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    Tax Deduction Limitations of IRC Sec. 199A for Financial Professionals

    Posted by Bill Jackson J.D. CLU on Wed, Mar 13, 2019 @ 12:00 PM

    Final regulations from the Internal Revenue Service (IRS) may impact the application of pass through income deductions for financial professionals. The Tax Cuts and Jobs Act (TCJA) is one of the most sweeping tax changes in 35 years. It provided major tax benefits for financial services businesses along with lower taxes for many individuals.

    tax-deduction-limits-199a

    TCJA Changes

    The TCJA reduced the maximum tax rate for regular corporations to 21% from 35%. A relevant pass through entity (RPE) like an “S” Corporation, Partnership, LLC, or Proprietorship can receive a 20% deduction under the new IRC Sec. 199A. However, there is a catch that not only affects potential business clients, it affects you as a financial professional.

    IRC Section 1202(e)(3)(A) refers to “any trade or business involving the performance of services 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 one or more of its employees.” For these businesses there is a phase out of the 20% deduction. 

    Limits to Sec. 199A Deduction

    The Sec. 199A deduction is limited by several factors. First there is a prorata reduction of the 20% deduction for income between $157,000 and $207,000 for single filers. If married and filing jointly the corridor is between $315,000 and $415,000. Both are indexed for inflation. So above these amounts the deduction is gone.

    Clarifying Regulations

    The Internal Revenue Service issued final regulations on January 18th, 2019 giving more clarity to the application of the pass-through income deduction. The final regulations carve out architecture, engineering, and Life Insurance Agents from this list. For financial professionals the result is clear and positive for life insurance agents but not for planners, fee-based advisors, Representatives, and even retirement annuity professionals. So, good and bad news from the final regulations for financial professionals.

    Potential for Clients

    These rules still provide significant marketing opportunities for potential business clients. As many as 95% of small businesses fall under the Sec. 199A limits mentioned earlier*. Strategies like buy-sell funding, key person coverage, executive bonus plans, and split dollar plans can be more affordable for these businesses under the new tax act.

    If you hypothetically had clients who own a small partnership, they likely understand they need a succession plan to protect their families in case either owner dies prematurely. They may not have had enough discretionary income In the past to afford funding a buy-sell agreement. If this hypothetical business is worth $1M, each owner is 48 years old, and each makes $200,000 from the business, the 199A deduction could save each of them $9,500 in income tax**. This savings could allow them the option to purchase of $500,000 coverage on each owner’s life, completing the buy sell agreement. Their policy could produce a cash value of $243,160 by age 65 in each owner’s policy***.  This strategy provides the protection they need without added financial stress and offers each owner a substantial retirement nest egg.

    Opportunities like this hypothetical situation are the norm rather than the exception in many communities around the country. Keep in mind these changes in taxation when preparing strategies for your clients and for your financial services business.


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    Tags: taxes

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    FOR PRODUCER USE ONLY. NOT FOR USE WITH CLIENTS.

    This content is for informational and educational purposes only and is not designed, or intended, to be applicable to any person's individual circumstances. It should not be considered as investment advice, nor does it constitute a recommendation that anyone engage in (or refrain from) a particular course of action.

    The third party tools and information included in this communication have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Partners Advantage.  Third party vendors are not affiliated with Partners Advantage.  Each Financial professional should carefully consider and research the merits of any third party materials that are provided to their clients.  

    * https://www.dailysignal.com/2018/06/22/as-a-tax-accountant-i-can-tell-you-tax-reform-is-helping-small-businesses-2/

    **2018 tax rates Assumes a $40,000 deduction from $200,000 of income. Tax rates of 24% from $165,000 to $200,000 and 22% from $160,000 to $165,000.

    ***Data provided by a Securian Orion illustration dated 3/4/2019 Case ID: 15605060

    Partners Advantage Insurance Services and their representatives do not give tax or legal advice. Accordingly, any tax information provided is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. Encourage your clients to consult their tax advisor or attorney.