Duquesne University Federal Tax Update - Business November
Duquesne University Federal Tax Update - Business November 21, 2019 Agenda I. 20% Deduction for Qualified Business Income (Section 199A) II. Interest Expense Limitation Section 163(j) III. S Corporation & Partnership Tax Basis 2 20% Deduction for Qualified
Business Income (Section 199A) 3 Section 199A - Background Deduction for Qualified Business Income Section 199A (20182025) 20% deduction from income of partnerships, S corporations and sole proprietorships (e.g., qualified business income) Limited to the greater of: 50% of W-2 wages paid by the business, or 25% of W-2 wages plus 2.5% of unadjusted basis of depreciable property (UBIA) Limitation is determined for each separate trade or business Income activities are netted against loss activities
A net loss is treated as a loss activity in the following year Overall limitation - 20% of taxable income in excess of capital gains Deduction is from adjusted gross income rather than an itemized deduction (available to all taxpayers) 4 Section 199A - Background Deduction for Qualified Business Income Section 199A (20182025) Deduction is not available to specified service businesses Health, law, accounting, consulting, athletics, performing arts, financial, investment and brokerage services Principal asset is the reputation or skill of one or more of its employees or owners Exemption from limitations for taxpayers with taxable income less than
$321,400 (MFJ) or $160,725 (S) Wage limitation does not apply Prohibition against specified service businesses does not apply Exemptions are phased out for income between $321,400 and $421,400 (MFJ), or $160,725 and $210,725 (S) 5 Section 199A - Background Deduction for Qualified Business Income Section 199A (20182025) Aggregation rules allow individuals and RPEs to treat certain trades or businesses as one ToB for purposes of determining QBI, W-2 wages and UBIA If elected, aggregation may increase the Section 199A deduction Allows individuals (or RPEs) to combine QBI, W-2 wages and UBIA
of aggregated trades or businesses prior to applying the W-2 and UBIA limitations May allow individuals to use W-2 wages and UBIA from loss ToBs 6 Section 199A - Example Taxable income = $500,000 Company W-2 wages = $1,000,000 Company UBIA = $1,500,000 QBI deduction is: $100,000 (20% x $500,000) = $37,000 tax savings Limited to greater of: $500,000 (50% share of W-2 wages) $287,500 (25% share of W-2 wages + 2.5% of unadjusted basis)
Reduces ETR from 37% to 29.6% 7 Trade or Business - Definition For Section 199A, trade or business is a ToB under Section 162 Two general requirements for determining whether an activity rises to the level of a trade or business for purposes of Section 162 (see, e.g., Commissioner v. Groetzinger, 480 US 23 (1987)) Regular, continuous activity Primary purpose is to earn a profit Determining if an activity is a ToB, or more than one ToB, is important No Section 199A deduction for income from activities that are not ToBs
Exception for REIT dividends and qualified PTP income Must determine QBI, W-2 wages and UBIA for qualified property separately for each ToB Having separate ToBs may prevent SSTB activities from tainting qualified activities Determination is made by the RPE 8 Trade or Business Relevant Factors Determining if an activity constitutes a ToB under Section 162 Factual determination Intent to make a profit Considerable, regular, continuous activity
Real estate ToBs Rev. Proc. 2019-38 provides a safe harbor for certain real estate rental activities Taxpayers meeting the safe harbor will be treated as engaged in a ToB for purposes of Section 199A (no requirement to rely on the safe harbor) Taxpayers outside of the safe harbor may still make a factual determination as to whether the activity constitutes a ToB Rentals or licensing of intangibles to a related individual or RPE is considered a ToB for purposes of Section 199A 9 Trade or Business Multiple ToBs Question of fact, relevant factors
Activities must have complete and separate sets of book and records Additional factors identified by the courts include (but not limited to): Separate and distinct operations Separate bank accounts Separate management, staff and locations Separate customers Holding out to the public as separate businesses
Must treat activities as separate ToBs for different purposes consistently (e.g., Sections 199A, 163(j)) 10 Trade or Business SSTBs Qualified ToB excludes: Specified service trades or businesses (SSTBs) ToB involves performance of services in fields of law, accounting, health, actuarial services, performing arts, consulting, athletics, financial and brokerage services, dealing in partnership interests/securities/commodities, investment management or ToB where the principal asset is the reputation or skill of one of more of its employees or owner(s)
11 SSTB De Minimis Rule If gross receipts < $25m, then the ToB is not an SSTB if less than 10% of the gross receipts are SSTB gross receipts 5% threshold if gross receipts >$25m If SSTB receipts are 10%/5% or more, then 100% of the ToB is an SSTB! The primary reason for separating SSTBs from non-SSTBs 12
SSTB Anti-abuse If a ToB provides Property or services to an SSTB and There is 50% or more common ownership of the ToB, then, That portion of the ToB of providing property or services to the 50% commonly-owned SSTB will be treated as a separate SSTB with respect to the related parties (Reg. 1.199A-5(c)(2)(ii)) 13 SSTB Anti-abuse, Ex. 1 Law Firm is a partnership that provides legal services to clients, owns its own office building and employs its own administration staff
L1 L2 50% 50% Fees for Services 100% Rent - 100% P1 P2 Legal Services to
Clients SSTB Building SSTB P3 Admin Staff SSTB 14 SSTB Anti-abuse, Ex. 1A Same as Ex 1, except P2 rents 50% of the building to P1 and 50% to an unrelated third party tenant(s)
Building SSTB 50% QBI 50% 15 Separate SSTB from non-SSTB, Ex. 2 Animal Care LLC provides veterinary services performed by licensed staff (health care) and also develops and sells its own line of organic dog food at its veterinary clients and online Vet 100% Animal Care LLC
> 10%/5% Vet Services Dog Food (1/3) (2/3) SSTB QBI
Separate books and records Separate employees Treats as separate ToB (Section 162) 16 Aggregation Requirements In order for an individual or RPE to aggregate multiple ToBs, the ToBs must meet all of the following At least one person or group of persons owns 50% or more of each ToB directly or through related parties (267(b) or 707(b)) Ownership exists for a majority of the tax year and on the last day (RPEs tax year if operated by an
RPE) All items for each ToB reported on returns with the same tax year, unless a short tax year No SSTBs 17 Aggregation Requirements Must satisfy at least 2 of 3 factors Provide products and services the same or customarily offered together Share facilities or share significant centralized business elements Operate in coordination with or reliance upon one or more businesses in the aggregated group (e.g., supply chain interdependencies)
18 Aggregation Requirements SSTBs cannot be aggregated (even if an individual is below the TI threshold) Once aggregated, ToBs must continue to be aggregated as long as they remain eligible Aggregation dissolved if ToB becomes ineligible, taxpayer may make new aggregation Aggregation generally cannot be done on an amended return Exception for 2018 Individual owner or RPE operating multiple ToBs may
aggregate Individual owner my add to, but not subtract from, RPE aggregation 19 Section 199A 1231 Gains and Losses Section 1231 Gains and Losses Reg. 1.199A-3(b)(2)(ii)(A) Any item of Capital Gain or Loss (short or long) is not included in determining QBI Section 1231 character is determined at individual level and if the net result is a Section 1231 loss then Section 1231 items of gain or loss are included in the calculation of QBI K-1 Reporting Do not include Section 1231 gain or loss
in reported QBI and add footnote to make it clear that these items were not included See explanation in Preamble to regulations 20 Section 199A UBIA Basis Adjustments UBIA and Section 743(b)/734(b) Reg. 1.199A-2(a)(3)(iv). In general, the amount of excess Section 743(b) to be included in partners UBIA is the portion of the Section 743(b) adjustment related to the UBIA amount of the underlying property (appreciation) Reg. 1.199A-2(c)(2)(v) for purposes of determining the depreciable period with regards to this adjustment, the placed-in-service date is deemed to be the date of the transfer of partnership interest
No additional UBIA for Section 734(b) amount Impact of depreciation of Section 743(b) amount on QBI No clear indication in regulations; however, assumption might be that due to inclusion of excess Section 743(b) amount in UBIA, a portion of Section 743 depreciation should be included in calculation of partners QBI 21 Interest Expense Limitation Section 163(j) 22 Section Sec 163(j) - Background Interest Expense
Deduction limited to interest income plus 30% of adjusted taxable income Adjusted taxable income = taxable income before interest expense, NOLs and depreciation and amortization (2018 2021) Exclusion for floor plan interest Exclusion for investment interest Elective exclusion for interest from a real estate business Must use ADS depreciation method Exemption for businesses with average gross receipts under $25m for prior three years Unused amounts can be carried forward indefinitely 23 Section 163(j) - Background Interest Expense
Special rules for partnerships and S corporations Limitation is determined at the entity level For partnerships, disallowed interest is passed through and treated by the owners as interest expense paid in the next succeeding year, and can only be used to the extent that the entity has excess taxable income in future years For S corporations, the limited interest remains as a carryforward inside the S corporations Excess taxable income of the entity must first be applied to carryforward interest expense from the same flow-through entity and is then available to offset other interest expense Owners distributive share of income from a pass-through entity is not included in determining adjusted taxable income (prevents double counting)
24 Small Business Exception Syndicate Small business exemption for entities with less than $25m in annual gross receipts and not a tax shelter Allocated vs. Allocable Definition of syndicate under Section 1256 and Reg. 1.448-1T caused debate regarding application of syndicate definition to small taxpayers Limited entrepreneur excludes: active members; lineal family members of active member; member has participated for a period not less than 5 years; and, estate of an active member Complex aggregation rule for purposes of the $25m gross receipts test would generally cause for most brother-sister
related family owned entities to be measured together for purposes of this test 25 Section 163(j) Other Considerations Debt issuance costs are to be included in interest expense under
Reg. 1.163(j)-1 May have previously been reported as amortization expense Depreciation included in the deduction for costs of goods sold is not eligible as an addback to the calculation of adjusted taxable income Need to revisit proper reporting or classification of overhead depreciation expense Prop. Reg. 1.163-6(m) requires that partnerships and S corporations exempt as small taxpayers must report the interest expense incurred to partners as a separately stated item subject to potential limitation at the individual level C Corporations (ASC-740) if a limitation is calculated and recorded as a deferred tax asset, a company needs to consider realizability for valuation purposes 26
S Corporation & Partnership Tax Basis 27 S Corporation Tax Basis Beginning in 2018, the IRS has expanded the requirement for individuals to attach S Corporation tax basis schedules to their tax returns Individual who has a loss, distribution, stock disposition, or loan repayment from an S corporation must attach the stock basis calculation to their tax return Additionally, the 2018 Form Schedule E, Part II, has a new check box requiring an individual to
affirmatively indicate when the S corporation basis computation is required to be attached. 28 Partnership Tax Basis Taxpayers are now required to report their tax basis capital where, prior to 2019, taxpayers had the option to report GAAP, Tax, 704, et al (see Draft 2019 K-1) 29 Federal Tax Update - Business Questions? 30
Contact Chris McElroy Shareholder Schneider Downs & Co., Inc. One PPG Place, Suite 1700 Phone: (412) 697-5453 [email protected] www.schneiderdowns.com 31
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