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IRS to Target Workarounds for $415 Billion Business Tax Break

The IRS’s proposed regulations will make clear that it considers a planning technique known as “crack and pack” to be abusive.

By Lynnley Browning

(Bloomberg) --The Internal Revenue Service will provide some long-awaited answers for business owners hoping to dodge the limits on a juicy new tax break.

The IRS’s proposed regulations, which haven’t yet been released, will make clear that it considers a planning technique known as “crack and pack” to be abusive, according to Treasury Department officials. The move had been eyed by professional service providers, such as law and accounting firms, to get around income limits set for so-called pass-through businesses, whose income is reported on their owners’ personal returns.

Under that strategy, business owners split their businesses into different entities or combine multiple businesses into one to take full advantage of the new 20 percent deduction.

The pass-through break under President Donald Trump’s tax law spurred tax professionals to circulate proposals and riff on each other’s ideas, as the industry looked to coalesce around strategies that would save their clients money.

Trump and Republican leaders have said middle-class Americans and small businesses would be the biggest beneficiaries under the $1.5 trillion tax cut. But the strategies under consideration to take advantage of the 20 percent pass-through deduction showed how top earners could ultimately reap the biggest gains.

All taxpayers who earn less than $157,500, or $315,000 for a married couple, can now deduct 20 percent of the income they receive via pass-through businesses from their overall taxable income. If taxpayers earn above those amounts and aren’t service professionals, they must meet tests to take the full deduction -- the size of their deduction depends on how much they pay in employee wages or how much they’ve invested in capital like real estate.

For “service professionals,” the break fully phases out if they earn more than $207,500 if they’re single, or $415,000 if they’re married.

Treasury officials said a law firm consisting of multiple, commonly-controlled entities, in which one entity provides its specified services back to the law firm, would be subject to the income limits on the services.

It’s unclear whether the proposed regulations will provide detailed answers about what’s a service business, since the law was vague and left hundreds of thousands of businesses wondering if they qualify. But, businesses with a relatively small amount of “specified” service income won’t be hit by the limits, the Treasury officials said.

Treasury plans on coming out with additional rules, including some to address a loophole in the tax law under which highly paid professionals, such as investment managers, doctors and lawyers, could form cooperatives to take advantage of the deduction, according to the officials.

The estimated cost of the pass-through deduction is $415 billion over the coming decade, according to the nonpartisan Joint Committee on Taxation. The tax break could be even more expensive if IRS regulations can’t keep gamesmanship to a minimum.

 
--With assistance from Ben Steverman. To contact the reporter on this story: Lynnley Browning in New York at [email protected] To contact the editors responsible for this story: Alexis Leondis at [email protected] Gregory Mott

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