Getting the 411 on IRC 199A: Just the Facts, Ma’am
- Jan 17, 2019
Melissa J. Willms of Davis & Willms, PLLC discussed the basics of Section 199A and how to apply this new section of the Code to the world of trust and estates.
The section applies so that either the trust or estate may be treated as an individual and qualify for the Section 199A deduction or the trust or estate is considered a relevant pass-through entity (“RPE”), passing the 199A deduction to the beneficiaries who as individuals will qualify for the Section 199A deduction on their personal returns.
Section 199A does not apply to grantor trusts. Grantor trusts pass all items of income, deduction, expenses and credits to the grantor and are reported on his/her personal income tax return. The grantor calculates the Section 199A deduction as if he/she personally conducted the activities attributed to the trust.
NON - GRANTOR TRUSTS
Section 199A does apply to non-grantor trusts and its beneficiaries. The taxable income threshold amounts follow that of single individuals. Therefore, the 2019 taxable income threshold whereby alternative tests are to be considered for the 199A deduction is $160,700. The taxable income threshold amounts are very important because they determine if there will be limitations on the amount of the 199A deduction allowed.
PARTIAL GRANTOR-NON GRANTOR TRUST
This can occur when gifts are made to a trust over which the beneficiary has the right to withdrawal BUT the withdrawal right is not enough to cover the gift. For example, assume a $100,000 gift is made to a trust but the beneficiary withdrawal right is only $5,000 that year. In this case, 5% of the trust ($5,000/$100,000) is considered a grantor trust and 95% is considered a non-grantor trust. Section 199A will apply to the 95% non-grantor portion with the components allocated accordingly.
When calculating the 199A deduction for a non-grantor trust, we use the concept of distributable net income (“DNI”). In most cases, DNI is the taxable income of the trust less net capital gains and including tax exempt income. Once we determine DNI, we will know how the trust falls within the Section 199A thresholds and how the additional limitation tests would apply.
One issue noted is that for 199A purposes, the proposed regulations say that trust taxable income is calculated before taking any distribution deduction. This means that in order to determine how we calculate the 199A deduction limitations (below phase-out, within phase-out range or above phase-out), all taxable income is considered even if distributed to beneficiaries.
The American College of Trusts and Estates Counsel commented on the proposed regulations illustrating the following example, which is punitive in nature:
Assume a trust has $300,000 of interest and dividend income. The trust distributes $180,000 to Beneficiary D. The $300,000 for all purposes except the 199A threshold calculation would be allocated $120,000 to trust and $180,000 to Beneficiary D for reporting on his/her individual return.
However, under the proposed regulations, the threshold taxable income amount for the trust is $300,000 and for Beneficiary D is $180,000. Therefore, a total of $480,000 is counted towards each threshold even though only $300,000 of income was received.
Hopefully clarity will arrive soon!
To read more Heckerling content, please see below:
- TCJA is the Gift That Keeps on Giving for Wealth Planning – at Least Until 2026
- Basis After the 2017 Tax Act—Important Before; Crucial Now
- Qualified Small Business Stock: The Next Big Bang
- Getting the 411 on IRC 199A: Just the Facts, Ma’am
- Recent Developments 2018
- Make Your Charitable Estate Plan Great Again
- Having Your Cake and Eating It Too
- Structuring the Tax Consequences of Marriage and Divorce After the Tax Cuts and Jobs Act (TCIA)
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Barbara Taibi is a Partner in the Private Client Services Group with years of public accounting and income tax planning and tax return preparation experience. Barbara focuses on helping clients plan for and meet their financial and tax goals.
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