Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A

The Tax Cuts and Jobs Act of 2017 (TCJA), the largest piece of tax legislation in the United States in over 30 years, introduced several new taxes and deductions, as well as a number of very significant changes. One of the most high-profile provisions of the TCJA is the new Section 199A, which provides a federal income tax deduction to owners of domestic pass-through businesses of up to 20 percent of their “qualified business income” (QBI). Section 199A is among the lengthiest and most complex provisions of the TCJA, and, even for experienced tax professionals, it is perhaps the most difficult section of that Act to understand and to apply for clients. Even with the issuance of proposed regulations under Section 199A on August 8, 2018, it is beset with unresolved issues of interpretation.

Written by an expert on LLC law, this first-of-its-kind resource provides comprehensive guidance to pass-through business owners and their professional advisers about how to obtain Section 199A deductions and how to accomplish the above structuring and restructuring to maximize these deductions. In addition, Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A addresses the issue of whether pass-through business owners should change their businesses to C corporations in order to take advantage of the federal income tax savings available under the flat 21 percent federal income tax rate applicable to C corporations under the TCJA. Also included in Maximizing Pass-Through Deductions Under Internal Revenue Code Section 199A are valuable practice tools, such as an illustration of the steps for computing the pass-through deduction of qualified trade or business owners under Section 199A, a client questionnaire for use with Section 199A clients, and a checklist of Section 199A federal income tax issues.

Foreword by Author

On January 1, 2018, the Tax Cuts and Jobs Act of 2017 (the “TCJA”) became effective. Section 199A, as set forth in section 11011 of the TCJA, provides a federal income tax deduction to owners of domestic pass-through businesses of up to 20 percent of their net business income. In addition, the section provides 20 percent deductions to taxpayers on their income from interests in real estate investment trusts and in certain types of publicly traded partnerships, and under section 199A(g), the section provides special deductions to farmers, horticulturalists, farm cooperatives, and horticultural cooperatives.

However, section 199A is among the lengthiest and most complex provisions of the TCJA, and even for experienced tax professionals, it is perhaps the most difficult section of that Act to understand and to apply for clients. Furthermore, pass-through business owners can obtain deductions under it only if they properly structure their personal, business, and federal tax arrangements; and in order to maximize their deductions, many pass-through business owners must substantially restructure these arrangements.

Hence, this book. The primary purpose of the book is to provide comprehensive guidance to tax professionals who advise the owners of closely held businesses about how these owners can obtain section 199A deductions on their shares of their business income and how they can accomplish the above structuring and restructuring so as to maximize these deductions. I hope that the book will also be useful to business lawyers and other professionals who represent business owners and, because the book is written to the maximum extent possible in plain English, even to business owners themselves.

The book also addresses the issue whether pass-through business owners should change the federal tax regimen of their businesses to Subchapter C in order to take advantage of the federal income tax savings available under that subchapter because of the flat 21 percent federal income tax rate applicable to C corporations under the TCJA.

Table of Exhibits

 

Chapter 1 SECTION 199A—GENERAL INTRODUCTION

 

• § 1.01 The Enactment and Purpose of the Tax Cuts and Jobs Act of

                2017; The Legislative Intent of Section 199A

• § 1.02 Legislative and Administrative Developments in 2020 and

                Thereafter Potentially Affecting Tax Practice Under Section 199A

• § 1.03 Overview of Section 199A
• § 1.04 The Impact of Section 199A on Owners of Closely Held Domestic Businesses
• § 1.05 The Purposes of This Book
• § 1.06 The Readers for Whom This Book Is Intended
• § 1.07 The Impact of Section 199A on Tax Professionals
• § 1.08 The Text of the TCJA and Its Legislative History; The Joint

                 Committee Report

• § 1.09 Eleven Federal Tax Authorities Other than Section 199A That

               Tax Professionals Must Understand in Order to Interpret and Apply Section 199A  

              Competently

• § 1.10 Preliminary Evaluation of Section 199A
• § 1.11 The Appendix Explained
• Exhibit 1-1 Text of Section 199A as Amended on March 23, 2018
• Exhibit 1-2 Table of Federal Tax Authorities That Tax Practitioners

               Must Master in Order to Be Competent to Advise Clients Under Section 199A

 

Chapter 2  THE EXTRAORDINARY DIFFICULTY OF UNDERSTANDING

AND APPLYING SECTION 199A

 

• § 2.01 Introduction
• § 2.02 The Structure of Section 199A—Subsections, Paragraphs,

                Clauses, etc.

• § 2.03 Even Apart from Its Formatting Structure, Why Is Section

               199A So Difficult to Understand and Apply?

• § 2.04 The Fundamental Anomaly in Section 199A; Overcoming the

               Anomaly

• Exhibit 2-1 The Nine Subsections of Section 199A and Sections 11011(b)

              Through (d)—Titles and Summaries of Contents

 

Chapter 3 THE 2018 PROPOSED REGULATIONS AND THE 2019 FINAL

REGULATIONS UNDER SECTION 199A

 

• § 3.01 Introduction to the 2018 Proposed Regulations and the 2019

                Final Regulations Under Section 199A

• § 3.02 Guidelines for Using the Proposed and Final Regulations for

               Taxable Years 2018 and Thereafter

• § 3.03 The Aggregation Provisions and Related Provisions in Reg.

                § 1.199A-4

• Exhibit 3-1 Table of Contents of Final Regulations
•  

Chapter 4 ELIGIBILITY FOR DEDUCTIONS UNDER SECTION 199A

• § 4.01 Taxpayers Eligible for Section 199A Pass-Through Deductions;

Pass-Through Entities; Allocations

• § 4.02 The Cap on Section 199A Deductions Under Sections 199A(a)

and 199A(b)(1); Example of the Operation of the Section

199A(a) Cap

• § 4.03 The Function of the Section 199A(a) Cap as Both a Limit of

the Deductions Available to Taxpayers and a Deduction Target

 

Chapter 5 THE MEANING OF “TRADE OR BUSINESS,” “QUALIFIED

TRADE OR BUSINESS,” AND “SPECIFIED SERVICE TRADE

OR BUSINESS” UNDER SECTION 199A

 

• § 5.01 Introduction
• § 5.02 The Section 199A Trade-or-Business Issue as Applicable to

Owners of Rental Real Estate Enterprises

• § 5.03 The Profitability Test—Need, Definition, and Grounds
• § 5.04 The Definition of “Qualified Trade or Business” Under

Section 199A and the Final Regulations

• § 5.05 The Definition of “Employment Services” Under Section 199A

and the Final Regulations

• § 5.06 The Definition of “Specified Service Trade or Business” Under

Section 199A and the Final Regulations

• § 5.07 Comments on the “Additional Rules” in

Regs. §§ 1.199A-5(b)(2)(ii) Through (xiii)

• § 5.08 The Definition of the Principal Asset Rule in

Reg. § 1.199A-5(b)(2)(xiv)

• § 5.09 The De Minimis Regulation; Miscellaneous Issues Concerning

the Treatment of Organizations That Provide Products,

Property or Services to SSTBs

 

Chapter 6 THE 34 KEY SECTION 199A PROVISIONS RELEVANT IN

COMPUTING DEDUCTIONS FOR OWNERS OF QUALIFIED

TRADES OR BUSINESSES—TEXTS AND COMMENTS

 

• § 6.01 Introduction
• § 6.02 The 34 Section 199A Provisions Relevant to the Computation

of Deduction from Qualified Business Income of Owners of

Qualified Trades or Businesses—Overview and Brief

Descriptions

• § 6.03 The 34 Section 199A Provisions—Texts and Comments

 

Chapter 7HOW TO COMPUTE PASS-THROUGH DEDUCTIONS UNDER

SECTION 199A

 

• § 7.01 Introduction
• § 7.02 Deductions Under Section 199A—Background Provisions and

Terms of Art

• § 7.03 Computing Deductions for Category 1 Taxpayers
• § 7.04 Computing Deductions for Category 2 Taxpayers
• § 7.05 Computing Deductions for Category 3 Taxpayers
• § 7.06 Computing Deductions for Category 4 Taxpayers
• § 7.07 Computing Deductions for Category 5 Taxpayers
• § 7.08 Computing Deductions for Category 6 Taxpayers
• § 7.09 Computing Deductions for Category 7 Taxpayers
• § 7.10 Subchapter S “Reasonable Compensation” Issues in Making

Pass-Through Deduction Computations Under Section 199A

• § 7.11 Conclusion

 

Chapter 8 FEDERAL INCOME TAX DEDUCTIONS FOR FARMERS,

HORTICULTURALISTS, AND AGRICULTURAL

COOPERATIVES UNDER SECTIONS 199A(a) AND (g)

 

• § 8.01 Introduction and Summary
• § 8.02 Section 199A(g)—Legislative History
• § 8.03 Miscellaneous Comments About Section 199A(g)
• § 8.04 Farmer Cooperatives—General Description; Economic Importance

of the Business of Farming and of Farmer Cooperatives

• § 8.05 The Business of Farming—Legal Structures and Federal Tax

Structures

• § 8.06 Section 199A(b) Deductions and Section 199A(g) Deductions

Allowable to Farmers

• § 8.07 Section 199A(g) Deductions Allowable to Farmer

Cooperatives—Overview

• § 8.08 Section 199A(g) Deductions Available to Farmer

Cooperatives—Key Section 199A(g) Provisions Other than

Section 199A(g)(1)(A)

• § 8.09 Restructuring Farmers’ Personal, Tax, and Business

Arrangements in Order to Obtain or Increase Available

Section 199A(g) Deductions

• § 8.10 Miscellaneous Services That Tax Professionals Should Provide

to Farmers Under Sections 199A(b) and 199A(g)

• § 8.11 Proposed Regulations, Issued June 18, 2019, Under

Section 199A(g)

• Exhibit 8-1 Treas. Reg. § 1.199-6—Agricultural and Horticultural

Cooperatives

 

Chapter 9 COMMENTS ON SECTIONS 11011(b) THROUGH (e) OF THE

TAX CUTS AND JOBS ACT OF 2017

 

• § 9.01 Introduction
• § 9.02 Comments on Sections 11011(b) Through (d) of the Tax Cuts

and Jobs Act of 2017

 

Chapter 10 WHICH FEDERAL TAX REGIMEN WILL PROVIDE GREATER

FEDERAL INCOME TAX SAVINGS TO THE OWNERS OF

CLOSELY HELD BUSINESSES—SUBCHAPTER C OR A

PASS-THROUGH REGIMEN?

 

• § 10.01 Preliminary Notes
• § 10.02 The Potential Federal Income Tax Advantages of Operating a

Closely Held Business as a C Corporation

• § 10.03 The Potential Federal Income Tax Disadvantages of Operating

a Closely Held Business as a C Corporation Rather than as a

Pass-Through Business Entity

• § 10.04 The Need of Many Business Owners to Play “TCJA Roulette”
• Exhibit 10-1 Factors to Consider in Choosing Between Subchapter C

and Section 199A for The Owners of Closely Held Businesses

 

Chapter 11 PROVIDING ADVICE UNDER SECTION 199A TO

INDIVIDUALS STARTING NEW BUSINESSES

 

• § 11.01 Introduction and Summary
• § 11.02 What Tasks Should Tax Professionals Perform in Making Tax

Choice of Entity?

• § 11.03 The Four Principal Federal Tax Regimens—Key Federal

Income Tax and Social Security Tax Considerations

• § 11.04 How to Make Traditional Tax Choices of Entity
• § 11.05 How to Make Tax Choices of Entity Under Section 199A
• Exhibit 11-1 Basic Information About Section 199A to Provide to

Individuals Starting New Businesses

• Exhibit 11-2 Six Questions to Ask Clients Forming New Businesses in

Order to Make Tax Choices of Entity for Them Under

Section 199A

 

Chapter 12 RESTRUCTURING EXISTING BUSINESSES TO MAXIMIZE

OWNERS’ SECTION 199A PASS-THROUGH DEDUCTIONS

 

• § 12.01 Introduction
• § 12.02 What Tax Professionals Need in Order to Handle Section 199A

Restructuring Competently—Overview

• § 12.03 Key Section 199A Provisions Relevant to Restructuring
• § 12.04 Prop. Reg. § 1.1402(a)-2
• § 12.05 Section 199A Restructuring—Developing Restructuring Plans
• § 12.06 The Ten Questions and Their Relationship to Section 199A

Restructuring

• § 12.07 The Key Role of Tax Preparers in Section 199A Restructuring;

Collaboration Between Tax Preparers and Business Lawyers in

Section 199A Restructuring

• § 12.08 Fourteen Commonly Occurring Situations in Which Business

Owners are Likely to Need Section 199A Restructuring

• § 12.09 Developing a Section 199A Restructuring Plan for Mary Jones
• § 12.10 Miscellaneous Section 199A Restructuring Guidelines
• Exhibit 12-1 The Seven Categories of Business Owners Eligible for

Section 199A Pass-Through Deductions; the Section

199A Computation Rules Applicable to Each Category

• Exhibit 12-2 The Twelve Types of Legal Tasks Potentially Necessary

in Section 199A Restructuring

• Exhibit 12-3 The Ten Questions to Address in Section 199A

Restructuring

• Exhibit 12-4 Fourteen Commonly Occurring Situations in Which

Business Owners May Need Section 199A Restructuring

 

Chapter 13 AVOIDING MALPRACTICE RISKS UNDER SECTION 199A—

GUIDELINES FOR TAX PROFESSIONALS

 

• § 13.01 Introduction
• § 13.02 The Two Principal Malpractice Risks That Tax Professionals

May Face Under Section 199A

• § 13.03 Other Section 199A Issues That May Create Malpractice Risks

for Tax Professionals

• § 13.04 The Implications of Berg v. Eisner, PLLC for Malpractice

Claims Under Section 199A

• Exhibit 13-1 Proposed Text of Model E-Mail for Use by Tax Professionals

in Advising Their Business Owner Clients About

Their Possible Need for Section 199A Restructuring

 

Chapter 14 SECTION 199A: THE SECONDARY LITERATURE

 

• § 14.01 Introduction
• § 14.02 Oei and Osofsky, “Legislation and Comment: The Making of

the § 199A Regulations,” 69 Emory L.J. 209 (2019)

• § 14.03 Sullivan, Martin A., “Economic Analysis: 19 Million

Taxpayers Take the Pass-Through Deduction,” Tax Notes

(Sept. 14, 2020)

• § 14.04 Banoff et al., “Section 162 Trades or Businesses: You’ll

Know Them When You See Them,” 133 Journal of Taxation

(Nov. 2020)

• § 14.05 Graetz, Michael, “Foreword—The 2017 Tax Cuts: How

Polarized Politics Produced Precarious Policy,” 128 Yale Law

Journal Forum 315 (2018) (With Brief Summary of Pieklik,

Catanese and Omasta, “Deducting Success: Congressional

Policy Goals and the Tax Cuts and Jobs Act of 2017,”

16 Pittsburgh Tax Review 1 (Fall 2018)

• § 14.06 August, Jerald, “Understanding the 199A Deduction After the

New Final Regulations: An IRS Perspective,” American Law

Institute Continuing Legal Education (Apr. 16, 2019)

• § 14.07 Bibliography

Appendix

SECTION 199A TERMINOLOGY—ANNOTATED GLOSSARY,

WITH EXAMPLES