Finnegan: New Section 199A Offers Tax Planning Opportunities

At the Oct. 22 DB regulatory update session at ASPPA’s 2018 Annual Conference, Tom Finnegan, EVP at CBIZ Savitz, explained the workings of the new Code Section 199A affecting qualified business income.

Created by the Tax Cuts and Jobs Act of 2017, the Section 199A generally provides a deduction of 20% of QBI to certain owners of pass-through entities, i.e., sole proprietors, partnerships, entities taxed as partnerships like LLCs and S Corps.

Under 199A, for owners of pass-through businesses with taxable income less than $157,000 ($315,000 if filing jointly) the deduction is simply 20% of the QBI. Between $315,000 and $415,000 (or $157,500 and $207,500), the deduction phases out in an accelerated (rather than straight-line) manner. “Basically, this means that owners of specified service entities can deduct 20% of their QBI if their taxable income is $315,000 or less,” said Finnegan. Also, he noted, the proposed regulations under Section 199A generally provide that QBI is determined after ordinary business expenses, including pension deductions.

After the TCJA was enacted, Finnegan noted, there was concern that for sole props and partnerships, QBI would have to be reduced by a reasonable compensation adjustment. However, there was no such adjustment specified in the proposed regs.

So what’s the impact on DB professionals? Finnegan explained that at the outset there was a concern that “this was going to kill their entire small plan business” because all owners of pass-through entities, the vast majority of which are small plan sponsors, would have lower tax rates on an ongoing basis than they would at retirement because they’d have a 20% deduction on all their qualified business income prior to retirement, after which it would be taxed as ordinary income.

“Because of the limitations that were placed on it and because the deduction was only 20% as opposed to some of the higher amounts that were being thrown about, the fact was that after 3 or 4 years, the effect of this really gets worn away,” he explained.

But what it has done is create an opportunity for plans for the owners of specified service entities who are above the thresholds to reduce their income below the thresholds and enjoy the full benefit of the tax deduction. “Now, bear in mind that this is not the great boon to people making more than a million dollars that some of the trade press have made this out to be,” he said. “But if you do have people who are marginally, or even not so marginally, above the $315,000 limit, and they’re married filing jointly, and the only source of income is QBI, this really can be a great reason to put in a cash balance plan or another DB plan with a very large deduction and get an even larger deduction by doing so.”

For example, he said, “imagine an owner who makes $500,000, is married filing jointly, and the spouse doesn’t work. You put in a cash balance plan that has a $150,000 deduction and a DC plan that provides more than $35,000 in deductions. Well, all of a sudden this person’s QBI is less than $315,000 because the carve-out business income is determined after all ordinary business expenses, including pensions.”

“One concern we did have with the regulations is that the law provides that reasonable compensation is not considered qualified business income,” Finnegan noted. That’s clearly an issue for owners of Subchapter S Corps, as profits from the business are considered qualified business income, and their W-2 earnings are not considered qualified business income. Said Finnegan, “The concern was whether or not for partnerships and sole props, you would first have to make an allowance for reasonable compensation inside their gross in­come. And the regs don’t provide for that adjustment. So for sole props, partnerships, and things taxed like partnerships, you just have one pool of assets and it's all qualified business income.”

Finnegan was joined at the podium by ACOPA Executive Director Marty Pippins, who outlined the DB-related provisions in a host of pension reform bills currently pending in Congress. We’ll report on that portion of this year’s DB regulatory update in a future post.