The new qualified business income (QBI) deduction under Section 199A has generated both questions regarding its complicated rules and strategies designed to take advantage of gray areas. Recent proposed reliance regulations provide clarity on several issues and curtail some avoidance plans, including use of multiple trusts.
Here’s some background. Under the QBI deduction, qualifying individuals, partnerships, S corporations, trusts, and estates may be able to deduct up to 20% of QBI. Complex rules limit the deduction, including the wage and property limitations. There is also a rule excluding specified service trades or businesses (SSTBs) (generally, any trade or business involving the performance of services other than engineering or architecture) from the definition of a qualified trade or business – thus, making them ineligible for the deduction. If income is under the statutory threshold amount (or within the phase-in range), SSTBs may qualify for the deduction, and the wage and property limitations don’t apply. All of this is covered in the Tax Advisors Planning System (Title 1, “Choice of Entity”).
Because the threshold amount ($157,500 for trusts in 2018) under Section 199A is determined at the trust level, dividing assets among multiple trusts, each with income under the threshold amount, would maximize the QBI deduction. However, the IRS has cracked down on this tactic. Under the proposed reliance regulations and Section 643(f), multiple trusts may be treated as a single trust for Federal income tax purposes. The proposed reliance regulations confirm that the multiple trust rules of Section 643(f) apply for purposes of the QBI deduction. The trusts are aggregated where two or more trusts have substantially the same grantor or grantors and substantially the same primary beneficiary or beneficiaries, and a principal purpose for establishing the trusts or contributing additional cash or other property to the trusts is the avoidance of Federal income tax. For this purpose, spouses are treated as one person. A presumption of tax avoidance applies where the creation of multiple trusts results in a significant income tax benefit, unless a significant non-tax purpose is established.
This anti-abuse rule means that trusts formed or funded with a significant purpose of receiving the QBI deduction under Section 199A will not be respected for purposes of Section 199A. While we’re discussing the QBI deduction here, the proposed reliance regulations addressing abusive multiple trusts are widely applicable and not limited to the avoidance of the QBI deduction limitations.
With careful planning, practitioners can help clients reap the benefits of multiple trusts despite the anti-abuse rule. Eluding the presumption that tax avoidance is a principal purpose for establishing or funding the separate trusts is key. This may be accomplished by designing the trusts with substantive terms that establish significant non-tax differences among them. Reviewing the intricacies of the operation and calculation of the QBI deduction will facilitate these planning goals. See Tax Advisors Planning System (Title 1, “Choice of Entity”).
To read more about the impact of Section 199A Qualified Business Income Deduction, please check out the following blog posts: