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Estate Planning for Section 199A Deduction

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As you might know, the Tax Cuts and Jobs Acts of 2017 (TCJA) greatly increases the lifetime estate and gift tax exemption. The TCJA created the new Section 199A deduction, which allows certain taxpayers a 20 percent deduction on qualified business income (QBI), or the non-wage portion of pass-through income. As a result, there are now new estate planning techniques that can help leverage the Section 199A deduction, reduce income taxes and increase a taxpayer’s estate.

Who is Eligible for the 199A Deduction?

The 199A deduction has taxable income limitations, based on taxpayers’ total income, not total QBI. There is a deduction phase-out when income is between $315,000 to $415,000 for married joint filers and $157,500 to $207,500 for single filers. Owners of specified service trades or business do not get a Section 199A deduction if their income exceeds $415,000 for married joint filers and $207,500 for single filers. A specified trade or service business is one “involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees, or which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.”

On the other hand, different rules apply for a trade or business which is not considered a specified service trade or business. For these businesses, the 199A deduction is still available for owners whose taxable income exceeds those in the above paragraph. However, the deduction is limited to the greater of a.) 50 percent of W-2 wages, or b.) 25 percent of W-2 wages plus 2.5 percent of qualified property.

Estate Planning for 199A

Typically, estate planners have advised business owners to sell, or gift minority interests in pass-through entities to trusts that are defective for income tax purposes (i.e. grantor trusts). However, if the grantor’s income is greater than the thresholds outlined above and in Section 199A, the grantor may not be eligible for the Section 199A deduction, or only a reduced deduction. As a result, taxpayers should consider utilizing nongrantor trusts, which are separate taxpayers, each eligible for the Section 199A deduction. The goal would be to create as many different nongrantor trusts as necessary so that each trust received the maximum amount of income before the phase-out threshold, thus allowing each nongrantor trust to qualify for a Section 199A deduction. Therefore, even if the grantor would not qualify for a Section 199A deduction against his or her total income, each trust would individually qualify for the Section 199A deduction.

Multiple Trust Caveat: Section 643(f)

When multiple trusts will be created, Section 643(f) should be considered, which states:

For purposes of this subchapter, under regulations prescribed by the Secretary, 2 or more trusts shall be treated as 1 trust if-(1) such trusts have substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries, and (2) a principal purpose of such trusts is the avoidance of the tax imposed by this chapter. For purposes of the preceding sentence, a husband and wife shall be treated as 1 person.

For more details or questions regarding estate planning using Section 199A deduction, please contact your Withum Tax Advisor or fill out the form below and we’ll respond to you shortly.

Hal R. Terr, CPA, PFS, CFP®, AEP®, Partner
(609) 520 1188
hterr@withum.com

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Ted Nappi, CPA/PFS, CSEP, Partner
(732) 842 3113
tnappi@withum.com

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