Tax Law, 0518 COBJ, Vol. 47, No. 5 Pg. 52

• Author: RONALD KOCH AND MICHAEL DIMANNA, J.
• Position: Vol. 47, 5 [Page 52]

47 Colo.Law. 52

The New 20% Pass-Through Tax Deduction

Vol. 47, No. 5 [Page 52]

The Colorado Lawyer

May, 2018

TAX LAW

RONALD KOCH AND MICHAEL DIMANNA, J.

On December 22, 2017, the President signed the Tax Cuts and Jobs Act¹ (the Act) into law. While the Act will impact many taxpayers, some of the more significant changes relate to how individuals and other non-corporate taxpayers are taxed on income from certain types of businesses and investments. Chief among these is the so-called “pass-through” deduction, under new section 199A of the Internal Revenue Code of 1986, as amended (the Code).² Tis one new section is over 22 pages long, employs approximately 20 defined terms, and includes 26 cross-references to other Code sections.

Whenever there is a new tax law or regulation, it is not uncommon for there to be confusion and different interpretations of Code provisions. With that in mind, this article will cover some of the basics so attorneys can be sure to relate the correct information to their clients.³

Who Qualifies for the Section 199A Deduction?

Starting January 1, 2018, and before 2026, anyone who generates “qualified business income” (QBI) will be entitled to take a deduction of 20% of QBI on their tax return in arriving at taxable income.⁴ Te section 199A deduction is available⁵ only for tax years after 2017 and before 2026.⁶

Pursuant to section 199A(c), “qualified business income” for a taxable year means “the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.” The term does not include “qualified REIT dividends,” “qualified cooperative dividends,” or “qualified publicly traded partnership income.”

Any taxpayer that is not a C corporation may qualify for the section 199A deduction.⁷ Tis includes individuals, trusts, and estates, regardless of whether the taxpayer is subject to alternative minimum tax.

A “qualified trade or business” is defined at section 199A(d) to be a business other than a “specified service trade or business” (SSTB) or services performed as an employee. However, an SSTB may be treated as a qualified trade or business if the taxpayer’s taxable income meets the specified thresholds, which are discussed below.

Generally, an SSTB is a trade or business where the principal asset is the skill of one or more employees or owners.^[8] Tis means that lawyers, doctors, nurses, financial service providers, actuaries, investment managers,, consultants, artists, and accountants will be able to use the section 199A deduction if they do not earn too much taxable income. The deduction is available for taxpayers engaged in an SSTB that do not have taxable income of more than the threshold amounts of $315,000 for joint filers, and $157,500 for single and all other qualified taxpayers, including head of household and married fling separately.⁹ Taxpayers with taxable income over these threshold amounts by a limited amount (i.e., an additional $100,000 for joint filers and $50,000 for single and all other qualified taxpayers) are entitled to take a partial deduction under section 199A(d)(3). Taxpayers engaged in other trades or businesses (All Other Entities) do not need to worry about these thresholds, except as to the W-2 and basis limitation discussed below.¹⁰

Te Deduction Applies to Most Pass-Trough Structures

Depending on the nature, size, and type of business a taxpayer engages in (as well as other factors), small-business structures (including sole proprietorships, partnerships, limited liability companies, and S corporations) may benefit from the new 20% pass-through deduction.¹¹ That said, the precise benefit a taxpayer receives will vary depending on the type of pass-through structure employed. For instance, clients may receive the deduction on all business income received from a sole proprietorship (net profits), but only on some or all of the net income they report per their Schedule K-1 from an S corporation.¹² The section 199A deduction applies to each trade or business separately.¹³

Te following types of entities will generally qualify for the deduction, because they generate pass-through earnings or income:

■ sole proprietorships (Schedule C);

■ real estate investors (Schedule E);

■ disregarded entities, such as single member LLCs (Schedule C);

■ partnerships and multi-member LLCs (Schedules C and/or E);

■ entities taxed as an S corporation (Schedule E); and

■ trusts and estates, REITs, and qualified cooperatives (Schedule E).

Entities under section 199A that have income derived from SSTBs, as defined in section 199A(d) (2), are defined under section 1202(e)(3)(A) to include the following, and are subject to limitation under section 199A(d)(3):

■ traditional service professionals such as doctors, attorneys, accountants, actuaries, and consultants;

■ performing artists who perform on stage or in a studio;

■ paid athletes;

■ anyone who works in the financial services or brokerage industry—for example, in banking, insurance, financing, and leasing; and

■ “any trade or business where the principal asset of such trade or business is the reputation or skill” of one or more of the owners or employees.

Section 199A(d)(2)(B) provides that any business consisting of investing and investment management, trading or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)) is also an SSTB.

All Other Entities includes, but is not limited to:

■ manufacturing, retail, publication, construction, wholesale, warehousing, and transportation;

■ liquor stores, food service companies, and insurance companies (not including insurance brokerage services);

■ mining, oil and gas, utilities, agriculture, and forestry; and

■ real estate (other than those that involve the performance of personal services, such as land developers, where the principal asset is the reputation or skill of one or more of the owners or employees) and medical services not involving personal services (e.g., hospitals, clinics, and MRI...