The Internal Revenue Services has completed major new 199A tax-deduction regulations that could lead professionals who work with annuities to try to redefine themselves.
Financial services groups could up spending years fighting over definitions in Washington because slight changes in what the IRS thinks certain terms mean could affect whether annuity sellers can, or can’t, get access to the 199A deduction.
Annuity sellers that qualify for the deduction may be able to subtract 20% of their profits from their taxable income.
IRC Section 199A Basics
Republicans put the provision creating the 199A tax deduction in the Tax Cuts and Jobs Act of 2017 (TCJA). The provision added Section 199A to the Internal Revenue Code.
The TCJA drafters wanted to use the 199A pass-through deduction to help Main Street kinds of businesses, not to make it look as if they were helping lawyers, doctors and movie stars wiggle out of taxes.
Because of that concern, drafters put strict limits on use of the deduction for profits from “specified service, trade or business” (SSTB) firms. The 199A deduction limit for SSTB profits, which will be indexed for inflation, will start at $207,500 for individual business owners and $415,000 for married business owners filing jointly.
The TCJA drafters defined SSTB to include a business that “involves the performance of services that consist of investing and investment management, trading, or dealing in securities,” and to a class of businesses already defined in IRC Section 1202(e)(3)(A).
IRC Section 1202(e)(3)(A) refers to “any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.”
The definitions mean that the new 199A deduction could give only limited help to actuaries.
The definitions could also mean that life insurance agents and brokers could face tight limits on their use of the deduction, if they were seen as providers of financial services, or providers of investing, investing management or securities services.
The New Final Regulations
The IRS is preparing to publish 199A final regulations in the Federal Register.
In a preliminary version of the final regulations, the IRS says that it will generally exclude life insurance (and banking) from the definition of “financial services,” for 199A purposes.
The IRS declined to exclude all sales of life insurance from the definition of “investing or investment management” for 199A purposes, or to provide any definition of “investment” for 199A purposes. But it says that “commission-based insurance sales of insurance policies will generally not be classified as “the performance of services in the field of investing and investing management for purposes of Section 199A.”
Here are five questions related to annuities that the IRS left unanswered, or is still in the process of answering.
1. How will the IRS define “life insurance” for IRC Section 199A purposes?
It’s possible that the rules for life insurance would apply to other products sold by life insurers, such as annuities. It’s also possible that the definition could end up applying to some types of life insurance but not to others.
2. How will the IRS treat fees, or other forms of compensation other than commissions, for owners of businesses that sell life insurance or annuities, and who want to take the 199A deduction?
The IRS does not talk in the new final rule about how it sees fees paid for life insurance or annuities.
3. How exactly will the IRS define “actuarial science”?
It’s possible that actuaries involved in the life and annuity sectors will find ways to redefine their activities in ways that will help them make more use of the 199A deduction.
4. What do the new IRS proposed 199A regulations mean for owners of charitable remainder trusts and split interest trusts?
In addition to the final regulations, the IRS released draft regulations that could affect trusts that pay unitrust or annuity amounts to people who have to pay federal income taxes. The IRS is proposing that a taxable recipient will have to count ordinary income from a trust first, and pay ordinary, higher income taxes on that amount, before the taxable recipient can start to count any profits that might be eligible for the 199A deduction.
The IRS has proposed applying existing rules for non-grantor trusts and estates to split interest trust.
Comments on the proposed regulations will be due 60 days after the Federal Register publication date. At press time, the Federal Register publication date was not immediately available?
5. Will the IRS ever use the 199A definitions for anything else?
IRS officials seem to be making it clear that they will exclude “life insurance” and “banking” from their definition of “financial services” for IRC Section 199A deduction access purposes.
In some cases, Congress and agencies end up re-using old definitions, and interpretations of definitions.
It could be interesting to see what might happen if the IRS included “annuity” in the definition of “life insurance,” and continued to exclude “life insurance” from the definition of “financial services” used in some other contexts.
A preview copy of the new 199A final regulations is available here.
A preview copy of the proposed regulations is available here.
The federal government’s docket folder for the proposed regulations that were released in August is available here. (To see public comments, make sure the “Public Submissions” box is checked.)
The preamble to the preliminary final regulations list Vishal Amin, Frank Fisher, Robert Alinsky, Margaret Burow and Wendy Kribell as the final regulation contact people.
— Read New Tax Deduction Might Favor Life Agents Over Retirement Advisors, on ThinkAdvisor.