2019 Year-End Tax Guide

THE MARCUM 2019 YEAR-END TAX GUIDE | www.marcumllp.com

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The IRS and Treasury recently issued regulations which provide significant guidance on the operation of the new section 199A deduction, including: n Determining if the activity constitutes a trade or business. n Whether businesses can be aggregated for purposes of calculating the limitations on the deduction. n Defining the meaning of “specified trades and services,” including providing an extremely limited interpretation of businesses falling within the catch-all. n Banning the “crack-and-pack” strategy. This is where operations or property is pulled from a specified service business (e.g., personnel, IT services, real or personal property rental) and placed into a separate business which then provides the services or leased the property to the related SSTB. The intention is to convert a portion of the SSTB income into income qualifying for the deduction. The proposed regulations treat the related entity as part of the SSTB in whole or in part. Rental Real Estate Particular issues are raised under general tax law principles as to whether rental real estate constitutes a trade or business. Treasury regulations provide some relief, stating that real property rental to a commonly controlled (based on a 50% or greater common ownership) individual and pass-through entity is deemed to be a trade or business. If the rental of the real property is made to a specified service trade or business (SSTB), then the rental (while a trade or business) will also be treated as a SSTB. Note that this automatic trade or business rule does not apply where the property is leased to a C corporation. The IRS has issued procedures which provide a safe harbor for establishing trade or business status for rental real estate activities. This requires that 250 hours be spent on the rental real estate enterprise (RREE) by the taxpayer, its employees or agents. Commercial properties can be combined with other commercial properties, and residential properties can be combined with other residential properties, but commercial and residential properties cannot be aggregated. Certain conditions must be satisfied for this safe harbor rule to apply, including that there be contemporaneous records maintained. However, the contemporaneous records requirement is waived for tax years beginning prior to January 1, 2020. Despite this waiver, IRS reminded taxpayers that they bear of burden of establishing the right to any claimed deductions. Generally, net lease properties are not included under the safe harbor rules.

Unadjusted Basis of Investment Assets (UBIA) Tax depreciation schedules must be reviewed to determine if the appropriate amounts are being included. Many software companies are not calculating UBIA correctly. In addition, certain transactions may cause depreciable basis to be different from UBIA (for example, where property is acquired under a like-kind exchange where the UBIA is based on the cost of the transferred property). Where UBIA is significant for obtaining the benefit of a continued section 199A deduction, the structure of a merger and acquisition (M&A) transaction can be impacted. For example, the regulations provide that a purchase of a partnership interest outside of the partnership (a cross- purchase) may produce a basis addition to the property which increased UBIA for the purchasing partner. However, a redemption of the interest, which may produce a comparable tax basis increase, is not treated as a new asset and does not increase UBIA. Since the asset must be owned at year-end to be included in UBIA, year-end disposition should be deferred until the following year where UBIA is used to qualify the section 199A deduction. W-2 Wages Where the limitations apply, maximizing W-2 wages becomes a significant issue. If there is a third-party payer, it is necessary to determine if the taxpayer is the common law employer. Related party management and common employee arrangements should be reviewed. Entity restructuring may produce different section 199A results. Where the 50% W-2 limit applies, the goal is to have W-2 wages (for both owners and non-owners) equal 28.75% of pre-salary taxable income. n If third party salaries are not sufficient, consider a conversion to S corporation status and pay salaries to owners to reach appropriate levels. However, non-section 199A implications must be considered. In addition, IRS could attack W-2 wages to owners as being too low and as not being reasonable. n If third party salaries are sufficient, consider use of partnerships. Guaranteed payments and proprietorship draws are not salaries. n Since guaranteed payments from a partnership do not qualify as QBI, many partnerships have reviewed their agreements to determine:

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