How New Tax Code Sec. 199A May Have Applications for Public Companies or Large Pass-Through Companies

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The following is a blog post by Winston & Strawn LLP Partner, Ruth Wimer and is republished here with permission of The Executive Compensation Blog

Possible Compensation Planning Opportunities in New Code Sec. 199A

As most readers know, last year’s Tax Cuts and Jobs Act created a new Code Sec. 199A, providing a generous 20% deduction for individual taxpayers to exclude pass-through trade or business income (i.e., from a sole proprietorship, partnership, LLC, S corporation) referred to as Qualified Business Income (QBI). Note that QBI includes quite an array of income but excludes certain types of service income such as financial services and specified services income such as law and accounting, other than for lower income taxpayers.

One might think that this new provision is only for the small entrepreneurial companies for which it was designed, with no application for executives at public companies or large pass-through companies. But one would be wrong! For public companies or large pass-through entities, which generate QBI as defined in Sec. 199A, we see the following planning opportunities.

  1. A public company might look among its subsidiaries and find a qualifying trade or business that throws off predictable income, and that could be housed in an LLC or other pass-through entity, or is already in a pass-through. Then the company could award partnership interests to a few senior executives. This approach could deliver compensation that:
      • Potentially avoids the deductibility cap of Code Sec. 162(m) – because that income never flows up to the public parent, and
      • Is taxable to the executive at a reduced rate of only 20%, due to the Sec. 199A deduction.
  1. Existing pass-through entities, such as S-corporations or LLC/partnerships, could pay executives with more non-wage and non-guaranteed payments, which could qualify for the 20% deduction resulting in a lower tax rate to the recipient. Along the same lines, a c-corporation could be converted to a pass-through to achieve the same result.

This week, the IRS published guidance on new Code Sec. 199A, in the form of FAQs, providing detailed guidance on the requirements and which inspired this blog. For example, the guidance is favorable with respect to determining what income qualifies as QBI.

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