In our last article, we explained the complexity and challenges in claiming the 20% pass-through deduction. Fortunately, there is a great planning opportunity for businesses that may be limited in their deduction. Today we will explain the best option available to taxpayers who may not be getting all the tax savings they should.
What Is the Aggregation (or Grouping) Election?
Very often, a business is operated through several different legal entities. This is done to minimize legal liability, because of factory restrictions on owning different franchises in the same company, or many other reasons. But often these businesses have the same executive team, centralized accounting or other functions, and they use the same software across the whole enterprise. These costs are allocated among different companies, and there really has not been a tax consequence to this until now. Under the rules for the QBI deduction, two identical businesses operations (different only in legal structure) could end up with different results in the calculation.
The good news is that there is a fix for this built into the law. IRS regulations released this August provide rules that allow businesses owners to aggregate related businesses with a grouping election on their 2018 tax return. Eligible businesses must have 50% common ownership and a certain degree of unity in operations (similar types of businesses, centralized functions or shared personnel, or that form a “supply chain”). While the requirements are somewhat complicated, we think that many businesses will be able to qualify.
Benefits of the Grouping Election
Making this grouping election has several benefits, such as eliminating the need to review and adjust intercompany fees and charges like management fees or rents. We always recommend that these agreements have terms that would be paid to unrelated parties, but we often find that leases and management agreements often are not updated. And with the degree of common ownership present in most closely-held businesses, there often is not a material shifting of income or tax consequences. However, under the 20% deduction calculation, you could have one entity generate a lot of qualified income but be limited based on the wage or asset threshold.
The grouping election lets you combine the wage and asset limit from all aggregated businesses. If you have a rental activity that produces a lot of qualified income but pays no wages and has a low asset basis, your deduction may be limited. But if you are eligible to group it with a dealership, you can use 50% of the dealership’s wages in computing the combined limit. The best part is that aggregation is totally optional. You have a lot of flexibility within the rules to pick certain businesses to group and omit others.
The bottom line is that if a related group of dealerships is limited in its 20% deduction calculation, they should consider the aggregation election to fix the problem.
What Should You Do Now?
Once a taxpayer makes a grouping election, they cannot change it until there is a material change in the way the business operates. Acquiring a new business or selling a business would be examples where the IRS would let you change your original grouping. This is an important decision that can have some lasting consequences, so we recommend that you consider all your options carefully before making the election.
Wipfli’s dealership group is available to help you consider all alternatives and help you make the right decision for your business. Contact us today to learn more.