199A W-2 Wage Allocation by Third Party Entities

[RETaxAcctBrk]

199A – 2 Wage Allocation by a Third Party – Primarily RE Mgmt / Owners

When must / can an entity allocate W2 wages to another entity for the purpose of calculating the QBI limitations and/or reporting by a RPE (Relevant Pass-Through Entity)?

I am struggling to arrive at a concise answer on this topic, I was hoping for some clarity from the Intuit Tax Community.  The assumption is that the Real Estate Entity (REE) exerts significant direct control over the Mgmt Company’s Employee’s work, directing how the work is done, when the work needs to be done, what materials to use, etc., and in related party cases can cause the actual termination of an employee.  I have found the following:

Per the 199A Final Regulations, page 180, 199A-2(b)(2)(ii) I conclude this states: A Taxpayer may include W2 wages paid by another person and reported on that other persons W2/W3 provided that the W2 wages are related to an individual’s labor that otherwise are the Taxpayers common law employees (the taxpayer has the right to control the details of how the services are performed).  I see 3 situations:

1) an unrelated Management Company with multiple clients – doubt the Mgmt Co Employee rises to the level of a common law employee of the rental, but common law says what matters most is control so maybe?.  I can’t see the Mgmt Co wanting to allocate its wages, unless contractually agreed in writing, so I conclude NO, these W2 wages would not be allocatable unless agreed to in writing.

2) a related party / controlled Mgmt Co with only related party clients (a centralized Mgmt Co that services only related party entities) – I believe the employee does rise to the level of a common law employee (they could easily be fired by the RE Entity, certainly the work is directed by the RE owner – which is also the mgmt co owner);

3) an unrelated Mgmt Co with only one client – it seems in this case there is enough control that the employee would rise to the level of a common law employee (if the RE Client did not like an employee, and not allow them to perform work, they would be effectively terminated).  But given they are un-related, it seems this would have to be in writing.

Bessemer Trust 199A – They have a 20 page analysis that on page 8 item 2 summarizes a “Management Company Exception” that outlines the situation where a RE investor has multiple LLC’s and a Centralized Mgmt Co (which I assume is also a separate entity), they conclude Reg 199A-2(b)(2)(II) does allow the allocation of W2 wages in this circumstance (situation 2 in my summary above).

Forbes Pass Through Deduction Article – They have a lengthy article that about 80% through has an entire section on W2 wages and states “the most important aspect of the final regulations is the flexibility afforded to taxpayers to allocate W2 wages paid by another party to a business as long as those wages were paid on behalf of common-law employees of the business receiving the allocation”.  So this issue seems to revolve around determining common law employee status, no easy matter.

Of course I doubt these are “substantial authorities”, but I assume both have people much smarter than I am.  The question seems to pivot around classifying the Common Law Employee, but I could not find anything that suggest an employee could be a common law employee of two entities at once.  The 199A regulations in the sections noted above state that the entity paying the actual wages that allocates W2 wages “can include, but are not limited to, [CPO, statutory employers, and agents]”.  So this appears to support the situations I outlined above in at least situations 2 and 3.

Finally, 199A-2(b)?(3) (page 184 – Allocation of wages) the regulations talk about a RPE that directly conducts more than one business MUST allocate wages among the various businesses.  I am not clear if a majority owner or managing member of say 2 LLC’s where one is the Mgmt co and one is the RE operations would be considered to DIRECTLY  or INDIRECTLY  conduct more than one business and therefore the allocation is required. 

Wow this is fun!  Fellow Tax Pros – any thoughts or clarity on this topic would be appreciated!

[George4Tacks]

I am glad you are having fun.
I am sure final regulations will be written by the time this code section expires

[itonewbie · Accepted solution]

Where is the ambiguity?

To understand §199A-2(b)(2)(ii), you need to read the preamble about comments the IRS had received and why it is structured the way it is.  It is there essentially to provide clarity on how W-2 income would be treated where a qualified trade or business engages professional employer organizations, payroll agents, and similar companies to administer employment formalities and payroll processes on their behalf and where these individuals to whom W-2 wages were paid are common law employees of the qualified trade or business.

If you are referring to an article published by organizations other than the IRS or state DOR, it would help to provide a link.  I looked up that the article from Bessemer Trust and read that differently.  It is clearly referring separate real estate businesses under common control and supported by a management company owned by the parent.  This is a setup contemplated within the regulations and not related to your scenario where the property management company is an unrelated third party service provider.

W-2 wages paid by third party property management companies to their employees are not relevant to rental enterprises although hours they incur in rendering rental services with respect to rental enterprises electing for safe harbor under Notice 2019-07 are counted towards the 250-hour requirement.

You can't argue that property owners have sufficient management and control over employees of these property management companies.  These owners sign an agreement with the property management company, which stipulates the terms and conditions of the engagement, and none of which would include direct supervision, control over the means of delivering services, power to hire and fire, pay decisions, among other things.  I doubt property owners want to be a common law employer of these individuals because being one comes with various liabilities.

[sjrcpa]

Non-duplication rule “an amount cannot be treated as W-2 wages by more than one trade or business”. I suggest here the key is a written agreement between the management company and client, which for consistency must be followed each year after.

Why would the management company give up their right to a QBI item?

FWIW - I'm siding with the Nos on the Managment company employee wages. Right now I'm working on a slew of RE partnerships, all of whom have management companies. The managment companies all have employees.  I think it is a stretch to say the management company's employees are employees of the RE partnerships. The management company cah hire and fire them, move them to different properties, control their hours, tell them what to do, etc. The RE partnership cannot.

Now when I get to my partnerships and corporations that use PEOs, I'm using those wages.

[RETaxAcctBrk]

Thank you!  Well - the regulations clearly indicate the ability to allocate wages, and don't limit the situation to PEO's.  I have several mgmt co / re entity relationships where the mgmt co employee works full time for a single RE owner's multiple RE entities, and the employee is selected by the RE owner, especially for locations where they only have the one RE client.  If the management company will not give up the right, then agree the discussion ends.  Otherwise if the two entities agree, and consistently apply, then 199A suggest it's valid. Further, in the case where the mgmt. company and RE entity are related, it seems this is exactly what the code was written for and in such a case under 199A2(b)(3), the wages must be allocated!?   Really, the issue here is when the mgmt. company is simply a facilitator to run one payroll for employees that work on multiple RE entities, vs each RE entity having to run payroll.  Related or not, assuming no profit motive by the management company.

[sjrcpa]

Your fact pattern is different than mine. Mgt company is unrelated. In a small realted company situation I might allocate the wages. I had an arrangemnt like that last year and I allocated wages for R&D.

[RETaxAcctBrk]

Thank you, again I appreciate the time and response. Possibly I am trying too hard, but often our job is about finding the nuances in the tax law to benefit our clients. Personally I don’t like making mistakes and am very conservative in the application of tax regulations. But 199A was broadly written so taxpayers could take the QBI, with even broader definitions being adopted to ensure rental real estate would be included. Follow Itonewbie’s lead:

Regarding the preamble to the proposed regulations, Par. A. W-2 wages attributable to a trade or business, page 18:

Excerpts (as found in order written):

1. Line 5 “…amounts paid to workers who receive Forms W-2 from third party payors (such as professional employer organizations, certified professional employer organizations, or agents under section 3504) that pay wages to workers on behalf of their clients [omitted], may be included in the W-2 wages of the clients of third party payors.”

2. Line 11 “, …the Form W-2 must be for employment by the taxpayer [or client].”

3. Line 14 “…since employees of the taxpayer are defined in the regulations as including only common law employees of the taxpayer…”

4. Line 20 “…a person may take into account any W-2 wages paid by another person and reported by the other person on Forms W-2 [omitted], providing that the W-2 wages were paid to common law employees…”

I believe this text supports an intent to include the ability of a centralized management company to allocate wages to the client as long as Item 2) and 3) above are met.

When the management company and client is a related party, it elevates the conversation to 199A-2(b)(3) Allocation of wages to trades or businesses, where “each individual or RPE that directly conducts more than one trade or business MUST allocate those wages among its various trades or businesses”

The Final Regulations (199A-2(b)(2)(ii), page 180) in line 10 of P.(ii) states: Third Party Payors “ can include, but are not limited to [CPEO Sec7705, Statutory Employers Sec3401, Agents Sec 3504]”.

If a Third Party Payor was limited to just these three types of payors, then why use language that states “such as” or “can include, but are not limited to”?  It appears these three payors are the ONLY types of IRS third party payors that assume employment tax liability (a PSP or RA does not – see https://www.irs.gov/businesses/small-businesses-self-employed/third-party-arrangement-chart ). Unless there are other types of third party payors that I cannot find, the law must then be indicating that ANY reasonable 3rd party payor arrangement that otherwise meets the “works for client and common law requirements” noted in 2) Line 11 and 3) Line 14 above, can be allocated.

Finally, the IRS acknowledge this broad definition could be subject to abuse, so both the proposed and final regulations put a clarifying statement found in 199A-2(b)(5): Non-duplication rule “an amount cannot be treated as W-2 wages by more than one trade or business”. I suggest here the key is a written agreement between the management company and client, which for consistency must be followed each year after.

Concluding: It seems as tax preparers we have the obligation to identify tax positions supported by authority. 199A uses very specific words which clearly indicate the ability to allocate wages form other than a CPEO Sec7705, Statutory Employers Sec3401, Agents Sec 3504. Unless my analysis is flawed somewhere, should we not rally behind the law and provide this tool to our clients?

Any opinions / thoughts from other Tax Law / Regulation / Employee Law Experts?  Sometimes it takes a village……

[RETaxAcctBrk]

Thank you, I appreciate the concise points, but respectfully I don’t see specifics in your response that lead me to dismiss my conclusion. I have gone over both the Reg’s and Preamble, but I have not been able to extract the clarity you suggest. Please, any succinct advice you or other tax professional can provide would be helpful for all!

The Question (simplified?):

When may (must) W2 wages be allocated between entities for the sole purpose of the QBI limitation calculations in the phase out range?

Itonewbie’s reply states “W-2 wages paid by third party property management companies to their employees are not relevant to rental enterprises”. I suggest the IRS regulations stipulate otherwise:

199A-2(b)(2)(ii) states W2 wages payed and reported “on behalf of …others can include, but are not limited to, certified professional employer organizations….statutory employers…and agents”. The regulation appears to present the case where one entity reports the W2 wages, but the work is actually done for and controlled another entity. The “but not limited to” suggest that in the case of a centralized management company, this allocation of W2 wages can be applied. I don’t see anything in the preamble that specifically rejects this finding.

The second hurdle to overcome is then who is the common law employer. Common Law Rules per the IRS (https://www.irs.gov/businesses/small-businesses-self-employed/employee-common-law-employee): “Under common-law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done.  [deleted] What matters is that you have the right to control the details of how the services are performed.”  Certainly anyone that is a hands-on owner of Real Estate knows they exert significant control over the people that work at the property (and generally have to be constantly supervised).

I understand it is this right of control, (exercised or not), that is the most important detail to determine relationship. A right to discharge a worker at will is also strong evidence of control. It seems that using the IRS definition, an individual could easily have multiple common law employers.

This definition of a Common Law Employer is certainly broad, I submit it is designed to distinguish between an independent contractor vs employee, it was not meant to distinguish or measure a degree of control between two entities where both can exert control. This is what gives rise the need to allocate W2 wages, limited by the single fact that the allocation of the W2 attribute cannot be duplicated, only one entity can claim them.

In the situation of a traditional Management Entity & Operation Entity relationship, I submit if the unrelated Management Company hires a person dedicated to an individual owners’ operations, and the owner manages that person’s work almost exclusively, the definition of common law employer is met. However, to avoid duplication of reporting the QBI W2 wages for the limitation calculation, it seems a written agreement would be needed before the Operating Entity could use the allocated wages (the assumption is the actual expense is already on the Operating Entities books as either management fees or a reimbursement of the employee cost). This is a situation where the W2 wages can be allocated (vs must be).

In the situation of related party Management Entity & Operated Entity, clearly the Operating Entity has the ability to control the employees work, in addition to being able to discharge the worker (the same person controls the ME and OE) in the same manner as Professional Employee Organization. Again, the actual employee cost is already reflected / allocated on the books of the Operating Entity through management fees or direct reimbursement. Here is seems clear the W2 characteristics MUST BE allocated to the Operating Entity because the individual directly conducts more than one trade or business.

I submit as support for this conclusion: 199A2(b)3 which states “each individual…that directly conducts more than one trade or business MUST allocate those wages amount its various trade or businesses. W2 wages must be allocated to the trade or business that generated those wages.”  This seems very clear and I cannot find evidence to the contrary in the preamble.

199A Background:

199A was designed to provide business owners (including certain real estate owners) tax relief (just as Corporations were given a tax rate decrease). The lengthy preamble of 199A suggests the regulations allow a taxpayer great flexibility in certain application of the regulations to most accurately report the character of revenue and expenses and tax attributes in manner that best represents an Individual’s or RPE’s separate trade or business.

Yet, despite spending hours striving to understand 199A, I acknowledge my lack of tax regulation interpretation skill-set (certainly it’s very own specialty) in this specific area of allocating W2 wages has not produced the level of clarity that I desire.

Thus, as a tax professional striving to best represent my client, I ask for help in finding errors in my analysis or suggest that this is a fantastic tool we should all use to help our clients maximize their potential QBI deduction.

So, can (or must) a Centralized Management Company allocate the 199A W2 wage attribute to the Operational Entity where the services are actually being performed, for purposes of calculating the potential QBI deduction limitation? If no, does the situation where the companies are related parties change the answer based on the regulations noted above? Finally, am I correct that the answer to these questions are applied the same between two “business” or a “business and real estate operation”?

Sincerely,

LRD

[itonewbie]

For the first question: You may like to read page 18 of the preamble.

For question two: The source you provided is a highly abridged and the devil is in the details.  There are numerous court cases on this and you may like to refer to Rev. Rul. 87-41 for the 20-factor tests the IRS uses to make that determination.

[RETaxAcctBrk]

Thank you, I appreciate the dialog and wisdom.  Page 18 read again, see my answer that follows.    Regarding Rev Rul 87-41 and the 20 factors, this was aimed at determining employee vs independent contractor, where the individual is not an employee of anyone.  199A suggests a new wrinkle, allocating valid W2 wages for the purpose maximizing a QBI deduction for the sole purpose of 199A.  And in fact in 199A-2(b)(3) it states wages MUST be allocated.  See my following answer.