As you might know, the Tax Cuts and Jobs Acts of 2017 (TCJA) made several significant changes to the income tax law. Some of this changes with the TCJA created the new Section 199A deduction, which allows certain taxpayers a 20 percent deduction on qualified business income (QBI), or the non-wage portion of pass-through income. As a result, there are now new estate planning opportunities for section 199a that can help leverage the Section 199A deduction, reduce income taxes and increase a taxpayer’s estate.
Who is Eligible for the 199A Deduction?
Section 199A of the Internal Revenue Code provides certain owners of sole proprietorships, partnerships, S corporations and some trusts and estates, a 20 % deduction of QBI (qualified business income) from a qualified trade or business. QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. A qualified trade or business is any section 162 trade or business, with three exceptions:
- A trade or business conducted by a C corporation.
- For taxpayers with a specified service trades or businesses (SSTBs) with taxable income that exceeds the threshold amount. A specified trade or service business is one “involving the performance of services in the fields of health, law, accounting, actuarial science, 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 1 or more of its employees, or which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.”
- The trade or business of performing services as an employee.
However, the deduction comes with significant qualifications. First, you need to determine if your business entity qualifies for the deduction. The 199A deduction has taxable income limitations, based on taxpayers’ total income, not total QBI (qualified business income). There is a deduction phase-out when income is between $315,000 to $415,000 for married joint filers and $157,500 to $207,500 for single filers. Owners of specified service trades or business do not get a Section 199A deduction if their income exceeds $415,000 for married joint filers and $207,500 for single filers.
On the other hand, different rules apply for a trade or business which is not considered a specified service trade or business. For these businesses, the 199A deduction is still available for owners whose taxable income exceeds those in the above paragraph. However, the deduction is limited to the greater of
a.) 50 percent of W-2 wages, or
b.) 25 percent of W-2 wages plus 2.5 percent of qualified property.
Estate Planning for 199A
Typically, estate planners have advised business owners to sell, or gift minority interests in pass-through entities to trusts that are defective for income tax purposes (i.e. grantor trusts). However, if the grantor’s income is greater than the thresholds outlined above and in Section 199A, the grantor may not be eligible for the Section 199A deduction, or only a reduced deduction. As a result, taxpayers should consider utilizing nongrantor trusts, which are separate taxpayers, each eligible for the Section 199A deduction. The goal would be to create as many different nongrantor trusts as necessary so that each trust received the maximum amount of income before the phase-out threshold, thus allowing each nongrantor trust to qualify for a Section 199A deduction. Therefore, even if the grantor would not qualify for a Section 199A deduction against his or her total income, each trust would individually qualify for the Section 199A deduction.
For more details or questions regarding estate planning using Section 199A deduction, please contact Cuevas & Cuevas Tax Advisors.
This is just one article within our 2019 Year-End Tax Guide. For more great insights, check out our 2019 Year-End Tax Guide or attend our individual or business year-end planning webinars.
THIS INFORMATION IS PROVIDED AS A COURTESY – NOT AS LEGAL ADVICE.
Please know that we are raising the above issues as a courtesy and for informational purposes only. It is not intended as a substitute for legal advice concerning a particular situation that may be affecting your business.
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