How Will the New 20% Pass-Through Tax Break Work?

The new 20% pass-through tax break could be a major benefit to corporations this tax season, but there is also a lot of uncertainty related to qualifications for real estate companies. At the moment, the tax cut allows taxpayers to take a cut from pass-through entities, including sole-proprietorships, partnerships, LLCs and S Corporations, and these could include real estate holdings, according to Phil Jelsma, of CGS3.

“The IRS published proposed regulations for this deduction in August 2018, but the section on rental real estate was unclear,” Jelsma, a partner and chair of the tax practice team at CGS3, tells GlobeSt.com. “The final regulations issued last month help clarify the confusion. “The final regulations still do not come up with simple answers, but generally, the 20% deduction now applies to qualified business income and is limited to the greater of 50% of the businesses W-2 wages or 25% of the W-2 wages and 2.5% of the acquisition cost of depreciable real estate.”

There are some restrictions. For example, service providers, including attorney and accountants, do not qualify. Certain service providers do not generate qualified business income because they are ‘specified service industries,’” says Jelsma.

The purpose of excluding these service providers is to stop a tax strategy known as crack-and-pack. According to Jelsma, this strategy has been used to avoid tax limitations. “This exclusion will stop companies from splitting their business to Using this crack and pack strategy, some businesses, such as law and accounting firms, have looked to split their businesses into different legal entities in an effort to separate income from professional service activities not entitled to the 20% deduction and other sources of income,” he says. “As an example, separating filing and data processing functions from a law or accounting firm so the client gets two bills each month—one from the law firm which is a specified service industry and one from the filing and data processing entity which is not.”

The regulation issued last month in regard to this tax break are the final word from the IRS, and helped to clarify the original deduction announcement in August 2018. In general, they have clarified questions for real estate professionals. “For example, the final regulations suggest that some entities such as assisted living facilities and employment staffing agencies are not ‘specified service industries’ and, therefore, are entitled to the 20% deduction,” says Jelsma. “However, some industries which were hoping to avoid being treated as specified service industries, among them radiologists, professional sports teams, lawyers, accountants, consulting firms, investment bankers and most health care providers are treated as specified service industries. As a result, these final regulations create a new group of haves and have-nots.”