Highly paid professionals including investment managers, doctors and lawyers are eyeing a loophole in what’s supposed to be a mom-and-pop benefit of the new tax law as a way to supersize their savings.
The loophole lies in the law’s 20 percent deduction for owners of small businesses run as partnerships, limited liability companies and the like. These so-called pass-through entities underpin the U.S. economy, ranging from small-town builders to law practices, but also private-equity and hedge fund firms.
The law features a guardrail intended to keep service professionals such as hedge fund managers or cardiologists from using the break once their income hits a certain level. But top earners can exploit a gap that lets the benefit go to anyone who runs profits through an obscure entity known as a cooperative.
“You can make gobs of money and still get the deduction,” said Erin Fraser, a tax and wealth-planning lawyer at Hanson Bridgett LLP in San Francisco, who has gotten calls in recent weeks from lawyers, consultants and a wealth management firm about the advantages of the cooperative model.
Signed by President Donald Trump in December, the law marked the biggest change to the tax code in a generation. Yet the rush by congressional Republicans to finish the bill may have inadvertently created a way for highly paid professionals to exploit a special break that the GOP has advertised as benefiting mom-and-pop operations.
The cooperatives benefit applies to a business model more often associated with farmers, groups that distribute electricity to rural residents and progressive collectives than with elite doctors’ offices.
A cooperative is a worker-owned, worker-run enterprise whose members earn salaries and share profits paid out as so-called patronage dividends. Members then pay ordinary rates on them. The dividends are deductible to the cooperative, which pays the corporate rate on anything retained for reinvestment in the business. Employees who aren’t members typically receive regular wages.
“It’s a weird little corner” of the tax code, Fraser said.
Bigger Savings
For cooperatives, the 20 percent deduction applies to a much larger bucket of income than it does for pass-through entities -- resulting in bigger savings that can potentially wipe out a tax bill.