Post-Reform Lessons From 2018 To Help Small Business Clients Save in 2019 and Beyond. Presented by William Byrnes and Robert Bloink February 6, 2019

Transcription

1 Post-Reform Lessons From 2018 To Help Small Business Clients Save in 2019 and Beyond Presented by William Byrnes and Robert Bloink February 6, 2019

2 Welcome William H. Byrnes, J.D., LL.M Author, Tax Facts Robert Bloink, J.D., LL.M, Author, Tax Facts Texas A&M School Of Law Master Program of Wealth Management

3 New Boss is the Same as the Old Boss: Seven-Bracket System Retained Under Tax Reform

4 Overriding Changes in Basic U.S. Tax Structure for Corporations and Individuals

5 A Side-by-Side Comparison: Effective Tax Rates for Corporations & Pass-Throughs

6 Planning for Pass-Throughs Corporations benefit from a newly reduced 21% tax rate, but pass-through income is passed through and taxed at the business owner s tax rate as high as 37%, and even more with the 3.8% ACA tax. The new rules governing the tax treatment of pass-through entities are complicated, and make income minimization and trust planning strategies valuable for many small business clients so that they, like C corporations, benefit postreform. The proposed regulations governing the new Section 199A deduction came late in 2018, and their complexity made it difficult for many clients to adequately plan to maximize the deduction for the 2018 tax year. As we move into 2019, advance planning under the finalized regulations can help more clients maximize the value of the 20 percent Section 199A deduction to save on taxes in , after which the new law is technically set to expire absent extension by Congress.

7 Tax Reform Introduced Significant Changes for Small Business Clients The 2017 tax reform legislation created a new 20 percent deduction for the qualified business income (QBI) of certain pass-through entities. Application of the deduction will vary based on circumstances, but the basic components of the rule are fairly straightforward. Basic Mechanics of the 199A Deduction Pass-through entitles are now generally entitled to deduct 20 percent of qualified business income, which excludes the income of certain service businesses with income that exceeds a threshold amount. The income threshold levels for purposes of the Section 199A deduction were increased for 2019 to $321,400 for married taxpayers, $160,725 for married taxpayers who file separate returns and $160,700 for single and head-ofhousehold tax returns.

8 How the Section 199A Deduction Works When a pass-through business income exceeds the annual threshold limits, the value of the new Section 199A deduction is capped at the greater of (1) 50 percent of W-2 wage income or (2) the sum of 25 percent of the business W-2 wages plus 2.5 percent of the unadjusted basis of all qualified property, as determined immediately after acquisition. Qualified Property Qualified property is generally defined to include depreciable property. W-2 Wage Tip: W-2 wages for purposes of the deduction do not count unless reported on a Form W-2 filed within 60 days of the filing deadline + extensions. For most taxpayers, that means April 1, Phase-in Rule A phase in rule applies, so that if the business income only exceeds the threshold by $50,000 (single filers) or $100,000 (married returns), a portion of the deduction will be available even if the business is a service business Service Businesses Section 199A specifies which businesses are service businesses, and so subject to more stringent restrictions on the Section 199A deduction. The regulations governing Section 199A more fully outline which businesses are properly classified as service businesses. Lawyers, doctors and many financial professionals are classified as service businesses.

9 Why is Minimizing Taxable Income Important for Small Business Clients Under Section 199A? If the business owner s income falls below the annual threshold levels, determining the value of the deduction is simple it s 20 percent of qualified business income. This is the case regardless of the type of business the client operates. Exceeding the threshold level adds multiple layers of calculation that not only results in a less valuable tax benefit, but also adds significant room for error. Business owners who exceed the thresholds must: Determine service business status Service businesses are prohibited from taking a deduction at all if their income exceeds certain limits. Regulations eliminated the ability of business owners to split off service-related businesses to qualify for the deduction. Apply the aggregation rules Small business owners must then determine whether to aggregate any businesses, calculate W-2 wages and determine the unadjusted basis of all qualifying property. Businesses who do not aggregate must apply a complex netting formula. Consider the phase-out rules The calculation is perhaps most complicated for business owners that exceed the annual thresholds by less than $50,000/$100,000 complex phase-out rules then apply to determine the partial deduction.

10 Reducing Income to Fall Below the 2019 Income Threshold Levels As noted above, the 20 percent deduction for qualified business income phases out for many business owners with income levels that exceed the annual threshold levels. Although business owners who exceed the thresholds may think the deduction is irrelevant, they can take steps to maximize the value of the deduction over the coming years. To do so, small business owners should be advised of possible ways to reduce taxable income. Contributing to tax-preferred retirement accounts can add value both in maximizing the Section 199A deduction and in giving the small business owner options to save for his or her future. Varied Options for Retirement Planning Include: SEP IRAs Traditional 401(k)s Cash Balance Plans

11 Evaluating the Retirement Plan Options for Minimizing Income Every business owner has different goals when it comes to creating a retirement plan. While income minimization is important, the small business client must still be apprised of the pros and cons of the various retirement planning options. Three popular types of plans include SEP IRAs, traditional 401(k)s and cash balance plans. SEP IRAs Contributions limited to $56,000 per year No need to contribute each year Must contribute to accounts for all employees if any annual contributions are made Cannot maintain another retirement plan Traditional 401(k) For business owners, $56,000 annual contribution limit generally applies (employee and employer portion) No need to make comparable contributions for every employee More expensive to administer Non-discrimination testing may be required Cash Balance Plans Higher annual contribution limit can allow business owners to contribute upwards of $250,000 per year Contributions must be actuarially determined and annual maximum will vary based on age Must contribute every year, including on behalf of nonhighly compensated employees

12 Defined Contribution (SEP or 401(k)) vs. Defined Benefit Cash Balance Plan Option Small business owners who exceed the threshold levels significantly may be more attracted to the defined benefit plan model because of the very high contribution limits. Every business is different, and many factors apart from the contribution limits may come into play- -the business staff size and income level are two of these considerations. Emphasis on Plan Contribution Limits Both SEP-IRAs and 401(k)s are only valuable income reduction techniques for small business owners whose income does not significantly exceed the threshold levels (i.e., by more than $56,000). Cash balance plans allow the business owner to reduce taxable income by a much more substantial amount, but do require actuarial assistance and contributions for other employees. Tip: The business owner can establish both a 401(k) plan and a cash balance plan to contribute even more funds.

13 Multiple Trust Planning and the Section 199A Regulations

14 Non-Grantor Trust Strategies Once the Section 199A deduction became law, advisors started coming up with strategies to work around the rules and a non-grantor trust strategy was one of the first to emerge. The IRS caught on quickly. Basics of the Non-Grantor Trust Strategy Ownership of the business entity would be split among multiple non-grantor trusts, so that the trusts would be treated as separate owners from the actual business owners. Each trust-owner would receive no more than the annual income threshold limit each year. Each trust-owner would therefore qualify for its own 20% deduction.

15 Proposed Regulations Nix Non-Grantor Trust Workaround Strategy The IRS regulations on the Section 199A deduction contained a rule that requires aggregation of trusts in certain circumstances. Aggregation Required If: Substantially the same grantor or grantors (trust creators) Substantially the same beneficiaries Principal purpose of creating the trust, or contributing new assets to an existing trust, was tax avoidance Principal Purpose of Tax Avoidance is Assumed Principal purpose of tax avoidance is assumed if creating the trust, or contributing additional funds, creates a significant tax benefit The assumption can be rebutted if a significant nontax benefit can be shown Significant Non-Tax Benefits Can Include: Centralized asset management Aggregation of ownership within the family Avoidance of repetitive asset transfers Asset protection Relieving a family member of asset management burdens

16 The Non-Grantor Trust Strategy May Still be Possible in Some Circumstances Even with the new trust aggregation rule, trust planning might still be possible in certain circumstances. Clients should first be advised of the expense and administrative issues, as well as the tax implications, of employing a non-grantor trust strategy to maximize the 199A deduction. Multi-Trust Planning May be Possible Under the 199A Regulations if: The business is divided between trusts, and each trust has a different beneficiary. Some business owners might consider the viability of naming multiple children or family members as trust beneficiaries to ensure no two trusts has the same beneficiary. The business owner can legitimately demonstrate a significant non-tax purpose for creating or contributing additional business assets to the trust.

17 Key Takeaways The Section 199A deduction is designed to give a tax break to pass-throughs that is similar to the reduced rate given to C corporations. Calculating the 199A deduction is extremely complicated once the business income exceeds the annual threshold limitations. Income minimization techniques are more important than ever in in helping small business clients maximize the 199A deduction. Retirement planning options allow small business clients to kill two birds with one stone minimizing taxable income to maximize 199A while saving for the future.

18 Tax laws and regulations are continually changing. Where can I find answers to my Tax questions?

19 Exclusive Inside Look! Current and Reliable Answers to Clients Pressing Tax Questions

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22 Q&A

23 Thank You For more information please contact: Robert S. Bloink William H. Byrnes Jason Gilbert Customer Service