Tags: tax | deductions | cost | complexity

New Guidance on 20 Percent Business Deduction Highlights Tax Complexity

New Guidance on 20 Percent Business Deduction Highlights Tax Complexity
(Brad Calkins/Dreamstime)

By    |   Monday, 13 August 2018 09:22 AM

The Tax Cut and Jobs Act created a potential 20% business deduction for certain types of businesses organized as “passthrough” entities under Code section 199A.

The businesses that may qualify are S corporations, partnerships, limited liability companies treated as partnerships, and those with the income reported on Form 1040 Schedule C or E.

Using an income flow through type business organization is exceedingly popular for privately held or closely held business operations since there is only one level of tax imposed.

Tax professionals quickly caught on to the fact that section 199A had gaps and presented a long list of questions on how a qualifying business could capture this new 20% tax deduction.

The deduction is subject to a number of limitations based on whether the business entity qualifies or specifically excluded; whether the entity’s income is from certain services (“Specified Services”) or certain property (“Qualified Property”); and whether the taxpayer’s income (“Qualified Business Income”) exceeds certain thresholds.

Let’s look at a very simple example of the benefit to the taxpayer.

A taxpayer’s business qualifies, generates $100,00 of qualifying income and has $20,000 of regular business deductions. This leaves the taxpayer with $80,000 of net income allowed a section 199A 20% deduction. The taxpayer can take an additional $16,000 deduction bringing down the net income to $64,000.

Unfortunately, nobody’s business is this simple and applying section 199A to the estimated 100,000 businesses expected to be affected are fraught problems.

One commentator used the example of a software company that also provides consulting services where 89% is sales, and 11% is service. For this taxpayer, all the business income is ineligible since the consulting services are more than 10% of the business income.

In response to the deep concerns of the professional tax industry, the Internal Revenue Service just issued a 184-page proposed regulation intended to give the government’s position on how to comply with this new byzantine tax provision.

While it goes a long way to answering questions, the tax law is extraordinarily convoluted and intricate.

The proposed regulation, for example, allows certain trusts, known as Electing Small Business Trusts (they hold Subchapter S stock) can qualify for the deduction on S-corporation income even though the statute does not explicitly state that.

But what about property inherited and then used in the heir’s business operations?

 Normally the basis of the inherited property would be stepped-up to the fair market value at the decedent’s death. But the regulation doesn’t provide for whether this basis reset is used for business depreciation for purposes of section 199A.

The new 20% deduction can amount to some real tax savings which can be better used by private and closely held businesses than by the government building bridges to nowhere.

Taxpayers will quickly learn that tax benefits come with a cost.

The proposed regulations estimate that some 25 million hours will be spent in complying with just this new section of the tax code.

Denis Kleinfeld is known as a strategic tax and wealth protection lawyer, widely published author and creative teacher.
 

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The new 20% deduction can amount to some real tax savings which can be better used by private and closely held businesses than by the government building bridges to nowhere.
tax, deductions, cost, complexity
506
2018-22-13
Monday, 13 August 2018 09:22 AM
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