(Editor’s note: This is part 2 of a two-part column on new tax regulations for pass-through entities. See part 1 here.)
Last week’s column discussed two of four major concerns for pass-through entity taxpayers as a result of the federal tax reform passed in 2017: business interest expense limitation and a new holding period for carried interest. This column outlines the other two.
1. Qualified Business Income deduction
The Section 199A Deduction, commonly known as the Qualified Business Income deduction, provides a 20% deduction to owners of pass-through entities whose taxable incomes are below certain dollar thresholds. For 2018, the thresholds are $315,000 for married taxpayers, and $157,500 for nonmarried taxpayers. As their taxable incomes creep over that threshold, they may be subject to certain limitations based on their business’s wages and the basis of property the business holds. Owners of specified services businesses will fare even worse because they will lose their deductions all together if their taxable income gets too high.
Interestingly, the Section 199A Deduction is not a business-level deduction; it is a deduction for individuals. However, for individuals to calculate their own deductions, the business entities must report additional items on Schedules K-1. Box 20 on Schedule K-1 includes new codes where entities can report Section 199A-specific information to their owners.
• Box 20, Code Z: Qualified Business Income: The 20% deduction is based on the taxpayer’s portion of the business’s “qualified business income.”
• Box 20, Codes AA & AB: W-2 Wages & Unadjusted Basis of Business Assets: Taxpayers whose taxable incomes exceed the thresholds must calculate whether their deductions will be limited based on the business’s W-2 wages or the unadjusted basis of the business assets just after acquisition.
• Box 20, Codes AC & AD: REIT Dividends and Qualified Publicly Traded Partnership Income: Dividends from real estate investment trusts and income from publicly traded partnerships may be eligible for 199A treatment, so these amounts must be reported to the business owners.
2. Global Intangible Low-Taxed Income
The Global Intangible Low-Taxed Income provision in the tax reform was created to deter taxpayers from moving income-generating activities to low-taxed jurisdictions. The law essentially imposes a minimum tax on all earnings of controlled foreign corporations. Under these provisions, any 10% or greater U.S. shareholder of a CFC must include in its gross income foreign earnings from the CFC that are in excess of a fixed return on the CFC’s assets. To help soften this imposition, the provision allows a deduction of up to 50% of the inclusion – through 2025 – to corporate shareholders.
All U.S. persons who are shareholders of a CFC, including shareholders who own a CFC indirectly through a partnership, S corporation, or trust, must worry about GILTI. The entity that is the direct owner of the CFC will need to report certain information to its shareholders or partners, including the following:
Taxpayers must pay tax on the GILTI that is allocated to them as the end shareholder, and they are responsible for paying the resulting tax.
Collecting this information, maintaining records and reporting the correct amounts to each owner will be a time-consuming process for pass-through entities and their tax practitioners. So, it is prudent to get started now to analyze the effect of each change in your reporting process. n
Tracy Dalpe and Kristen Terceira are tax directors and members of the Private Equity & Venture Capital Practice in the New England office of CBIZ & MHM.