(Note this post raises questions but provides no substantive advice or conclusions. My focus in this and most blog posts is the practical effect on my target client group rather than an academic assessment of the law).
I gave myself a personal ‘refresher course’ yesterday in re-reading parts of 1.199A-5 and REG-107892-18 , two of the applicable but difficult tax regulations related to the 20% business income deduction. My focus was a situation when a non-incorporated person’s business generates income from both a ‘specified service trade or business’ (SSTBs) and not SSTBs, then: 1) What are the accounting/reporting requirements, and more important, 2) What are the planning opportunities? My interest sparked by tax questions from a multi-line financial services guy with a $500k income.
Note that the SSTB is not relevant to micro-businesses whose income falls below the statutory threshold. At lower income levels, owners of SSTB as well as non-SSTB businesses can qualify for the same QBI deduction of 20% of either type of taxable income. Coincidently, my own aggregated business management model is similar to my ‘test case’, although smaller, so I also have a personal interest in the topic. I also have a much different ratio of income source than my ‘test case’, however, and income ratio matters under this regulation.
After brushing up on the law, my hope was to find an easy answer that many have delved into and are using the planning opportunities. That is not what I found.
What’s at stake? In a common micro-business with real estate or heavy asset involvement (my typical clients) with $100,00 net income that may be subject to potential planning, a theoretical $15,300 self-employment tax and perhaps a $4,800 income tax may be at stake. Those may offset, not necessarily aggregate. I am assuming in my theoretical planning consideration that the taxpayer has access to other entity forms of reporting. This may not be true. Since this decision is likely to have multi-year impact, the NPV of the planning is multiplied. So, whatever the specifics, this is a big deal to a small business owner who may be affected.
Useful resources:
Overview from Grant Thornton
https://www.grantthornton.com/insights/articles/private-companies/2019/aggregation-rules-pass-through-deduction-opportunities
AICPA discussion
https://us.aicpa.org/interestareas/personalfinancialplanning/cpeandevents/learning-library/20181019-planning-strategies
Real estate issues
https://www.kmco.com/resource-center/alerts/last-minute-planning-opportunities-under-the-new-section-199a-pass-through-deduction/
I have not reached that conclusion yet in my ‘test case’, especially with regard to disclosure of allowable aggregation of business reporting, I suspect that it is more likely that I haven’t found appropriate 3rd party discussion yet rather than the possibility that the planning topic is not adequately documented.
The conclusions that I am able to affirm:
1) The choices made here for current income tax purposes have potentially greater tax impact upon death of the taxpayer.
2) This issue should be addressed on a case by case basis. Blanket recommendations are not appropriate.
3) Many or most micro-businesses will not pay for this type of tax planning.
4) In the event that tax planning is not considered, it may be advisable to stick with the more simple strategies and forms of ownership.