Section 199A Deduction is Complicated for Shareholders Owning Other Businesses

• September 17, 2018
• Amanda Garnett

As we have discussed previously, the tax reform legislation includes a deduction of up to 20 percent of qualified business income for S Corporations as well as certain other businesses.  Though it may sound simple on the surface, the Section 199A deduction is one of the Tax Cuts and Jobs Act’s most complicated provisions.  This is particularly true when shareholders are involved in multiple business entities.

Shareholder Level Differences

The Section 199A deduction is calculated at the shareholder level rather than at the corporate level (though the corporation will need to provide the shareholder with certain information on the Schedule K-1 to do the calculation).  Because of this, financial institutions will often not be able to predict the amount of Section 199A deduction their shareholders will claim on their personal returns.

Shareholders will inevitably have a lot of questions about how your institution’s income impacts their personal tax situation and some shareholders may have surprises on their returns come tax day.

Examples to Demonstrate

Let’s assume your bank has 10 shareholders who each own 10% of the outstanding S Corporation stock.

At the end of 2018, they each get an identical K-1 reporting the following information:

• Qualified business income = $200,000
• Qualified wages for purposes of Section 199A = $150,000
• Qualified business assets for purposes of Section 199A = $100,000

Though their K-1s are identical, their Section 199A deductions may be very different.

SH #	Filing Status	Taxable Income before 199A Deduction	Non-Bank Qualified Business Income	Non-Bank Qualified Wages	Non-Bank Qualified Business Assets	Total Section 199A Deduction
1	Single	$200,000	$0	$0	$0	$40,000
2	Married	$200,000	$0	$0	$0	$40,000
3	Single	$400,000	$100,000	$0	$0	$40,000
4	Married	$400,000	$100,000	$0	$0	$46,000
5	Single	$1,000,000	$500,000	$100,000	$100,000	$90,000
6	Single	$1,000,000	$500,000	$300,000	$100,000	$140,000
7	Married	$150,000	($50,000)	$10,000	$10,000	$30,000
8	Married	$50,000	($150,000)	$10,000	$10,000	$10,000
9	Single	$1,000,000	($200,000)	$100,000	$100,000	$0
10	Single	$500,000	$300,000	$0	$0	$40,000

 

Though we believe most banks will report adequate wages and qualified business assets to allow a shareholder to claim the full 20% deduction for the bank on a stand-alone basis (as shown for shareholders 1 and 2 above), other items on the shareholder’s personal return will also effect the overall deduction they receiver.

When shareholders own multiple businesses (as shown for shareholders 3 thru 10 above), the overall Section 199A deduction is impacted not only by the K-1 items for the bank but also the qualified business income, wages, and assets reported for each of their other businesses.

The rules can be even more complicated than shown above for shareholders who are also farmers or who are involved in certain service-related businesses such as lawyers and accountants because of some additional rules that may apply.

How Should Institutions React?

Institutions certainly can’t control tax losses from other businesses that a shareholder might own, a shareholder’s overall taxable income, or whether they are single or married.

But, there are ways that institutions can be proactive in addressing these complexities by:

• Communicating with shareholders about the new Section 199A deduction and encouraging them to meet with their personal tax advisors to project their 2018 taxes
• Carefully evaluating their tax distribution policies for 2018 in light of the Section 199A deduction as well as other tax law changes and communicating openly with shareholders about any planned reductions in 2018 tax distributions
• Analyzing whether staying an S Corporation remains the best strategic plan for your institution in the short and long-term in light of the new tax law and the lower 21% tax rate now in effect for C Corporations

How CLA Can Help

CLA is here to help you analyze how tax reform impacts your institution and its shareholders.  The rules are complex and every situation is unique.  We can assist you in performing a detailed assessment.  Please contact us.

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