition transfers) trade or business to an existing aggregated trade or business. In a subsequent year, if there is a change in facts and circumstances such that an individual s prior aggregation of trades or businesses no longer qualifies for aggregation under the rules of this section, then the trades or businesses will no longer be aggregated within the meaning of this section, and the individual must reapply the aggregation rules to determine a new permissible aggregation (if any).

43 43 Definitions Aggregation of Trade or Business Why all the focus on aggregation? If a QTB with losses has significant Wages or Basis, these items are wasted because they can NOT be used to allow for a greater 199A Deduction with respect to a separate QTB. Focus on combining the QTBs.

44 44 Definitions Required Annual Disclosure For each taxable year, individuals must attach a statement to their returns identifying each trade or business aggregated. The statement must contain: Description of each trade or business; The name and EIN of each entity in which a trade or business is operated; Information identifying any trade or business that was formed, ceased operations, was acquired, or was disposed of during the taxable year; and Such other information as the Commissioner may require in forms, instructions, or other published guidance.

45 45 Applying Sec. 199A to trusts, estates, and beneficiaries A trust or estate computes its section 199A deduction based on the QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income that are allocated to the trust or estate An individual beneficiary of a trust or estate takes into account any QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income allocated from a trust or estate in calculating the beneficiary s section 199A deduction, in the same manner as though the items had been allocated from an RPE

46 46 Applying Sec. 199A to trusts, estates, and beneficiaries A trust or estate is treated as an RPE to the extent it allocates QBI and other items to its beneficiaries and is treated as an individual to the extent it retains the QBI and other items.

47 47 Grantor trusts and Section 199A To the extent that the grantor or another person is treated as owning all or part of a trust, such person computes its section 199A deduction as if that person directly conducted the activities of the trust with respect to the portion of the trust treated as owned by the grantor or another person.

48 48 Non-grantor trusts and Section 199A A trust or estate must calculate its QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income The QBI (including any amounts that may be less than zero as calculated at the trust or estate level), W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income of a trust or estate are allocated to each beneficiary and to the trust or estate based on the relative proportion of the trust s or estate s distributable net income (DNI), for the taxable year that is distributed or required to be distributed to the beneficiary or is retained by the trust or estate.

49 49 Applying Sec. 199A to trusts, estates, and beneficiaries non-grantor trusts If the trust or estate has no DNI for the taxable year, any QBI, W-2 wages, UBIA of qualified property, qualified REIT dividends, and qualified PTP income are allocated entirely to the trust or estate The threshold amount applicable to a trust or estate is $157,500 for any taxable year beginning before 2019

50 50 Applying Sec. 199A to trusts, estates, and beneficiaries non-grantor trusts For taxable years beginning after 2018, the threshold amount shall be $157,500 increased by the cost-of-living adjustment For purposes of determining whether a trust or estate has taxable income that exceeds the threshold amount, the taxable income of a trust or estate is determined before taking into account any distribution deduction under sections 651 or 661.

51

52 52 Conclusions

53 53 Conclusions No entity is penalized under the new tax law. Some entities and situations might not qualify or be limited in some fashion, but no one pays more than they did the old 2017 tax law (unless you owe GILTI which is another webinar entirely). Taxable income becomes a big deal for two reasons. First, $1 over $157,500 or $315,000 starts the specified service business disqualification and W-2 limitation (and there is also a depreciation component that we are glossing over in this summary). Second, the Section 199A deduction is limited by 20% of taxable income from all sources (what would be reported on your tax returns).

54 54 Conclusions W-2 wages include all W-2 wages, not just those paid to the owner(s). Converting a 1099 contractor to a W- 2 employee might increase the 199A deduction (but might cost more in benefits owed to the new employee). It appears that self-employment taxes will still be calculated on the net business income BEFORE the Section 199A deduction since the deduction is taken below the line on Form So you could earn $100,000 and deduct $20,000 under Section 199A, but still pay selfemployment taxes on $100,000.

55 55 Conclusions S corporations remain a critical small business tax saving tool for two reasons. First, the usual self-employment tax savings remains intact for all business owners including specified service trades or businesses. Second, a business owner whose income is over the threshold amount might want to pay W-2 wages to himself or herself to not be limited by the W-2 wage limitation, and only corporations can pay W-2 wages to owners. An LLC taxed as a partnership or disregarded entity cannot and must make an entity classification ( check the box ) and an S Corp election in order to pay wages to its owner.

56 56 Conclusions Any individual subject to tax by the United States on their QBI may qualify for the deduction, assuming all other requirements are satisfied, including the following persons: A nonresident alien who is a partner in a partnership with an effectively connected trade or business; A citizen or resident alien (taxable on worldwide income) with respect to any qualified trade or business conducted directly or through a disregarded entity, an S corporation, or a partnership even a non-us partnership. Foreign-source losses could reduce taxable income and thus reduce the QBI deduction.

57 57 Flow Chart

58 58 Flowchart of Obstacles to Getting Deduction Noncorporate taxpayer? 1 No No Deduction! DEDUCTION = LESSER of Yes Domestic Income? 2 Yes No Yes Specified service trade / business? 8 No 20% of QBI OR GREATER of 50% of W-2 wages OR 25% of W-2 wages + 2.5% qualified property Qualified Business Income? 3 No Yes Yes Specified agri- or horticultural co-op? 4 No Taxable income > full phaseout amount? 9 No + 20% of Qualified REIT dividends 20% Qualified PTP income Yes DEDUCTION 5 = 9% of LESSER of Qualified production activities income 6 OR Co-op taxable income 7 Taxable income < phaseout threshold? 10 DEDUCTION = 20% of QBI + Yes 20% of Qualified REIT dividends 20% Qualified PTP income No REDUCED DEDUCTION 11 (pro rata between trigger amount and full phaseout) Special rule for agri- and horticultural co-ops. In all cases The Sec. 199A deduction is limited to 20% of taxable income in excess of net capital gains as defined in Sec. 1(h). (Sec. 199A(a)(2))

59 59 Flowchart Notes 1. Is the entity a taxpayer other than a C corporation (including a trust or estate) that owns a: Sole proprietorship S corporation Partnership 2. Domestic: Effectively connected with conduct of trade/business within U.S. & Puerto Rico 3. QBI: Net amount of items of income, gain, deduction & loss with respect to any qualified trade or business, except Reasonable compensation Guaranteed payments Investment income Short-term & long-term capital gain/loss Dividend income Interest income Note: Overall loss treated as loss for purposes of calculation in subsequent year 4. Cooperative that is significantly engaged in the marketing, manufacturing, production, growth or extraction of any agricultural or horticultural product, including fertilizer, diesel fuel & other supplies (New 199A) 5. Deduction limited to 50 percent of W-2 wages allocable to domestic production gross receipts 6. Qualified production activities income: Domestic production gross receipts less the cost of goods sold, losses & other expenses properly allocable to those receipts 8. Specified service business: Any trade or business involving performance of services in fields of Health Law Accounting Actuarial science Performance arts Investing & investment management, trading or dealing in securities, partnership interests or commodities Consulting Athletics Financial services Brokerage services Principal asset is reputation or skill of one or more of its employees or owners 9. Full phaseout amount = $207,500 (single) $415,000 (married filing jointly (MFJ)), indexed 10. Threshold amount = $157,500 (single) $315,000 (MFJ), indexed 11. Reduced deduction: Wage limitation phases in & the deduction for specified service businesses phases out on a pro-rata basis between the threshold & full phase-out amounts 7. Taxable income determined before any deduction for patronage dividends, per-unit retain allocations & nonpatronage dividends

60 60 Examples

61 61 Examples Example 1: A, a single taxpayer, has qualified business income of $100,000, long-term capital gain of $50,000, and deductions of $75,000, resulting in taxable income of $75,000. A s tentative Sec. 199A deduction of $20,000 is limited to $5,000 (20% of the excess of taxable income of $75,000 over long-term capital gain of $50,000). Example 2: A is married and has taxable income of $500,000, including income of $300,000 from a specified service business. Because the income is from a specified service business and taxable income exceeds $415,000, no deduction is permitted.

62 62 Examples Example 3: A is married and has taxable income of $385,000, including income of $300,000 from a specified service business. A s share of the W- 2 wages of the business is $150,000. Because taxable income is greater than $315,000 but less than $415,000, A is entitled to a partial deduction. To determine the deduction, A takes into account his applicable percentage of the qualified business income and the W-2 wages. The applicable percentage is (100% - (($385,000 - $315,000)/$100,000)) or 30%. Thus, A s qualified business income is $90,000 and his share of W-2 wages is $45,000. A s deduction is equal to $18,000, the lesser of $18,000 ($90,000 * 20%) or $22,500 ($45,000 * 50%).

63 63 Examples Example 4: A is married and has taxable income of $300,000, including income of $200,000 from a specified service business. A s share of the W- 2 wages of the business is $20,000. Because taxable income is less than $315,000, A is entitled to a deduction equal to $40,000 ($200,000 * 20%). Neither the prohibition on specified service businesses nor the W-2 limitations apply at this level of taxable income.

64 64 Examples Example 5: A is married and has taxable income of $335,000, including income of $300,000 from a business that is NOT a specified service business. A s share of the W-2 wages of the business is $100,000. Because taxable income is greater than $315,000 but less than $415,000, A is entitled to a partial deduction. To determine the deduction, A must reduce his excess amount of $10,000 ($300,000 * 20%, or $60,000 less 50% of $100,000, or $50,000) by a percentage. The percentage is 20% (($335,000 - $315,000) / $100,000). Thus, A must reduce his $10,000 excess amount by $2,000. This leaves A with a deduction of $58,000.

65 65 Examples Example 6: A is married and has taxable income of $465,000, including income of $300,000 from a business that is NOT a specified service business. A s share of the W-2 wages of the business is $100,000. Because taxable income is greater than $415,000, A is entitled to a deduction of $60,000, limited to the greater of: 50% of W-2 wages, or $50,000, or 25% of W-2 wages, or $25,000, plus 2.5% of his share of the unadjusted basis of qualified property, or $0, for a total of $25,000. Thus, A is entitled to a deduction of $50,000.

66 66 Real Estate Examples #RE1 Owner buys land for $15mm and net leases to airport for $1mm per year. 20% of $1mm would be $200, A deduction. Owner has no wages and land is not depreciable. Thus, the 199A deduction is ZERO. #RE2 Owner, after buying land, constructs parking garage for $20mm and net leases to airport for $2.5mm per year. Annual depreciation is approximately $500,000. Net income is $2mm per year. 20% of $2mm would be $400,000. Owner has no wages. For Wage/Basis Limitation, 2.5% of $20mm depreciable property is $500,000. Thus, the 199A deduction is $400,000 (if Net Lease is a QTB!!) #RE3 Same as #RE2 except purchase of land and garage construction was 100% financed at 4% interest. Annual interest expense of $1,400,000 ($35mm x4%). Net income is $600,000 ($2.5mm net lease income less $1.4mm interest & $500,000 depreciation). 20% of $600,000 is $120,000. Thus, the 199A deduction is $120,000. (Wage/Basis Limitation is still $500,000).

67 67 Real Estate Examples #RE4 Same as #RE3 except Owner asserts 15 year (rather than 39 year) recovery period. Annual depreciation is approximately $1.3mm. Net loss of $200,000 ($2.5mm net lease income less $1.4mm interest & $1.3mm depreciation). Thus, no 199A deduction. #RE5 Same as #RE3 (back to 39 year depreciation) except that, after 10 years, it s time for a new lease and the airport is booming, land is scarce and the parking garage is overflowing. Owner decides not to renew lease and instead hires personnel for security, maintenance, fee collection, etc. Owner collects $7.5mm per year in parking fees, has $1mm in wage expense and $1.5mm in insurance and other costs. With EBITDA at $5mm, net income is $3.1mm ($5mm EBITDA less $1.4mm interest & $500,000 depreciation). 20% of $3.1mm is $620,000. The Wage Limitation is $500,000 (50% of $1mm). The Wage/Basis Limitation is $750,000 (25% of 1mm plus 2.5% of $20mm). Thus, the 199A deduction is $620,000.

68 68 Reporting Requirements

69 69 Reporting Requirements Reporting Requirements of RPEs The proposed regulations require the following information to be provided by the RPE for each trade or business it directly engages in: Each owner s allocable share of QBI, W-2 wages, and UBIA. Whether any of the trades or businesses are SSTBs. If an RPE itself owns a direct or indirect interest in an RPE it must also report the QBI, W-2 wages, UBIA, and SSTB status on an attachment to the K-1 for those lower-tier RPEs

70 70 Reporting Requirements Reporting Requirements of RPEs RPEs must also report quailed REIT dividends and qualified PTP income or loss whether earned directly or through lower-tier RPEs. Failure to report this information results in all amounts presumed to be zero. Implications: Multi-tier RPEs will result in items on the face of the K-1 and on attachments Complexity in identifying each trade or business (even if aggregated). SSTBs will still have to comply with reporting requirements

71 71 Two Types of Taxpayers Those with significant income from various enterprises How do the rules and computations overlap to either increase or decrease the 199A deduction Focus on whether aggregating enterprises is helpful Potential tainting of Specified Service Trade or Business (aka Bad) to Qualified Trade or Business Those with income near or below the Threshold Amount Broader ability to utilize the 199A deduction Specified Service Trade or Business is not excluded But beware the presumption for former employees Wage/Basis Limitations do not apply

72 72 Strategies Focus on Wage/Basis Limitations Focus on Aggregating Businesses to avoid Limitations Focus on Taxable Income Limitation (perhaps bunching of other income/deductions) Leveraging various concepts simultaneously

73 73 Strategies Deleverage your qualified business: Suppose your portfolio consists of two assets: A $1,000,000 Bond paying you 4% interest. And a profitable rental property encumbered by a $1,000,000 mortgage costing you 4% interest. In this situation, you can increase your qualified business income by $40,000 if you cash in the Bond and use that money to pay off the real property s mortgage. That $40,000 increase in qualified business income should increase your Sec. 199A deduction by $8,000 and could cut your federal income taxes by as much as $3,000.

74 74 Strategies Reallocate from growth stocks to equity-income stock: If your taxable income equals $150,000 and that amount includes $50,000 of long-term capital gains, your Section 199A deduction can t exceed 20% of $100,000. That Section 199A deduction is still substantial at $20,000. But if your taxable income equals $150,000 and that amount includes, $50,000 of qualified dividends instead, your Section 199A deduction can t exceed 20% of $150,000. That Section 199A deduction equals $30,000. That could save you $2,400. Holding equity-income stocks paying dividends in your taxable account rather than growth stocks generating capital gains.

75 75 Strategies Domestic Investments Not International Sec. 199A applies to only to domestic income. Not foreign income. For example, a rental property in Florida potentially creates a Sec. 199A deduction. But an identical property in the Bahamas does not. A domestic REIT creates a Section 199A deduction, but a foreign REIT typically does not. You may have great reasons to invest internationally. But be aware that a domestic equivalent investment may allow you to avoid income taxes on the last twenty percent of the investment s income.

76 76 Application of the 199A Deduction For Taxpayer s years beginning After 2017 and Before 2026 Applies to a Taxpayer s RPEs with taxable year beginning in 2017 if the year ends in 2018.

77

78 78 Structure of the Regulations

79 79 Prop. Reg. Section 1.199A-1 Operational Rules Important definitions Computational rules where taxable income does not exceed the Threshold Amount Basic calculation Negative amounts (QBI and/or REIT/PTP income) Computational rules where taxable income exceeds the Threshold Amount Basic calculation Netting and carryover rules Negative amounts (QBI and/or REIT/PTP income)

80 80 Prop. Reg. Section 1.199A-2 Operational Rules Determination of W-2 Wages Allocation of wages to a trade or business Allocation of wages to QBI Determination of UBIA of Qualified Property General rules Special situations

81 81 Prop. Reg. Section 1.199A-3 Operational Rules Qualified Business Income, REIT Dividends, & PTP Income Definition of QBI specific inclusions and exclusions Definition of REIT dividends and PTP income Anti-abuse rules

82 82 Prop. Reg. Section 1.199A-4 Aggregation General aggregation rules provide flexibility but exclude SSTBs Aggregation occurs at the individual taxpayer level, not the entity level Binding election Reporting requirements

83 83 Prop. Reg. Section 1.199A-5 Specified Service Trade or Business Defines the meaning of each listed SSTB De minimisrules based on gross receipts Incidental rule relating to non-sstbs Aggregation rule for non-sstbs providing products or services to a related SSTB Performance of services as an employee

84 84 Prop. Reg. Section 1.199A-6 Relevant Passthrough Entities, PTPs, Trusts, and Estates Order of steps in computing QBI Reporting rules for QBI Computational and reporting rules for PTPs Application to trusts, estates, and beneficiaries

85 85 Final Thoughts

86 86 David M Lehn david.lehn@withersworldwide.com Tel: Richard S LeVine richard.levine@withersworldwide.com Tel: