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IRS Pass-Through Tax Confusion Spells Opportunity for Advisors

February 7, 2018

The Internal Revenue Service has yet to release guidance on the GOP’s new tax law but financial professionals see the resulting confusion as a potential opportunity to save some money for their wealthy clients through the new 20% deduction on pass-through businesses, Bloomberg writes.

The deduction applies to taxpayers earning less than $157,500 individually or $315,000 as a married couple, but there are several caveats, according to the news service. For example, for “service professionals” earning over $207,500 if they’re single, or $415,000 for those married, the deduction is phased out completely, Bloomberg writes. Meanwhile, even though the tax code does define certain occupations as service businesses, including accounting, consulting, and athletics, as well as financial and brokerage services, the language is “broad and vague and the IRS has never provided guidance as to what those terms mean,” Mark Nash, a tax partner at PricewaterhouseCoopers LLP, tells Bloomberg. And few professionals are certain about what the IRS means by the exclusion from the new break of “any trade or business” whose “principal asset” is the “reputation or skill” of its owners or employees, the news service writes.

But for savvy tax planners and financial advisors, the ambiguity spells opportunity, according to Bloomberg. For example, an accountant with a side gig in real estate could potentially put everything under one company and qualify for the break because they would no longer be viewed by the IRS as a service-based business, Richard Kollauf, director of business advisory at BMO Private Bank, tells the news service.

Other business owners whose income mostly comes from services could take the opposite tack and break up a company to take advantage of the pass-through deduction on some of the income, Bloomberg writes. And some service professionals could diversify into real estate and then lease the property back to their own firm, Nicholas Sher, a certified public accountant, tells the news service. A service business such as a law firm, meanwhile, could set up “an employee-leasing entity” that could qualify the income for the pass-through deduction even though the lawyers would still be performing professional services, Kenneth Brier, a partner at tax-planning firm Brier & Ganz, tells Bloomberg. For some pass-through firms, meanwhile, it could make sense to convert to a C corporation to take advantage of the new 21% top corporate tax rate, the news service writes.

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But some of these loopholes could easily be shut down by the IRS, while the really aggressive tactics could result in picking a fight with tax authorities, according to the newswire. Yet the IRS may have a hard time keeping up: its budget has been knocked back 20% since 2010, adjusting for inflation, according to Taxpayer Advocate Service estimates cited by the news service.

By Alex Padalka
  • To read the Bloomberg article cited in this story, click here.