‘Creative’ Estate Planning Requires Caution with Section 199A Reform

Entrepreneurs and closely held family businesses that have established multiple trusts, or plan to create trusts based on tax reform, should pay attention to certain opportunities and dangers for new tax compliance, especially regarding Section 199A.

You have probably heard that a new 20 percent federal income tax deduction is available for Qualified Business Income, applicable to a married couple with taxable income of no more than $315,000 and for an unmarried individual with taxable income of no more than $157,500. There is a phase-out of the deduction from $315,000 to $415,000 for married taxpayers and from $157,500 to $207,500 for unmarried taxpayers.   

Seeing the opportunity for their clients, some estate planners may advise clients (qualifying partnerships, S corporations, trusts, and estates) to separate business interests into as many different owners as possible to each receive income up to the $157,500 threshold of taxable income — thus qualifying for the 20 percent QBI tax deduction. Beneficiaries may include other business partners or key employees, qualifying children, grandchildren and other family members. 

Of course it’s not that simple. A clause in IRC Section 643(f) was long ago approved to allow the IRS to combine trusts that have substantially the same grantor or grantors and the same primary beneficiary or beneficiaries and treat them as one trust for taxation purposes. This treatment will be even more likely if the IRS deems that the trust was created primarily for avoiding federal income tax. 

Savvy estate planners may still succeed at getting around this anti-abuse rule through the types of trusts established (e.g. non-grantor trusts) or for clients whose businesses qualify as Non-Specified Service Businesses. An IRC 199A deduction is also available for owners of non-specified service businesses whose taxable income exceeds the dollar amounts outlined above, but is limited to the greater of (a) 50% of W-2 wages or (b) 25% of W-2 wages plus 2.5% of Qualified Property (certain depreciable property such as buildings and equipment). 

Designing trust terms that establish significant non-tax differences among different trusts may also help clients fly under the IRS’ “tax avoidance” presumption. But again, these are complex maneuvers that require careful planning and administration as well as accurate tax reporting. 

If you are uncertain as to how the new 20 percent Qualified Business Income (QBI) deduction could apply to your taxable business income, or you would like a second opinion for estate planning purposes, contact LvHJ and learn about our tax consulting for individuals and families.


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