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IRS provides guidance on “crack and pack” planning technique

President Donald Trump pushed through tax reform at the end of 2017. The Trump administration stated the new tax law, the Tax Cuts and Jobs Act (TCJA) would result in tax savings for many Americans. Unfortunately, it has also led to confusion. Many provisions within the law are unclear and taxpayers are struggling to determine how the law will impact their returns.

One particular area that requires further explanation: income limits for pass-through businesses.

What are pass-through businesses? Pass-through businesses are those who report income on the business owners’ personal tax returns. These can include sole proprietorships, partnerships and S-corporations.

Certain businesses, like accounting firms and other professional service providers, have attempted to reduce tax obligations that result from income limits set by the TCJA. Various tax planning strategies can reduce these obligations but one particular tax move, referred to as “crack and pack,” has been questioned.

What is the “crack and pack” tax planning strategy? This strategy essentially involves splitting a business into separate entities. The move allows one entity to take a tax deduction for the other.

A common example provided in a recent article by Bloomberg involves professional firm placing the professionals, such as physicians, in one entity and the support staff, such as administrative assistants, in another. The professional entity could then take a deduction for the administrative entity even though they are, essentially, both part of one business.

Is this technique legal? The Internal Revenue Service (IRS) recently provided some guidance on this technique. Ultimately, the agency has stated the technique is abusive and illegal.

What does this mean for pass-through businesses? Businesses are wise to review their tax planning strategies. In many cases, other legal alternatives are available that reduce the business’ tax obligations. An attorney experienced in these matters can review the business’ obligations and discuss these options. The attorneys at Goldburd McCone LLP can help.

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