Published in NH Bar News (8/15/2018)
On December 22, 2019, new Internal Revenue Code Section 199A was signed into law as part of the Tax Cuts and Jobs Act of 2017 (TCJA). It became effective on January 1, 2018.
Section 199A is amazing: It provides the owners of at least 70 million passthrough businesses - i.e., sole proprietors, shareholders of S corporations and partners of entities taxable as partnerships, including most multi-member LLCs - with federal income tax deductions of up to 20 percent from their business income. In addition, shareholders of C corporations who convert the federal tax regimen of their business to a pass-through regimen are eligible for the deduction.
The number of owners in New Hampshire businesses who can benefit from Section 199A is impossible to calculate with precision, but the section unquestionably can benefit many tens of thousands of them. For many of these New Hampshire business owners, maximizing their Section 199A deductions could mean the difference between business failure and business success.
However, Section 199A is among the lengthiest and most complex provisions of the TCJA, and it is among the most difficult to understand and apply for pass-through business owners. All tax accountants know of the section, but, in my experience, very few of them are Section 199A experts. And very few pass-through business owners are even aware of the section.
What does this mean for you if you are a New Hampshire business lawyer? It means that as a matter of good client service, you yourself must inform your business clients about the basics of Section 199A. If they don't already know, they may not find out about the section until it is too late for them to take advantage of it. It also means that if you yourself are not a Section 199A expert, you must help your clients to identify and retain one.
Here are the Section 199A basics of which you should inform your business clients:
- For most pass-through business owners, the maximum Section 199A deduction will be 20 percent of their net business income.
- Many New Hampshire business owners do business through S corporations and are both shareholders and employees of these corporations. Federal tax rules require that they corporations pay their employees, including shareholder-employees, W-2 wages that meet "reasonable compensation" requirements. Under the relevant federal tax authorities, sole proprietorships and entities taxable as partnerships aren't allowed to pay their owners W-2 wages. But for many sold proprietors and partners, not paying themselves these wages will mean maximizing their deductions under that section. Thus, many New Hampshire S corporation shareholders should convert the federal tax regimen of their business to that of sole proprietorships or partnerships.
However, if partnership owners want not only to maximize their Section 199A deductions but also to minimize their Self-Employment Tax and Medicare Tax liabilities, they should reflect in their partnership agreements a little known IRS proposed regulation known as Prop. Reg 1.1402(a)-2. It is a dynamite regulation.
- There are also many other changes that New Hampshire business owners may have to make in their personal, tax and business arrangements in order to obtain or to maximize Section 199A deductions. These include, believe it or not, getting married if they are single and, if they are married, filing their federal tax returns separately instead of jointly.
- Under the TCJA, Section 199A is scheduled to expire on December 31, 2025. However, in view of the substantial federal income tax increase that any such expiration will cause for tens of millions of pass-through business owners, my guess is that eventually, Congress will extend the section indefinitely.
To sum up: If you want to do your business clients a big favor, ask them if they know about Section 199A. If they don't, tell them about it and put them in touch with a Section 199A expert.
John Cunningham is of counsel to the law firm of McLane Middleton. His practic efocuses on LLC law and tax and in handling issues under the IRC Section 199A. He is the principal author of "Drafting Limited Liability Company Operating Agreements," the author of "Maximizing Pass-Through Deduction - A Section 199A Practice Manual."