Originally published on Forbes.com.
Ask your tax pro about 199A. That pretty much is most of the practical advice that you need to take away from this piece, which is more a reflection on the way significant changes in the tax law are actually implemented than anything else. Although it is also a bit of a memoir as for the first time in 39 years I don’t have a “tax season” to look forward to in January. We’ll start with 199A, which is something that you should at least know exists unless you are certain that the only substantial income you will ever have is from W-2 employment.
199A A Cynical View
They called it the Tax Cuts and Jobs Act and there was some logic to it. An inference that you can make from the bill is that jobs – specifically employment that results in somebody getting a W-2 – are a good thing. Therefore “ job creators” should pay less income tax on the money that they make than “jobholders” pay on the money that they make. How much less? Well, they settled on 20%. In the House version of the bill, the emphasis on job creation was not as strong. It was pretty much just that people who get business income without doing any work should pay less than people who get income from working. And it was implemented by a special rate. Section 199A which is what we ended up with is a deduction.
How much did you make from your business (proprietorship, partnership, S corporation “flow-through” – not salary or guaranteed payment)? Take 20% of that and deduct it from your taxable income. It will actually work out that way for some people. Like me for example. For many people, though, it is not nearly that simple. Not even close.
Because 199A makes explicit the connection between getting the benefit and being a “job creator”. If your taxable income before the 199A deduction is greater than $157,500 (Double that for married filing joint), the benefit begins phasing out unless the business is paying substantial W-2 wages (or has a lot of tangible property). It also phases out if you are in the wrong sort of business- like the field of health for one example or accounting for another.
The devilish details of how all that works are explained by me a little bit, but much more thoroughly by Tony Nitti most recently here. Alan Glassman has also weighed in – most recently here. My biggest contribution was the derivation of a magic number. Friday I learned that some nitpicker has suggested that it should be modified. He’s probably right, but I never thought it was a good idea to use the exact number anyway, so I am not crestfallen.
All my reading could probably be enough, but on Friday, I went to a seminar. And if you are in New England and you have enough business going on that you use a CPA to do your tax returns, there is a good chance that I was getting the word the way your CPA is getting it either directly or indirectly – a Boston Tax Institute seminar led by Lucien Gauthier.
About Lu Gauthier And The Boston Tax Institute
My favorite Edmund Burke quote is something that I am not always that good at practicing. It goes like this:
To be attached to the subdivision, to love the little platoon we belong to in society, is the first principle (the germ as it were) of public affections. It is the first link in the series by which we proceed towards a love to our country, and to mankind. The interest of that portion of social arrangement is a trust in the hands of all those who compose it; and as none but bad men would justify it in abuse, none but traitors would barter it away for their own personal advantage.
One of the themes of this blog is gentle mockery of my profession (tax focused CPA). They sometimes makes tax season sound like a combat deployment. You learn all the math you need for it by the fourth grade.
Actually I really do love my little platoon and they are a good bunch. Not all that collegial though. A good place to see quite a few of us together is a BTI seminar, because BTI is probably the best continuing professional education value in New England. You can get five one day seminars for $875 and that is what you need to do in a year to meet the Massachusetts licensing requirement. They are held in the meeting rooms of hotels like Comfort Inn convenient to the interstates. The coffee and snacks are so so and you are on your own for lunch.
BTI’s marketing seems to pretty much consist of word-of-mouth, the website and a regular email. I don’t know if there is still snail mail going out. The effect seems to be that Lu Gauthier’s students are growing old with him. Based on his resume, he is over seventy, but he projects the energy of a much younger man in his presentation. The pupils are a different story. People kept drifting in so my nose count is a little off, but I put it at 38 men and 6 women, which is the circa 1980 gender mix you would expect. All white which sad to say has not changed all that much since then unlike the gender mix. The average male age was north of 60. The women were mostly younger probably Gen-X.
Most of us were able to remember Lu Gauthier teaching us about the Tax Reform Act of 1986 . Chatting before the start of class I remarked about how he had handed out applications to tractor trailer driving school back then. Lu reached into his briefcase and showed us that he still carries one of them around. The idea was that Code Section 469 was making our job impossible.
Tax Work Is Not For Perfectionists
Lu started off commenting on 199A and the resulting regs as not being something that can be reasonably administered. The probability of audits has been going down, but of course we can’t make decisions and recommendations based on that. Nonetheless the thing he reminded us to worry about, even more than IRS penalties on our clients and ourselves, is missing out on a tax benefit that our competitors point out. That is the basis for the BTI mission statement:
If you are walking in the woods with a competitor and you see a bear, remember this: you do not have to outrun the bear, you only have to outrun your competitors! As your Equalizer, BTI’s mission is to help you outrun your bigger competitors and make sure that you and your clients are not leaving money on the table!!!
He doesn’t expect that the software companies will be able to get the 199A computation correct and that many returns will end up having something incorrect in them.
The Perils Of Being A Tax Celebrity
Lu Gauthier is one of those rare people who reads almost everything – including tax blogs. I had to take the abuse for a nit that he had to pick with one of Tony Nitti’s pieces. He believed that Tony had written it so that people might end up confusing aggregation with grouping. Can you believe such a thing could happen? He also broke the news that one of his students had found a weakness in my magic number (It is the percentage of profit an S corp owner should take as salary in order to maximize the 199A deduction if there are no other W-2 wages). I forgot to consider the effect of the resulting deduction of medicare tax.
The Important Takeaways
If you are making over the threshold, your deduction will be phased out if you are in a “specified service trade or business”. Pending regulations there had been a lot of speculation on what the precise meaning of some of the fields were that made up the SSTBs – (health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in securities, principal asset is reputation or skill).
The regulations were somewhat generous in defining the fields that are excluded from treatment. We had been worried about “any trade or business where the principal asset of the trade or business is the reputation or skill of one or more of its employees”. That was narrowed to being pretty much people who are getting paid for use of their name or image or for showing up at events. Ironically, it probably includes a good part of President Trump’s income. So maybe he wasn’t kidding when he said the bill was not good for him.
Brokerage was also defined narrowly. It only refers to people dealing in securities.
There are still some gray areas. One of the things we discussed was taking a close look at the SIC code that is put on returns. A lot of times not much reflection goes into it in the initial year and then it is just copied. If you have an argument that what you are doing is not “consulting”, don’t shoot yourself in the foot, by listing your occupation as consultant.
Whether a real estate activity “rises to the level of a trade or business” is another source of concern.
If you have multiple businesses and flow throughs a big concern will be if W-2 wages and tangible assets are not well matched up with “qualified business income”. That is where “aggregating” comes in. I’m not going to try to explain those rules. All I can tell you is that the time to look at them is now. If your life has a lot of moving parts and you are using a CPA as your tax adviser, they should be calling you now. The devilish details of this are applying the rules to your particular facts. And of course, you still have time to do things to affect 2018 outcomes.
So call now and ask about 199A. If your adviser does not seem to be on top of it, you may want to be thinking about making a change. You may be dealing with somebody who is going to get caught by the bear.
Another thing Lu emphasized that I am not getting into here is the possibility of accounting method changes to get off the accrual method and avoid the need for inventories for businesses with less than $25 million in gross receipts.
How Tax Law Gets Applied
Lu told us that we were attending his 48th presentation on 199A. About eighty people had taken it twice and a few had come three times. I mentally tried to project how many businesses are going to be affected by his reading of 199A. It runs well into the thousands. Many practitioners don’t engage that much with original source material. So for a significant part of the economy in this region 199A will end up being what Lu Gauthier says it is. We all just need to hope that he uses his power for good.
Full Disclosure
I taught a BTI course a million years ago. The most memorable comment on the evaluation form was an answer to the question about how the course might be improved. The disgruntled student suggested somebody else teach it. Being a glutton for punishment I pitched Lu on doing another one, so he put me on the schedule for June – Hobby Losses. I’ll let you know how it goes.
About The Headline
The headline – Ask Your Tax Pro About 199A – is inspired by the genius who transformed the way that pharmaceutical products are marketed. No longer was it just “detail men” showing up at the doctor’s office to give them free samples of the latest new drug. Now there are TV commercials that portray how wonderful your life would be if some, possibly embarrassing, condition were treated. At the end, before a quick review of possible side effects, often including death, that seem worse than the condition, you are urged to “Ask you doctor about __________”.
I have heard that doctors hate those commercials. It brought to my mind, one of the few things I remembered from the “business core” courses I had to take in order to get an accounting degree. It was in the marketing course, that I learned about the “decision-making unit”. In order for marketing to be effective, you need to direct it to the decision-maker. The “ask your doctor” message transformed the decision-making unit, so it was no longer just the doctor.
I’m suggesting that you become that type of proactive consumer with your tax adviser.