The Sport of Kings to Benefit from the Federal Tax Cuts and Jobs Act of 2017
May 22, 2019
By Timothy Speiss and Andrew Goldstein
As cited by sportswriter Mark Inabinett and others, heading into the 2019 Preakness Stakes, Bob Baffert was positioned to win his record eighth Preakness Stakes when he sent morning-line favorite Improbable to the starting gate at Pimlico Race Course on Saturday, May 18. It didn’t work out that way: Mark Casse’s War of Will won the race after taking an inside path along the rail and taking charge down the back stretch.
Why is EisnerAmper reporting the race result? Some background: We know that in 1973 and with records that still stand forty-six years later, Secretariat won the Triple Crown starting with the Kentucky Derby and a time of 1:59, and then the Preakness, setting another record winning time of 1:53, although this time was not confirmed until 2012, as cited in the June 19 edition Daily Racing Form.
After 1973, the horse racing industry faced some challenges. Demand for horses slackened considerably; prices plummeted and the number of newborn thoroughbreds in North America fell dramatically. Interestingly, many industry experts point to the Tax Reform Act of 1986, which accelerated the erosion by reducing tax-loss write-offs and eliminating capital gains exclusions for racehorse investors.
Fast forward to the Tax Cuts and Jobs Act of 2017 (“TCJA”), which benefits the horse racing industry, and other sports activities, by reducing corporate tax rates, most individual tax rates, doubling the estate tax exemption from $5.49 million in 2017 to $11.4 million this year, and generally providing special tax treatment for certain pass-through entities. The new deduction is likely to encourage many people who work in the horse industry (e.g., veterinarians, trainers, laborers and farriers) to work independently.
With an impact on the taxation of the horse industry, the TCJA also allows a 20% deduction under IRC Sec. 199A for pass-through entities—including sole proprietorships, partnerships, S corporations and LLCs—on qualified business income, subject to phase-outs for taxpayers in “specified service trades or businesses” (“SSTBs”). SSTBs include any trade or business involving the performance of services in various fields or trade or business, where the principal asset is “the reputation or skill of one or more of its employees.”
Business owners operating an SSTB can only claim a qualified business income (“QBI”) deduction where the taxpayer’s (individual’s) taxable income is within certain ranges. The calculation of a taxpayer's QBI deduction depends on whether the taxpayer's taxable income is below a lower taxable income threshold (($157,500, or $315,000 if filing a joint return), or above a higher taxable income threshold ($207,500, or $415,000 if filing a joint return), or between the lower and higher taxable income thresholds. There are additional rules not cited here, for example limitations based upon W-2 wages of the trade or business and the unadjusted basis of qualified depreciable business property.
The above summary definitions under IRC Sec. 199A were problematic for businesses that both provide services and sell products. However, the IRS did provide a de minimis exception that allows a business that sells products and performs services to escape the SSTB designation if less than 10% of gross receipts are attributable to services (or less than 5% if the business has more than $25 million in gross receipts). The original legislative text also excluded from 199A eligibility any trade or business that relies on the reputation or skill of one or more employees or owners. The IRS takes an extremely narrow definition of reputation or skill and clarifies that this only applies when an employee or owner would:
- Endorse a product or service
- License his or her image, name, trademark, and so forth
- Receive appearance fees
So what does this all mean in 2019 for horse racing and the various industries that support it? The typical jockey, with net earnings from racing of less than $157,500 (as a single individual) or $315,000 if married and filing a joint return, will be eligible for the 20% QBI deduction regardless of whether or not jockeys are considered athletes or pay any W-2 wages to support staff. Owners, trainers, breeders and others in the industry that are generally organized as pass-through entities (partnerships and limited liability companies for owning horses and real estate, S corporations for operating farms and training facilities) may also be eligible for the QBI deduction if their income is below the cited thresholds, or if their income is above the thresholds and they pay wages or have sufficient depreciable assets in their business. They also need to determine whether or not they are in the business of athletics or not.
The TCJA includes other positive changes to horse racing taxation, specifically depreciating and expensing yearlings, breeding stock, farm equipment and other qualifying depreciable property. These include:
- Bonus Depreciation. An increase in bonus depreciation from 50% to 100% for both new and used property acquired and put into service after September 27, 2017, and before January 1, 2023. Bonus depreciation permits first-year, full expensing for purchases such as yearlings, breeding stock and farm equipment. Current law provides for 50% depreciation on new property only. The new benefits will be effective at the 100% rate through 2022. Beginning with 2023, bonus depreciation will be phased out at a rate of 20% each year until fully phased out after 2027.
- IRC Sec. 179 Deduction. The maximum amount that may be expensed has been increased from $500,000 to $1 million for new and used property. Additionally, the phase-out threshold for the deduction has been increased from $2 million to $2.5 million. Both the maximum deduction and phase-out amounts are permanently extended and will be indexed for inflation.
- Farm Property. Farm equipment will be granted accelerated depreciation with a useful life of only five years and depreciation using the 200% declining balance method. The current law provides for a useful life of seven years and depreciation using the 150% declining balance method.
And one more note from the rail: Trainer Bob Baffert did not win his eighth Preakness Stake, so he remains tied at seven wins with trainer Robert Wyndham Walden, who won the Preakness seven times between the years 1875 and 1888. A taxing point: The name of Walden’s 1888 winner was Refund.