As many business readers will know, Section 199A of the Internal Revenue Code (IRC) provides annual federal income tax to owners of “pass-through” businesses (ie, sole proprietorships, S-companies, and corporations liable to tax as partnerships) Deduction of up to 20% of their share of the net income of their business. The significance of the deduction from Section 199A is enormous; For many companies, this can mean the difference between business success and failure.
Although Section 199A is slated to expire in late 2025, both the U.S. Senate and House of Representatives have just introduced bills that make Section 199A permanent. In my view, it is almost certain that these bills will pass as they benefit at least 17 million business owners who receive Section 199A deductions.
However, now and in the future, your Section 199A deduction will depend on your “Threshold Amount” in that section. For 2020, the Section 199A threshold is $ 326,600 for married couples and $ 163,300 for most individuals filing separately. For individuals (likely including most of the readers of this column) whose thresholds are at or below these amounts, their deductions will be a full 20% of their share of net business income.
However, in 2020, many New Hampshire taxable corporations – including nearly all New Hampshire multi-member LLCs, limited partnerships, and state partnerships – shared their business income among their owners by paying them salaries (known as “guaranteed payments”) . in relation to the partnership tax). The problem for these companies is that these salaries are expenses that reduce their net business income and hence their Section 199A deductions. And for New Hampshire tax and other purposes, many New Hampshire corporations have paid virtually all of their business income in addition to non-owner compensation as salaries.
If your company paid its owners significant salaries in 2020, reducing their Section 199A deductions in 2020, is there a solution? The answer is yes. Incredibly, IRC section 761 (c) (one of my favorites among the thousands of provisions on IRC) effectively provides for corporations that are taxpayable as partnerships to be able to effectively amend their partnership agreements (including in the case of multi-member LLCs listed as Partnerships, their LLC agreements) retroactive to January 1, 2020. These changes provide that amounts these companies pay their owners as salaries under their partnership agreements will not be salaries under those agreements, but rather as profit distributions are dealt with their business. These distributions are not a charge for federal income tax purposes and do not reduce business results.
Unless the partnership agreements of these companies already include consent or dissolution provisions that protect their owners from 5% New Hampshire Interest and Dividend Tax (I&D), business owners can effectively change the terms of partnership or LLC agreements , with retroactive effect from January 1, 2020 to ensure this. Also, other than considerations for Section 199A, their partnership agreements should probably only do so for I&D tax purposes alone.
Before you and your co-owners make the above changes to your partnership agreements, you should ensure that the resulting federal tax benefits outweigh your investment retirement account, tax self-sufficiency, and New Hampshire tax considerations. But I suspect if you do the math you will find that Section 761 (a) will be a miracle cure on that net basis as well.
(John Cunningham is a Concord, NH attorney with McLane Middleton, PA. His practice focuses on LLC formations, general business and tax law, advising clients under IRC Section 199A, and estate planning. His phone number is (603) 856- 7172, his email address is law[email protected] and the link to his website is www.llc199A.com.)