8599 / Can a trade or business establish multiple non-grantor trusts in order to maximize the value of the Section 199A QBI deduction?

Example: Amy owns and operates a pizzeria and several gas stations. Amy’s annual income from these businesses and other sources exceeds the Section 199A threshold amount, and the W-2 wages properly allocable to these businesses are not sufficient for her to maximize the QBI deduction. Amy reads an article that suggests that taxpayers can avoid the W-2 wage limitation of Section 199A by contributing portions of their family businesses to multiple identical trusts established for family members. Based on this advice, in 2018, Amy establishes three irrevocable, non-grantor trusts: Trust 1 for the benefit of Amy’s sister, Betty, and Amy’s brothers, Chuck and Dan; Trust 2 for the benefit of Amy’s second sister, Emily, and for Chuck and Dan; and Trust 3 for the benefit of Emily. Under each trust instrument, the trustee is given discretion to pay any current or accumulated income to any one or more of the beneficiaries. The trust agreements otherwise have nearly identical terms. But for the enactment of Section 199A and Amy’s desire to avoid the W-2 wage limitation of that provision, Amy would not have created or funded such trusts. Amy names her oldest son, Fred, as the trustee for each trust.

Amy forms a family limited partnership, and contributes the ownership interests in the pizzeria and gas stations to the partnership in exchange for a 50-percent general partner interest and a 50-percent limited partner interest. Amy later contributes to each trust a 15 percent limited partner interest. Under the partnership agreement, the trustee does not have any power or discretion to manage the partnership or any of its businesses on behalf of the trusts, or to dispose of the limited partnership interests without the approval of the general partner. Each of the trusts claims the Section 199A deduction on its Form 1041 in full based on the amount of QBI allocable to that trust from the limited partnership, as if such trust was not subject to the wage limitation in Section 199A(b)(2)(B). Under these facts, for Federal income tax purposes under this section, Trust 1, Trust 2, and Trust 3 would be aggregated and treated as a single trust.²

Planning Point: Significant non-tax reasons often include aggregation of ownership within the family, centralized asset management, avoidance of repetitive asset transfers within the family, asset protection or to relieve a transferring family member of asset management burdens.

1. Treas. Reg. § 1.643(f)-1.

2. Treas. Reg. § 1.643(f)-1(c), Example 1.