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 Overview of Section 199A
• 1.03 The Impact of Section 199A on Owners of Closely Held Domestic Businesses
• 1.04 The Purposes of This Book
• 1.05 The Readers for Whom This Book Is Intended
• 1.06 The Impact of Section 199A on Tax Professionals
• 1.07 The Text of the TCJA and Its Legislative History; The Joint Committee Report
• 1.08 Ten Federal Tax Authorities Other than Section 199A That Tax Professionals Must Understand in Order to Interpret and Apply Section 199A Competently
• 1.09 Preliminary Evaluation of Section 199A
• Exhibit 1-1 Text of Section 199A as Amended on March 23, 2018

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-5
• Exhibit 3-1 Table of Contents of the Final Regulation

Chapter 4: Who is Eligible for Deductions Under Section 199A? The Section 199A(A) Cap on Section 199A Deductions

• 4.01 Who Is Eligible for Section 199A Deductions?
• 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 and the Final Regulations

• 5.01 Introduction
• 5.02 What Is a “Trade or Business” Under Section 199A, the Final Regulations, and the Proposed Revenue Procedure?
• 5.03 What Is the Definition of “Qualified Trade or Business” Under Section 199A and the Final Regulations?
• 5.04 What Is the Definition of “Employment Services” Under Section 199A and the Final Regulations?
• 5.05 What Is the Definition of “Specified Service Trade or Business” Under Section 199A and the Final Regulations?
• 5.06 Comments on the “Additional Rules” in REGs. 1.199A-5(b)(2)(ii) Through (xii)
• 5.07 The Definition of the Principal Asset Rule in REG. 1.199A-5(b)(2)(xiv)
• 5.08 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 Pass-Through 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 Pass-Through Deduction from Their Business Income for Owners of Qualified Trades or Businesses—Overview and Brief Descriptions
• 6.03 The 34 Section 199A Provisions Relevant to the Computation of Pass-Through Deductions from Their Business Income for Owners of Qualified Trades or Businesses

Chapter 7: How to Computer Pass-Through Deductions Under Section 199A

• 7.01 Introduction
• 7.02 Pass-Through Deductions Under Section 199A—Background Provisions and Terms of Art
• 7.03 Computing Pass-Through Deductions for Category 1 Taxpayers
• 7.04 Computing Pass-Through Deductions for Category 2 Taxpayers
• 7.05 Computing Pass-Through Deductions for Category 3 Taxpayers
• 7.06 Computing Pass-Through Deductions for Category 4 Taxpayers
• 7.07 Computing Pass-Through Deductions for Category 5 Taxpayers
• 7.08 Computing Pass-Through Deductions for Category 6 Taxpayers
• 7.09 Computing Pass-Through Deductions for Category 7 Taxpayers
• 7.10 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) Pass-Through 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 Section 199A(g) Deductions Available to Them
• 8.10 Miscellaneous Services That Tax Professionals Should Provide to Farmers Under Sections 199A(b) and 199A(g)
• Exhibit 8-1 Treas. Reg. 1.199-6 - Agricultural and Horticultural Cooperatives

Chapter 9: Comments on Sections 11011(B) through (ED) 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 Introduction
• 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

Chapter 11: Structuring and Restructuring Closely Held Businesses to Maximize Section 199A Pass-Through Deductions

• 11.01 Introduction: The Purpose of This Chapter; References to Business Entities in the Chapter 11.02 The Main Types of Clients Who May Need Advice from Tax Professionals About How to Obtain or Maximize Section 199A Pass-Through Deductions
• 11.03 The Federal Tax Consequences of Changing the Federal Tax Regimens of Businesses
• 11.04 Choosing the Best Federal Tax Regimen for Start-Up Businesses on Federal Income Tax Grounds Before the Enactment of the TCJA
• 11.05 Choosing the Best Federal Tax Regimen for Start-Up Businesses on Federal Income Tax Grounds Under the TCJA
• 11.06 The Potential Importance of Prop. Reg. § 1.1402(A)-2 in Structuring and Restructuring Pass-Through Businesses Under Section 199A
• 11.07 The Role of LLCs in Structuring and Restructuring Closely Held Businesses Under Section 199A
• 11.08 Choosing the Best Pass-Through Federal Tax Regimen for Section 199A Clients Starting New Businesses
• 11.09 Determining Whether and How to Restructure the Federal Tax Regimen of Existing Pass-Through Businesses in Order to Maximize Their Owners’ Section 199A Pass-Through Deductions
• 11.10 Miscellaneous Clients Who May Need Advice About How to Obtain or Increase Section 199A Pass-Through Deductions
• 11.11 Using Partnerships Whose Partners Can Change from Time to Time from the Status of Individuals to That of S Corporations or Vice Versa in Order to Maximize the Partners’ Section 199A Pass-Through Deductions; Use of Holding Company/Operating Company Structures Under Section 199A

Chapter 12: Advising Clients on How to Maximize Their Section 199A(A) Pass-Through Deductions – Client Questionnaire and Checklist of Section 199A Federal Income Tax Issues

• 12.01 Introduction
• 12.02 Client Questionnaire
• 12.03 Section 199A Issues to Address with Your Client—Introduction
• 12.04 Checklist of Section 199A Issues to Address with Clients
• Exhibit 12-1 Client Questionaire for Use with Section 199A Clients
• Exhibit 12-2 Checklist of Section 199A(a) Federal Income Tax issues

Chapter 13: Tax and Legal Practice Under Section 199A and Amended Section 11(B) – Practice Tasks and the Issue of Competence

• 13.01 Introduction
• 13.02 What Types of Tasks Must Tax Accountants be Able to Handle for Their Section 199A Clients?
• 13.03 What Types of Knowledge, Practice Skills, Practice Tools, and Practice Experience Must Tax Accountants Have in Order in Order to be Competent in Their Section 199A Practice?
• 13.04 Section 199A Practice by Tax Lawyers
• 13.05 Section 199A Practice by Business Organization Lawyers—Overview
• 13.06 Types of Knowledge, etc., That Business Organization Lawyers Need in Their Section 199A Practice

Chapter 14: Avoiding Professional Pitfalls Under Section 199A

• 14.01 Introduction
• 14.02 Actions That Tax Professionals Can Take to Avoid Section 199A Pitfalls
• 14.03 Actions That Non-Tax Professionals Can Take to Avoid Section 199A Pitfalls

Index

• Table of Exhibits
• EXHIBIT 1-1 Text of Section 199A as Amended on March 23, 2018
• EXHIBIT 2-1 The Nine Subsections of Section 199A and Sections 11011(b) Through (d)—Titles and Summaries of Contents
• EXHIBIT 3-1 Table of Contents of the Final Regulations
• EXHIBIT 8-1 Treas. Reg. § 1.199-6—Agricultural and Horticultural Cooperatives
• EXHIBIT 10-1 Factors to Consider in Choosing Between Subchapter C and Section 199A
• EXHIBIT 12-1 Client Questionnaire for Use with Section 199A Clients
• EXHIBIT 12-2 Checklist of Section 199A(a) Federal Income Tax Issues