In the second episode of Practical Tax, tax attorneys Steve Moskowitz and Liz Prehn discuss the new tax law of 2018 – specifically, section 199A. If you qualify, this section lets you pay taxes on only 80% of your profit, instead of 100%. Listen to the podcast to learn more!
Speaker 1: 00:00 I think I’m a pretty smart guy. I mean, I read the Wall Street Journal. Then this guy I know the gym tells me he’s paying taxes on only 80% of his income. It’s this thing in the new tax law called 199A. It sounds interesting. We have the same occupation. Am I missing something?
Speaker 2: 00:15 You’re listening to Practical Tax, with tax attorney Steve Moskowitz.
Steve Moskowitz: 00:20 The new tax law of 2018 has remarkable opportunities for taxpayers to save money, but it also has some very precise requirements that can take those benefits away from you. Today we’re going to discuss my absolute favorite new section of the Internal Revenue Code, 199A, that, if you qualify, lets you pay taxes on only 80% of your profit instead of 100%. Joining me is my longtime colleague, tax attorney Liz Prehn.
Liz Prehn: 00:50 Hi, Steve. Why don’t you give us a little bit of the basics of 199A. It’s so fascinating. We’ve had a lot of fun with it this year.
Steve Moskowitz: 00:56 Well, first, for the first time in American tax law, it matters what you do for a living. There’s a special group, and it’s not good to be in this group. It’s called specified trades or businesses, for example, doctors, lawyers.
Liz Prehn: 01:09 Sometimes it can be good.
Steve Moskowitz: 01:10 Well, it can if you know it and how to get around it. So we say, “Well, all right. We have a situation where there’s some magic numbers. If you’re single, it’s 157,500, married, it’s 315,000, double that, with an extra 50,000 if you’re single for a partial benefit and a hundred if you’re married.” But let’s take an example of Sally. Sally is an orthopedic surgeon. She makes a profit of $1 million. Say, “Well, wait a minute. Sally is way over the limit.” Is there any deduction for her? Liz, is there some way around to get the… this orthopedic surgeon?
Liz Prehn: 01:43 Well, plus she’s in a specified service group, right? That was one of the interesting things this year, was counseling some of our doctors and lawyers and accountant clients as to how this tax provision is going to affect them because they don’t get the benefit. Generally, the general rule is they don’t get the benefit of the 20% tax deduction. But we had a lot of fun really diving into our clients’ businesses and figuring out maybe what qualified and what did not, or what could be spun off as a different business entity. Now the revenue service did give us some guidelines. Final guidelines were… When were those issued Steve?
Steve Moskowitz: 02:15 Very recently. For example, Sally in my example could set up a separate business that’s not part of the specified trader business. In her case, it’s, forgive the colloquialism, selling spare parts, the artificial knees, the artificial hips. What she can do is set up a separate S corporation that’s not subject to these more stringent rules and get around the fact that she’s in this specified group. That’s one of the things that, if you’re in this specified group, you want to take a look at because if you qualify, that’s a way around them.
Liz Prehn: 02:47 Right. I think some of the law practices had a little bit harder time trying to fit into these new regulations. But a lot of what we found, was a lot of the law partners that had these associations, they also held real estate and different real estate interests. Now real estate was also a big boom to this new tax law.
Steve Moskowitz: 03:04 Yes it was. With real estate, we have all kinds of things. First of all, does real estate qualify for the 80% of the profit deal? Yes, if it’s a real estate business. No, if it’s a real estate investment. But also the government was given away the store, they greatly increased depreciation. For example, bonus depreciation went up from 50% to 100%. So now that a lot of property that, instead of writing the property off over many years, you can write it off in the year of acquisition. As we know with the time value of money, it’s always better to have the benefit now than many years from now.
Liz Prehn: 03:39 Yeah. I had a couple of clients that made some big improvements to their properties. One involved a Tesla charging station, one involved a new parking lot.
Steve Moskowitz: 03:48 There’s lots of other things too for depreciation. Although it’s not new, the new law makes something else that’s been around for quite a while, cost segregation analysis, even more valuable. What that does, once again, it can greatly accelerate depreciation. For example, if you buy a rental building, we know that the life is 39 years, residential properties, 27 and a half. But here with cost segregation analysis, an engineer is sent to inspect the property and he or she says, “Well, wait a minute. This is 39 year property, but this is 15 year property, 10 year property, 5 year property.” It once again greatly accelerates the depreciation, giving a client a lot more benefit now.
Liz Prehn: 04:28 Steve, I’m glad you brought that up. In one instance, we were able to save a client a lot of money. He purchased a building and made $600,000 of improvements that needed to be… they don’t… you don’t get to qualify for those types of improvements over the course of… for bonus depreciation. So he had to separate that out. So over 39 years. We were able to do a cost segregation study and it came back and a lot of the property qualified as five year property, as ten year property. It was really beneficial.
Steve Moskowitz: 05:00 Absolutely. It’s one of the things, is that oftentimes I’ve had guests come in the office and look at the difference in faces coming in and going out. That’s an example of one of the very happy faces going out because you save them so much money Liz.
Liz Prehn: 05:16 He did leave here happy. He originally just came in for a tax return because his prior CPA… he didn’t believe his prior CPA about the having to allocate the startup to his building over a number of years. We were able by talking to him and doing a deep dive into his business and getting to know him and seeing that this cost segregation, they have… really beneficial. We were able to recommend that and it really was, it saved him a ton of money.
Steve Moskowitz: 05:44 Also by doing that deep dive into the business, a lot of times we’ll discover something else and say, “Hey, in addition to a particular code section like our favorite 199A, do you know you’re also entitled to do this, this and this?” People are just amazed. This is something where oftentimes clients with little or no change in what they’re doing in business can have a huge difference in their taxes.