5/21/2019

1

IRC SECTION199A

Bobby Rich & Leif Ratliff

199A – UPDATE

Bobby Rich

5/21/2019

2

This Section Will Cover…

■ 199A Qualified Business Income Deduction Overview

■ Regulations Update

Overview

■ The deduction allows individuals and trusts and estates (if not all distributable net income is distributed to its beneficiaries) to deduct from taxable income up to:

■ 20 percent of the Qualified Business Income (QBI)

+

■ 20 percent of qualified real estate investment trust (REIT) dividends

and

20 percent of qualified publicly traded partnership (PTP) income.

5/21/2019

3

Limitations on 20% deduction

■ Taxable income less net capital gains (includes qualified dividends)

■ Taxable income limitations (2018 - $315,000 for married filing jointly; $157,500 for other filing statuses)

■ Business is classified as a specified service trade or business (SSTB)

Various Other Notes

■ Does not reduce income subject to self-employment tax or Net Investment Income tax

■ Allowed for both regular and AMT tax purposes

■ Does not reduce pass-through owners’ basis

5/21/2019

4

QBI Deduction – No Limitations

5/21/2019

5

QBI Deduction – Partial Limitation

QBI Deduction – Limited

5/21/2019

6

Operational Rule Changes

■ Taxpayer is not required to materially participate in order to take the 199A deduction

■ 50% or more commonly controlled attribution rules now refer to Sec. 267(b) and 707(b) which includes more relations than the proposed regulation narrow family relations (now includes brother, sister, trusts, etc.)

■ Safe harbor for real estate to qualify as a trade or business (Notice 2019-7)

Qualified Business Income

■ Suspended losses are taken in FIFO order (pre-2018 suspended losses do not reduce QBI)

■ Carried over suspended losses are treated as a loss from a separate trade or business (not same one as created from)

■ To the extent that deductions for SE health insurance, ½ SE tax, and retirement plan contributions are related to a trade or business with QBI, those deductions will reduce the related trade or business’ QBI

■ Ordinary income gains and losses are included in calculation of QBI (including depreciation recapture); S-T and L-T capital gains and losses continue to be excluded from QBI

5/21/2019

7

Qualified Business Income –Continued■ Section 1231 gains and losses must be netted to determine if they will affect

QBI. If there is a net 1231 loss, all 1231 gains and losses will be included in each TB’s QBI calculation. If there is a net 1231 gain, none of the 1231 gains and losses will affect the trade or business’ QBI calculation

■ SSTB rules apply to publicly traded partnerships

W-2 Limitations

■ Revenue Procedure 2019-11 provided more guidance on the calculation of the W-2 limitation factor

■ Should not include statutory employee wages■ Calendar Year Entities:

Use the calendar year W-3 and any of the three methods.■ Fiscal Year Entities:

Use the calendar year W-3 that falls within the fiscal year and can use any of the three methods.

5/21/2019

8

W-2 Limitations - Continued

■ Short Year Entities:For short year entities, method 3 (the tracking method) must be used. The taxpayer would start with the total amount of wages for the short year period subject to federal income tax withholding and reported on Form W-2 for the calendar year ending with or within that short taxable year. If the short year, does not contain a calendar year ending with or within the short year, you would use wages subject to federal income tax withholding that are actually or constructively paid to employees during the short year and reported on Form W-2 for that calendar year containing the short year and add only the portion of the total amounts that would be reported in Box 12, Code D, E, F, G, and S on Form W-2 that are actually deferred or contributed during the short tax year.

W-2 Limitation Calculation

5/21/2019

9

Unadjusted Basis Immediately after Acquisition (UBIA) Limitations■ Section 734(b) basis adjustments do not qualify for part of UBIA calculations

■ “Excess” Section 743(b) basis adjustments do qualify as an adjustment to UBIA

■ Sections 1031, 1033, and other tax-deferred exchanges do not reduce the original UBIA to the adjusted basis

■ In the case of property at a decedent’s death, the FMV at date of death is the UBIA value and the depreciable period starts at date of death

Excess 743(b) for UBIA

5/21/2019

10

Aggregation

■ Trade or business can be aggregated at entity level■ Multiple SMLLCs owned by the same owner are automatically aggregated

since they are disregarded entities■ Confirms SSTBs can’t be aggregated■ 50% common ownership requirement ownership expanded by reference to

Sec. 267(b) and 707(b)■ Ownership must be met for majority of tax year and also on last day of tax

year■ Trade or business must provide same products and services revised to

include “or property”

Aggregation - Continued

■ New example indicates rental of commercial and residential buildings are not same property

■ PTEs that make aggregation election must report same four qualifications as individuals indicating why trade or business can qualify to be aggregated

■ Individuals must include PTE aggregation statement with their return if applicable

■ If aggregation disclosure statement is not attached, Commissioner may disaggregate the trade or business

■ If Commissioner disaggregates trade or business, there is a three-year waiting period before they can be aggregated again

■ If trade or businesses that could be aggregated are not, that does not qualify as an election to not aggregate.

5/21/2019

11

Aggregation Benefit Example

Reporting

■ If an item of 199A (QBI, Wages, UBIA) is not reported by a pass through entity, only that item is presumed to be zero instead of all items

■ Draft forms 8995 and 8995-A released April 15th. Closely follows the worksheets included in Publication 535, Chapter 12

5/21/2019

12

5/21/2019

13

5/21/2019

14

199A RENTALS AND SSTB’S

Leif Ratliff

Outline

■ How rental property is treated under 199A rules– Safe-harbor.– Triple net leases. – Self-rentals.

■ Specified Service Trade or Business– General Rule.– What types of businesses are SSTB’s?– 3 situations that can occur with SSTB’s.

5/21/2019

15

Rental Property

■ Is Rental Property Considered to be a Qualified Trade or Business for purposes of the New Pass-through Deduction?

■ The first thought was yes it does. This was because of the unadjusted basis limitation.

■ Final regulations provides a Safe-Harbor, as well as facts and circumstances if the Safe-Harbor is not met.

What is the issue with rental Property? ■ Is it truly an actual trade or business or is it merely and investment?

■ The following two examples help highlight the difference between the two.

5/21/2019

16

Example 1

You've recently relocated half-way across the country for a new job. Since the housing market has been stagnant for the last few years in your old home town, you've decided to rent your old home until property values improve. It quickly becomes apparent that you'll have to engage a property manager to take care of finding tenants and maintaining the property.

Based on these facts and circumstances, it would appear that this rental is investment property and would not qualify for the pass-through deduction.

Example 2

You own 10 different rental houses in the city in which you live. You advertise for tenants, negotiate leases and terms, collect rent, take care of maintenance issues, and pay relating expenses. During a normal week, you spend between 15 and 20 hours managing these properties.

Based on these fact and circumstances, it would appear that these activities represent a trade or business and would qualify for the pass-through deductions.

5/21/2019

17

Safe-Harbor Requirements

1. Separate Books and Records maintained for each rental activity (or combined enterprise if grouped together). Commercial cannot be grouped with residential.

2. 250 Hours or more of "rental services" are performed per year for activity or combined enterprise. (defined on next slide)

3. Taxpayer or entity must maintain contemporaneous records including time reports or similar documents regarding the following:a. Hours of all services performed b. Description of services performedc. Dates performed d. By who.

4. This election must be signed by the taxpayer.

“Rental Services” Defined

Rental Services are defined as:■ Advertising to rent or lease.■ Negotiating and executing leases.■ Verifying information contained in prospective tenant applications.■ Collection of rent.■ Daily operation, maintenance, and repairs.■ Management of property.■ Purchase of materials and supervision of employees or contractors. (Does

NOT include financial or investment management activities)

5/21/2019

18

Safe-Harbor Takeaways

■ To meet the safe harbor hours it is roughly 5 hours per week.

■ Triple net leases are not eligible for the Safe-Harbor.

■ The Safe-Harbor is not allowed for properties that the taxpayer uses for personal purposes more than 14 days per year.

■ Even if the Safe-Harbor is not an option a facts and circumstances analysis can still qualify the rental as a trade or business for 199A purposes.

Triple Net Leases

■ What is a triple net lease? ■ A triple net lease is any lease where the landlord passes on the responsibility

for paying the following to the tenant: – Real estate taxes – Insurance– Maintenance

■ For a single property it would be hard to justify a triple net lease as a business. This is because there is little work to be done on the part of the landlord and appears to be more of an investment.

■ However, if multiple properties are owned and operated this way, an argument could be made that the taxpayer is in the business of owning this type of property.

5/21/2019

19

What About Self-Rentals?

■ The final regs provide an exception that a rental activity will be treated as a trade or business if it is rented to a "commonly controlled" trade or business owned by the taxpayer (cannot be rented to a C- Corporation).

■ However, if that rental property is rented to a commonly owned business that is classified as a specified service trade or business, then the real estate activity is also classified as a specified service trade or business.

■ This could eliminate the 199A deduction entirely based on the taxpayer’s level of income.

Rental - Other items

■ If you are going to make a facts and circumstances argument of your rental being a business here are two things that you could do to help your case. – Issue 1099’s for the maintenance, upkeep, or administration of the

rental property. – Document as much as possible. Even if the Safe-Harbor isn’t exactly

met, having documentation of these items can help point towards the rental being a trade or business.

5/21/2019

20

Specified Service Trade or Business Income

General Rule

■ A "Specified Service Trade Or Business" (SSTB) is generally excluded from the definition of a "qualified trade or business" for purposes of the §199A 20% deduction.

■ As the name suggests the exclusion applies to trades or businesses that provide services as their primary source of income.

■ SSTB’s specifically do not include businesses engaged in architectural or engineering services.

■ So, what businesses are considered SSTB’s?

5/21/2019

21

A SSTB includes a trade or business in one of the following fields:

■ Health

■ Law

■ Accounting

■ Actuarial Science

■ Performing Arts

■ Consulting

■ Athletics

■ Financial Services

■ Brokerage Services

■ Investing and Investment Management Services

■ Trading Services

■ Dealing In Securities, Partnership Interests, and Commodities

■ A Trade or Business Where The Principal Asset Is Reputation Or Skill Of One Or More Employees Or Owners

Health

Includes:

■ Physicians

■ Nurses

■ Dentists

■ Veterinarians

■ Psychologists

Does not Include:

■ Health clubs

■ Health Spas

■ Payment processing

■ Research / Testing

■ Manufacturing of pharmaceuticals or medical devices

5/21/2019

22

Law

Includes:

■ Lawyers

■ Paralegals

■ Arbitrators

■ Mediators

Does not Include:

■ Services that do not require skills unique to the field of law such as stenography services.

Accounting

Includes:

■ Accountants

■ Enrolled agents

■ Return preparers

■ Financial auditors

Does not Include:

■ Proposed regs state that payment processing and billing analysis. Final regs do not mention this at all.

5/21/2019

23

Actuarial Science

Includes:

■ Services by individuals such as actuaries and similar professionals performing services in their capacity as such.

Does not Include:

■ Analysts

■ Economists

■ Mathematicians

■ Statisticians

Performing Arts

Includes:

■ Actors

■ Singers

■ Musicians

■ Entertainers

■ Directors

Does not Include:

■ Broadcasters of audio or video

■ Operators of equipment used in the preforming arts

5/21/2019

24

Consulting

Includes:

■ Professional advice and counsel to clients to assist the client in achieving goals and solving problems.

■ Lobbyists

Does not Include:

■ Sales

■ Teaching training and educational courses

■ Consulting that is ancillary or embedded in the sale of goods or performance of other services.

Athletics

Includes:

■ Athletes

■ Coaches

■ Team managers

Does not Include:

■ Services that do not require skills unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events

■ Broadcasters of video or audio for athletic events to the public

5/21/2019

25

Financial Services

Includes:

■ Managing wealth

■ Advising client with respect to finances

■ Developing retirement plans

■ Developing wealth transition plans

■ Underwriting

Does not Include:

■ Making loans

■ Receiving deposits

Brokerage Services

Includes:

■ Services in which a person arranges transactions between a buyer and a seller with respect to securities for a commission or fee (i.e. Stock Brokers)

Does not Include:

■ Real estate agents

■ Insurance agents

5/21/2019

26

Investing Services

Includes:

■ Investing

■ Asset management

■ Providing advice on buying and selling investments

Does not Include:

■ Directly managing real property

Trading Services

Includes:

■ A trade or business of trading in securities, commodities, or partnership interests. (i.e. day traders)

Does not Include:

■ Manufacturers or farmers hedging as part of their normal trade or business

■ Normal investors in securities

5/21/2019

27

Dealing in Securities, Partnership Interests and Commodities Includes:

■ Regularly purchasing securities from and selling securities to customers in the ordinary course of a trade or business

Does not Include:

■ Originating loans in the ordinary course of a trade or business of making loans

Trade or Business Where The Principal Asset Is Reputation Of One Or More Employees Or OwnersIncludes:

■ Fees for celebrity endorsements

■ Fees for use of celebrity image or trademark

■ Appearance fees

Does not Include:

■ Having a good reputation as a mechanic, chef, barber, etc.

5/21/2019

28

Example

■ L is a well-known chef and the sole owner of multiple restaurants each of which is owned in a disregarded entity.

■ Due to L's skill and reputation as a chef, L receives an endorsement fee of $500,000 for the use of L's name on a line of cooking utensils and cookware.

Conclusion

■ L is in the trade or business of being a chef and owning restaurants and such trades or businesses are not SSTBs.

■ However, L is also in the trade or business of receiving endorsement income.

■ L's trade or business consisting of the receipt of the endorsement fee for L's skill and/or reputation is an SSTB whose principal asset is the reputation or skill of one or more employees or owners.

5/21/2019

29

Three Possible Situations

■ SSTB Income That Qualifies Fully For The 20% 199A Deduction.– "Taxable Income" for 2018 (excluding the 20% 199A deduction) that

does not exceed $315,000 if married filing jointly, or $157,500 for others.

■ SSTB Income That Does Not Qualify At All For The 20% 199A Deduction.– "Taxable Income" for 2018 (excluding the 20% 199A deduction) of the

taxpayer is at least $415,000 if married filing jointly, or $207,500 for others.

■ SSTB Income That May Partially Qualify For The 199A Deduction.– Taxpayers that their “Taxable Income” falls between the $315,000 and

$415,000 ranges if MFJ, or $157,500 to $207,500 for others.

SSTB Income That Qualifies Fully For The 20% 199A DeductionExample:

■ Betty is a physician who owns 50% of S Corp (which operates a medical practice).

■ S Corp has $700,000 of QBI, $200,000 of W-2 Wages, and no Qualified Property for 2018.

■ For 2018, Betty and her husband Joe file a joint return and have $315,000 of taxable income (before the 20% deduction).

■ They have no Qualified REIT Dividends and no Qualified Publicly-Traded Partnership Income.

5/21/2019

30

Example (cont’d)

■ Since Betty and Joe's "taxable income" (before the §199A deduction) is not over $315,000, Betty's SSTB QBI qualifies for the §199A deduction and there is no W-2 Wage and Qualified Property Limitation for 2018.

■ Betty's allocable share of S Corp's QBI is $350,000 (.5 X $700,000).

■ Betty's Tentative §199A Deduction Amount is $70,000 (20% of $350,000).

■ Betty & Joe's §199A Deduction for 2018 is $63,000 ((the lesser of 1) $70,000 (.20 X $350,000 QBI) or 2) $63,000 (.2 X $315,000 [Taxable Income of $315,000)).

SSTB Income That Does Not Qualify At All For The 20% 199A Deduction

Example:

■ The facts are the same as the previous example except Betty and Joe's taxable income is $415,000. Since Betty and Joe's 2018 Taxable Income is $415,000, none of Betty's share of the S corporation's SSTB Income of $350,000 (.5 X $700,000) qualifies for the 20% §199A deduction.

5/21/2019

31

SSTB Income That May Partially Qualify For The 199A Deduction■ See handout for example.

10%/5% De Minimis SSTB Safe Harbor■ If a trade or business has gross receipts of $25 million or less for the

taxable year, the business will not be classified as an SSTB if less than 10% of its overall gross receipts is generated by an SSTB activity.

■ If the trade or business has greater than $25 million in gross receipts for the year, the 10% threshold for SSTB income is reduced to "less than 5%.“

■ Two examples were given in the final regs to help illustrate this Safe Harbor.

5/21/2019

32

Example 1

■ Landscape LLC sells lawn care and landscaping equipment (a Non-SSTB).■ Landscape LLC also provides advice and counsel on landscape design for

large office parks and residential buildings (includes advice on the selection and placement of trees, shrubs, and flowers and is considered to be in field of "CONSULTING" and therefore an SSTB).

■ Landscape LLC separately invoices for its landscape design services.■ Landscape LLC does not sell the trees, shrubs, or flowers it recommends for

use in the landscape design.■ Landscape LLC maintains one set of books and records and treats the

equipment sales and design services as a single trade or business.■ Landscape LLC has total gross receipts of $2 million ($250,000 of which is

attributable to the landscape design services - an SSTB).

Conclusion

■ Because gross receipts from the consulting services exceed 10% of Landscape LLC's total gross receipts, the entirety of Landscape LLC's trade or business is considered an SSTB.

■ The final regs make it clear that if a taxpayer's SSTB gross receipts exceed the 10%/5% de minimis threshold, the entire trade or business is treated as an SSTB!

■ How could this be avoided?

5/21/2019

33

Example 2

■ Animal Care LLC provides veterinarian services performed by licensed staff considered to be in field of "HEALTH" (an SSTB).

■ Animal Care LLC also develops and sells its own line of organic dog food at its veterinarian clinic and online (a Non-SSTB).

■ Animal Care LLC; separately invoices for its veterinarian services and the sale of its organic dog food, maintains separate books and records for its veterinarian clinic and its development and sale of its dog food, and has separate employees who are unaffiliated with the veterinary clinic and who only work on the formulation, marketing, sales, and distribution of the organic dog food products.

■ Animal Care LLC treats its veterinary practice and the dog food development and sales as separate trades or businesses.

■ Animal Care LLC has aggregate gross receipts of $3,000,000 ($1 ,000,000 of which is attributable to the veterinary services, an SSTB).

Conclusion

■ Although gross receipts from services in the field of health ($1,000,000) exceed 10% of Animal Care LLC's total gross receipts, the dog food development and sales business is not an SSTB since the veterinary practice and the dog food development/sales operation are separate trades or businesses.

■ This highlights the fact that the 10%/5% De Minimis SSTB Gross Receipts Safe Harbor Applies on a Trade-Or-Business by Trade-Or-Business basis not on an Entity-By-Entity basis.

5/21/2019

34

Takeaways from 199A

■ This new tax law can provide a significant tax savings to many individuals.

■ Careful planning and record keeping can help avoid issues with rental properties and SSTB’s being reclassified as not eligible for the deduction.

■ There will be some taxpayers who lose out on this deduction no matter how much planning is done.