Many federal tax scholars have described the Section 199A pass-through withholding that is available to qualified taxpayers as “largely complex.” (Pursuant to Section 199A, “qualified taxpayer” means owner of sole proprietorship, S-company, and corporations such as LLCs that are taxable as partnerships.) However, the deduction is hugely important to these taxpayers – it can be up to to 20% of their shares in the net business income of their business.
I taught a Zoom webinar on pass-through deductions for members of the Massachusetts CPA Society last Wednesday. The basis for the webinar was a sentence overview, which you can access if you are interested using the “Form 6.2” button at the top of my website. The link to the website is www.llc199A.com. Since some of the readers of this column are accountants and other qualified taxpayers, I will summarize the most important points in the sentence overview.
– President-elect Biden has announced that at some point after he takes office, he will amend Section 199A to apply only to qualified taxpayers whose annual collective or individual taxable income is less than $ 400,000. It is unclear whether he will extend the section beyond 2025 if his terms call for it to expire. However, I am confident that Congress will extend the section indefinitely before 2025, otherwise tens of millions of qualified taxpayers will be seriously harmed.
– The rules for calculating the Pass-Through Deduction in Section 199A may vary significantly depending on whether a business owner owns a “Qualified Trade or Business” or a “Specific Service Trade or Business”. Appendix A to my sentence lists the 13 types of specified service industries and businesses as per Section 199A. All other companies are qualified trades or companies.
– The provisions of Section 199A are scattered around the information about seven different classes of qualified taxpayers and the rules for calculating the transit allowance that apply to each of them. Table B of my sentence overview identifies these seven categories and rules.
– However, there is a special rule relating to the requirement of Section 199A “Trade or Commerce” that applies to qualified taxpayers who are retired or who have a full-time employment but who engage in part-time businesses that result from the acquisition and holding of residential or commercial property Commercial real estate consists of owning and renting this property to tenants. There are likely thousands of such people in New Hampshire alone, and millions more across the country. An IRS ruling states that if they and their property managers, employees, and independent contractors work in their part-time property rentals business for at least 250 hours per year, these individuals can get the pass-through deduction. However, I think that if these taxpayers follow certain rules they can get the pass-through deduction on a much shorter time basis if they follow a “profitability” rule that I outline in the sentence.
– When filing tax returns for their clients and making pass-through deduction claims for them, it should be obvious to accountants that some of these clients will have to radically reorganize their tax and legal regimes, and sometimes even their business and personal regimes, to make their passport Get through or maximize deductions.
For example, most C company shareholders should change their federal tax regime to Sub-Chapter S or Sub-Chapter K (Personal Taxation) in order to receive their pass-through deduction. And many partners in partnership should amend their partnership agreements (in many cases LLC works agreements) so that those agreements no longer include partner salaries (referred to in partnership terminology as “guaranteed payments”). Often times, these changes can be made retrospectively, as per Section 761 (c) of the Internal Revenue Code.
– What if accountants realize that certain clients need a Section 199A restructuring for tax preparation but fail to advise their clients? If their clients realize they need this reorganization but their accountants haven’t advised them like this, can these clients sue their accountants? The law is unclear, but certain cases suggest that the answer is yes.
In short, Section 199A is not only complex, but also potentially dangerous for accountants.
John Cunningham is a lawyer from McLord Middleton, PA, Concord, NH. His practice focuses on LLC formation, 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 [email protected], and the link to his website is www.llc199A.com.