By Allan Gassman
SPECIAL TRUSTS THAT CAN BE USED FOR HIGH EARNER TAXPAYERS WHO MIGHT NOT OTHERWISE QUALIFY FOR THE DEDUCTION
My recent blog post on the discriminatory nature of Section 199A makes mention of having high-income taxpayers falling under the SSTB (Specified Service Trade or Business) category consider the use of management, billing, marketing, and intellectual property entities held at arm’s- length to reduce taxes, and discusses that if the proposed regulations that were issued on August 8, 2018 become final, then such entities will be aggregated with the affiliated SSTB and thus ineligible for the Section 199A deduction if the owner’s taxable income exceeds the $207,500/$415,000 levels, or phased out ratable for income exceeding $157,500 for single filers and $315,000 for married filers. Therefore, taxpayers with income above these levels may shift ownership of such entities to trusts that can be held for descendants, parents, and other lower-bracket taxpayers (those with income below the $157,500/$315,000 levels).
The same applies for high income taxpayers that have income from Specified Trades and Businesses that do not have sufficient wages or qualified property to allow for the full, if any Section 199A deduction.
For example, Joe Accountant owns an S corporation that operates his very successful accounting firm, and may wish to establish an arm’s-length management company that provides billing, management, marketing, and other services for his accounting firm.
Joe's arm's-length management company may be owned one‑third (33%) each, by separate trusts for his three children, who each earn less than $157,500 but then Joe loses control of the ownership interests and might not want the income to actually be paid to the children or they may give the interests to people Joe does not like or lose them in a divorce. Instead of using direct ownership or non-grantor trusts, which are taxed as separate entities that are disfavored under the new proposed regulations Joe may choose to use what are called "Section 678 Trusts", which are treated as being owned by one or more of the beneficiaries of the trust for income tax purposes, but allow a trustee selected by Joe to use the trust income and assets for such purposes and people as the trustee determines to be appropriate.
Many advisors will recommend the use of “non-grantor” complex trusts which are taxed on their own retained income and can also provide significant tax savings, which include the ability to take the Section 199A deduction as a taxpayer with taxable income of less than $157,500, avoidance of approximately $2,000 a year in taxes on the first $12,500 of retained income that is taxed at lower brackets and immune from the 3.85 Medicare tax, the ability to have what is equivalent to a charitable deduction for amounts distributed to charities, the ability to deduct up to $10,000 of property taxes when personal use property or owned by the trust, and the ability to retain or pay moneys or investments as determined by the trustee each year.