CURRENT ISSUES IN AGRICULTURAL LAW CONFERENCE UNIVERSITY OF WYOMING COLLEGE OF LAW LARAMIE, WYOMING MARCH 29, 2019 FEDERAL TAX, ESTATE AND BUSINESS PLANNNING UPDATE Roger A. McEowen Kansas Farm Bureau Professor of Agricultural Law Washburn University School of Law roger.mceowen@washburn.edu www.washburnlaw.edu/waltr @WashburnWaltr PART ONE I. I.R.C. §199A – Qualified Business Income Deduction A. Proposed regulations. 1. On August 8, 2018, the Treasury issued proposed regulations under I.R.C. §199A that was created by the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. REG-107982. Those proposed regulations are intended to provide taxpayers guidance on planning for and utilizing the new 20 percent pass-through deduction (known as the QBID) available for businesses other than C corporations for tax years beginning after 2017 and ending before 2026. 2. While some aspects of the proposed regulations are favorable to agriculture, other aspects create additional confusion, and some issues are not addressed at all. 3. The proposed regulations provide a favorable aggregation provision that allows a farming operation with multiple businesses (e.g., row-crop; livestock; etc.) to aggregate the businesses for purposes of the QBID. This is, perhaps, the most important feature of the proposed regulations with respect to agricultural businesses because it allows a higher income farming or ranching business to make an election to aggregate their common controlled entities into a single entity for purposes of the QBID. 4. In several areas, the proposed regulations are helpful to farming and ranching operations. These include an aggregation rule that allows a farmer to combine the rental income from one entity with the farm income from another entity and compute the QBID based on the combined net income (and wages and qualified property if the taxpayer is over the applicable income threshold). 5. Similar to the benefit of aggregation, farms with multiple entities can allocate qualified W-2 wages to the appropriate entity that employs the employee under common law principles. This avoids the taxpayer being required to start payroll in each entity. 1
6. Likewise, carryover losses that were incurred before 2018 and that are now allowed in years 2018-2025 will be ignored in calculating qualified business income (QBI) for purposes of the QBID. This is an important issue for taxpayers that have had passive losses that have been suspended under the passive loss rules. a. The passive loss rules of I.R.C. §469 are applied before determining QBI. For example, if a rental activity incurs a $10,000 loss in 2018, but I.R.C. §469 only allows $5,000 of the loss to be netted against another rental with $5,000 of income, net QBI will be zero. The rental loss to be carried forward from 2018 is $5,000 and the QBI loss carryforward will be $5,000. b. Attention should be paid to ensure that tax software is treating I.R.C. §469 loss carryovers properly. 7. For farmers that also do consulting, a favorable rule is included that this “specified service trade or business” (SSTB) income is ignored if it is less than 10 percent of overall income from the business if average gross revenues are less than $25 million. In that instance, the income will be treated as “normal” business income for QBID purposes. 8. Under the proposed regulations, if a farmer or rancher only has one business and the business shows a loss, a QBID cannot be claimed in the current year and the loss will carry forward to the following year as a “separate” item of qualified business income (QBI). However, for farming and ranching business multiple entities, if one entity shows a loss, that loss must be netted against the income of the other entities. For taxpayers that are beneath the income threshold, the net amount is multiplied by 20 percent to compute the QBID. For taxpayers over the threshold, the proposed regulations contain a calculation procedure that will be favorable for farmers, ranchers and other taxpayers. 9. The proposed regulations confirm that real estate leasing activities can qualify for the QBID without regard to whether they are active or passive in nature. See, e.g., Prop. Treas. Reg. §1.199A-1(d)(4), Examples 1 and 2. That is certainly the case if the rental is between “commonly controlled” entities. For rentals not between commonly controlled entities, the income is QBI if the rental activity constitutes a trade or business under I.R.C. §162. B. Comparing the proposed regulations with the final regulations issued on January 18, 2019. Note - The final regulations are effective upon being published in the Federal Register. But, in general, a taxpayer can rely on either the final or proposed regulations for tax years that end in 2018. Some parts of the final regulations apply to tax years ending after December 22, 2017, or to tax years ending after August 16, 2018. However, these situations apply to the anti-abuse rules, including the anti-abuse rules that apply to trusts. 1. Losses a. Proposed regulations. Under the proposed regulations, carryover losses that were incurred before 2018 and that are now allowed in years 2018-2025 will be ignored in calculating qualified business income (QBI) for purposes of the QBID. This is an important issue for taxpayers that have had passive losses that have been suspended under the passive loss rules. While this loss allocation rule is generally favorable, clarification was needed on a couple of points. For instance, could a taxpayer also ignore pre-2018 suspended losses for purposes of the Excess Business Loss rule under I.R.C. §461(l)? 2
b. Final regulations. The final regulations, consistent with the regulations issued under former I.R.C. §199, provide that any losses that are disallowed, suspended, or limited under I.R.C. §465 (passive loss rules) §704 and I.R.C. §1365 (or any other similar provision) are to be used on a first-in, first-out basis. i. In addition, the final regulations clarify that an NOL deduction (in accordance with I.R.C. §172) is generally not considered to be in connection with a trade or business. Excess business losses (the amount over $500,000 (mfj)) are not allowed for the tax year. ii. However, an Excess Business Loss under I.R.C. §461(l) is treated as an NOL carryover to the next tax year where it reduces QBI in that year. The carry forward becomes part of the taxpayer's NOL carryforward in later years. There is no mention whether this amount gets retested under I.R.C. §461(j) (involving subsidized farming losses). Under prior law, those disallowed losses retained their character in a later tax year. That is no longer the case and it appeared that the NOL generated under I.R.C. §461(l) would not be subject to other loss limitation provisions. 2. Included and Excluded Items a. Under the proposed regulations, QBI includes net amounts of income, gain, deduction, and loss with respect to any qualified trade or business. I.R.C. §199A(c). b. Business-related items that constitute QBI include ordinary gains and losses from Form 4797; deductions that are attributable to a business that is carried on in an earlier year; the deduction for self-employed health insurance under I.R.C. §162(l); and the deductible portion of self-employment tax under I.R.C. §164(f). c. The final regulations are consistent with the proposed regulations on the treatment of the self-employed health insurance deduction and retirement plan contributions. Prop. Treas. Reg. §1.199A-1(b)(4) defines QBI as the net amount of qualified items of income, gain, deduction and loss with respect to a trade or business as determined under the rules of Prop. Treas. Reg. §1.199A-3(b). The above-the-line adjustments for S.E. tax, self-employed heath insurance deduction and the self-employed retirement deduction are examples of such deductions. i. QBI is reduced by certain deductions reported on the return that the business doesn’t specifically pay, including the deduction for one-half of the self- employment tax, the self-employed health insurance deduction, and retirement plan contributions. ii. The self-employed health insurance deduction may only “apply” to Schedule F farmers because, with respect to partnerships and S corporations, it is actually a component of either shareholder wages for an S corporation shareholder or guaranteed payments to a partner and, thus, may not reduce QBI. iii. The self-employed health insurance deduction should not be removed from an S- corporate owner on their individual return because it has already been removed on Form 1120-S. Do not deduct it twice. If QBI were reduced by the amount of the I.R.C. §162(l) deduction on the 1040, QBI would be (incorrectly) reduced twice. In other words, QBI should not be reduced by the self-employed health insurance from the S corporation or the partnership. The deduction for the S corporation 3
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