Tax Cuts and Jobs Acts: The Impact of Section 199A

For over 40 years, members of the RMC Group have been talking about the importance of planning for retirement. In addition, it has long been our opinion that a defined benefit pension plan is the best way to ensure a secure retirement. A DB plan enables an employer to maximize its contributions to a qualified retirement plan and to provide the maximum benefit permitted by law. There may now be another reason for an employer to adopt a defined benefit pension plan.

In December, 2017, President Trump signed the Tax Cuts and Jobs Act (the “Act”), which cut the corporate income tax rate from 35% to 21%. The Act also reduced the top rate for individual taxpayers, but only to 37%. As a result, it would seem that so-called “pass-through entities”, such as s-corporations, LLCs, partnerships and sole proprietors, the income of which is taxed to their owners at the individual rates, do not benefit as much from the Act.

However, the Act also added section 199A to the Internal Revenue Code. Section 199A provides a deduction from taxable income for the owners of certain “pass-through entities”. The deduction is designed to lower the effective rate paid by the owners of “pass-through entities” in order to equalize the benefits of the Act.

The problem is that not all “pass-through entities” are treated the same. In order to take advantage of the section 199A deduction, a taxpayer must have income from a “qualified trade or business”. Most professionals, such as lawyers, doctors and accountants, are excluded from the definition of “qualified trade or business”. However, section 199A provides an exception for professionals with taxable income below a threshold amount. The threshold amount is $157,500 for a single taxpayer and $315,000 for a married taxpayer. [A single taxpayer with taxable income greater than $157,500, but less than $207,500, and a married taxpayer with taxable income greater than $315,000, but less than $415,000, are eligible for phased-out section 199A deductions.]

This is where a defined benefit pension plan may be able to help. Taxable income is determined after allowable deductions. So, a “pass-through entity”, making contributions to a defined benefit pension plan, may be able to lower its owner’s taxable income below the section 199A threshold amount. In other words, to the extent that its contributions to a defined benefit pension plan are deductible, an employer may be able to provide its owners with a valuable retirement benefit, as well as the section 199A deduction.

To learn more about defined benefit pension plans, contact your regional representative or call us at 888-599-5553. Of course, section 199A is very complicated, and the IRS has yet to provide any guidance. A client should consult with its tax and legal advisors.