Old Tax Code Section Answers Questions on New Pass-Through Break(1)

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By Laura Davison

Banking, insurance, and leasing sectors don’t know whether they are eligible for a tax break for pass-through businesses in the new law and are turning to the previous tax law for answers.

The confusion stems from the definition of the type of of businesses that qualify for the 20 percent deduction for pass-through entities under Section 199A of the 2017 tax act (Pub. L. No. 115-97).

Under the act, a service business isn’t eligible for the tax break. Lawmakers plucked the definition of a service business from an existing provision under tax code Section 1202. But in naming sectors that don’t qualify for the break, they listed some—not all—of the sectors identified in the existing provision.

Certainty won’t come until the IRS issues guidance, but for some practitioners the initial head-scratching has given way to some level of comfort with the new law as written.

The law didn’t add “banking, insurance, financing, leasing, investing, or similar businesses” to the list of companies defined as service businesses under Section 1202(e)(3)(B) that can’t take the deduction. That has led tax practitioners to believe that those industries can qualify for the tax break, Bruce Booken of Buchanan Ingersoll & Rooney PC, told Bloomberg Tax.

“I don’t know that’s a gray area unless there are unusual circumstances,” he said. “Section 1202 makes reference to banking, insurance and leasing, and that was not picked up in 199A.”

Lawmakers specifically didn’t bring those words with them, said Michael Greenwald, a partner at Friedman LLP in New York, which makes him “fairly comfortable” that lawmakers didn’t intend to include them in the list of services business that are ineligible for the deduction.

High Stakes for Companies

Lots of dollars are at stake for pass-throughs. Making sure that one’s business is squarely outside the bounds of that excluded list has been a high priority for owners anxious that the effects of the tax law aren’t as clear-cut for them as they are for corporations.

Other businesses defined as service businesses under Section 1202(e)(3)(A) are those “in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.” The new tax law includes that list but specifically doesn’t include engineering and architecture, making those businesses eligible for the deduction.

Treasury officials have said guidance about who qualifies for the deduction is among the priority projects government officials hope to release by the end of June. That would give companies some time to restructure if they want to after getting a glimpse at how the Internal Revenue Service plans to administer the new law.

Interpreting who’s in and who’s out of the new pass-through deduction has been difficult because it doesn’t seem to have a cohesive policy underpinning, Lilian Faulhaber, an associate professor at Georgetown Law School in Washington, said at an Urban-Brookings Tax Policy Center event. The law favors certain industries and excludes others, and then takes a biased approach about certain types of income within those industries, she said.

“At this point, all you have is the statute,” Booken said. “There was not a lot of hearings and discussions with some robust legislative history that you can point to.”

Let the Parsing Begin

Alan Keller, vice president of legislative policy at the Independent Community Bankers of America in Washington, said the group has received assurances from staff on the House Ways and Means and Senate Finance committees that Congress intends banks structured as pass-throughs to be eligible for the deduction.

Members of the two tax-writing committees didn’t return a request for comment.

Every industry on the list of excluded groups or adjacent to those definitions will be closely examining how the IRS will define them, said Kevin Anderson, a partner in the National Tax Office of BDO USA LLP in Washington. For example, people will be parsing what it means to be a brokerage service or in the field of athletics, he said.

There could be some instances, in leasing for example, where companies aren’t eligible for the deduction, Booken said. That has more to do, however, with the fact that it isn’t determined to be an active trade or business, rather than that the business involved is in leasing, he said.

Some examples of what may not be eligible for the deduction include an individual who owns a vacation home and rents it out, he said. Another example could be a limited liability company that owns a commercial building with a single tenant that has a triple net lease, where the occupant pays all the real estate taxes, building insurance, and maintenance, so the LLC is essentially just getting a check each month.

Until guidance comes out later this year, there is likely to be some ambiguity in interpreting the law, Georgetown Law’s Faulhaber said.

“It’s all over the map,” she said. “It doesn’t seem to have one clear message.”

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