You may have to rethink how you advise wealthy clients who seek to take advantage of innovative restructuring to deduct a portion of income from their pass-through business. Lawmakers are looking to end that option.

The speed with which Congress passed the Tax Cuts and Jobs Act appears to have led to oversights. One example: splitting a company into separate parts (aka “crack and pack”) so high earners such as lawyers, doctors and other professionals who don’t qualify for the new 20 percent pass-through deduction can get the benefit by running profits through an entity known as a cooperative.

Bill Smith, a Bethesda, Md.-based managing director in the CBIZ MHM national tax office, offered the example of four attorneys forming a cooperative with the administrative functions of the attorneys—billing and collecting payment from clients, paying rent, purchasing supplies, marketing and so forth—assumed by the cooperative. The income of the attorneys becomes the income of the cooperative, which would then distribute as deductible patronage dividends each attorney’s share of income proportionate to the value of work contributed by each attorney.

The benefit comes in the pay from which the 20 percent is figured. Under tax reform, cooperatives have been allowed the deduction to their gross income; pass-throughs can only apply the break to net taxable income.

Late last month, however, President Trump signed an omnibus government spending bill that included a provision fixing the “grain glitch” in the new tax law. The glitch gave farm cooperatives an edge over corporate-owned feed producers, allowing farmers who sell their crops to agricultural co-ops to take advantage of the deduction for pass-through businesses.

The legislation may close a potential loophole for other kinds of cooperatives, according to Smith and others. The recent “Modification of Deduction for Qualified Business Income of a Cooperative and Its Patrons” repeals the special deduction for qualified cooperative dividends and “repeals the rule that excludes qualified cooperative dividends from qualified business income of a qualified trade or business.”

While this new language is specific to agricultural cooperatives, it’s also applicable to all cooperatives, according to some CPAs, who added that planners would be wise to view forming a cooperative to circumvent the limitations on the 20 percent deduction as no longer valid.

All this comes as high-net-worth taxpayers struggle to understand the sweeping and sudden changes of reform in other areas and as regulators continue to issue new guidance.

“Wealthy clients’ understanding of the new law ... depends on their level of interest and how proactive their advisors are in informing them,” said Jeff Fosselman, CFP/CPA and senior wealth advisor at Relative Value Partners in Northbrook, Ill. Taking best advantage of the new law "will require making shifts mid-year, rather than delaying until mid-December.” He has had no clients ask about this specific loophole, but “my sense is that many HNW individuals are cautious by nature. The structural changes to form a cooperative can seem daunting and expensive. Also, given that this strategy isn’t yet tested, most individuals are going to be reluctant.”

“We’ve been discussing the new provision with our clients since the proposal was first made public and while we—and, to a certain extent, our clients—have a strong understanding of the new pass-through deduction, we’re awaiting additional guidance from Congress, the Treasury and the IRS,” said Michael Gillen, director of the tax accounting group at Duane Morris in Philadelphia.

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