The tax authority is moving to curb how businesses - which may include those in the wealth management industry - use a new tax break that came into force late last year.

The Internal Revenue Service is proposing to stymie attempts by professional service firms such as accountancy and legal practices to circumvent income limits set for what are called pass-through businesses.

A planning method dubbed “crack and pack” enabled business owners to divide their operations into different parts to reduce tax bills under the system. The pass-through tax change was introduced late last year by the Trump administration alongside a number of other measures, including those that affected high net worth US citizens and their advisors (see here).

The pass-through break, as is often the case with such moves, caused some businesses to adjust in order to squeeze as much of a tax reduction as possible. The IRS has now moved to cut off this tactic.

The tax authority this week said it has “issued proposed regulations…for a new provision allowing many owners of sole proprietorships, partnerships, trusts and S corporations to deduct 20 per cent of their qualified business income”. The IRS said the new deduction was introduced as part of last year’s Tax Cuts and Jobs Act.

“The deduction is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. It’s generally equal to the lesser of 20 per cent of their qualified business income plus 20 per cent of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20 per cent of taxable income minus net capital gains,” the IRS continued. “Deductions for taxpayers above the $157,500/$315,000 taxable income thresholds may be limited. Those limitations are fully described in the proposed regulations. Qualified business income includes domestic income from a trade or business. Employee wages, capital gain, interest and dividend income are excluded,” it concluded.

Under the new pass-through tax regime, profits “pass through” to owners and are taxed at the individual level, rather than carrying a corporate tax and then hit with individual taxes after money is distributed to owners. Corporate tax rates have been cut, but the new regime still means that if a firm splits itself up, it can make sense to operate as “pass-throughs”, cutting their effective maximum individual rate to 29.6 per cent from 37 per cent, which is the new top rate for employed pay.

Among other items that stirred controversy in last December’s tax bill was a doubling of estate tax exemptions and limits to what taxpayers can deduct against local and state taxes, a move seen as penalizing residents in relatively high-tax, Democrat-leaning parts of the country, such as in California and New York. There has even been speculation on whether such changes might lead some family offices to restructure so that they are more like corporations.