{"id":6304,"date":"2017-12-19T10:57:24","date_gmt":"2017-12-19T18:57:24","guid":{"rendered":"http:\/\/evergreensmallbusiness.com\/?p=6304"},"modified":"2019-03-01T11:44:37","modified_gmt":"2019-03-01T19:44:37","slug":"pass-thru-income-deduction-dozen-things-every-business-owner-must-know","status":"publish","type":"post","link":"https:\/\/evergreensmallbusiness.com\/pass-thru-income-deduction-dozen-things-every-business-owner-must-know\/","title":{"rendered":"Pass-through Income Deduction: Top 12 Things Every Business Must Know"},"content":{"rendered":"\"top<\/a>\r\n\r\nLate in 2017, Congress passed the Tax Cuts and Jobs Act of 2017, an enormous, complicated 500-page chunk of tax law. Among other things, the new law happens to provide the best small business tax break of the last fifty years: the pass-thru income deduction.\r\n\r\nYou\u2019ll want to learn and understand how this new deduction works. Understanding the law may be the key to you actually benefiting and starting your tax savings earlier.\r\n\r\nNote:<\/strong> This blog post has been updated for the Section 199A final regulations and is current as of January 18, 2019.\r\n

Thing #1: First Two Key Terms<\/h2>\r\nYou will want to know the correct name for the new law, Section 199A.\u00a0This small technical detail will help you do any research.\r\n\r\nFurther, knowing the actual Internal Revenue Code section will let you find and read the the actual law if you’re interested.\r\n\r\nOne other thing: You want to know that tax law gives this new loophole a name, the “Qualified Business Income” deduction. Knowing that name will also help you with any online research.\r\n

Thing #2: Deduction Available Starting January 1, 2018<\/h2>\r\nThe pass-through income deduction works for tax years starting on or after January 1, 2018.\r\n\r\nYou therefore first get the deduction on the return you prepare in 2019 and file for 2018.\r\n\r\nA related note while on the subject of effective dates: The Section 199A deduction only works until 2025. In other words, the statute makes the deduction available for eight years.\r\n

Thing #3: Pass-through Entities<\/h2>\r\nThe deduction works for pass-through entities, which includes sole proprietorships, real estate investors, partnerships, S corporations, trusts and estates, REITs and qualified cooperatives.\r\n\r\nThe deduction doesn\u2019t work for traditional corporations technically known as \u201cC corporations.\u201d\r\n

Thing #4: Pass-through Income Deduction Equals 20 Percent<\/h2>\r\nThe Section 199A deduction, tentatively, equals 20 percent of a pass-through entity\u2019s business income.\r\n\r\nFor example, and keeping the math easy, if a pass-through entity makes $100,000, the deduction tentatively equals $20,000.\r\n\r\nI use the adverb \u201ctentatively\u201d a couple of times in the preceding sentences because the law includes a number of limitations on the basic formula.\r\n\r\n
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Need Section 199A expertise because you’re a CPA? Consider our best-selling e-book.<\/a> Instant download. Money back guarantee.\u00a0<\/figcaption><\/figure>\r\n

Thing #5: Taxable Income Usually Limits Actual Deduction<\/h2>\r\nA first limitation that applies to every taxpayer: Tax law limits the Section 199A deduction to no more than 20% of the taxpayer\u2019s taxable income subject to ordinary income tax rates.\r\n\r\nA taxpayer with $100,000 of pass-through income might hope for a deduction equal to 20 percent of $100,000, for example.\r\n\r\nBut if the taxpayer\u2019s taxable income taxed at ordinary income rates equals $50,000, the actual deduction equals 20 percent of that $50,000.\r\n

Thing #6: Tax Savings Equals Top Rate Times Deduction<\/h2>\r\nThe tax savings the deduction produces equals the deduction times the taxpayer\u2019s top tax rate.\r\n\r\nIf a taxpayer gets a $10,000 deduction and pays a top rate of 12 percent\u2014probably the typical middle-class top tax rate under the new law\u2014savings equal $1,200.\r\n

Thing #7: Foreign Businesses and Real Estate Excluded<\/h2>\r\nThe new deduction applies to businesses operated and real estate located \u201cinside\u201d the United States.\r\n\r\nTaxpayers don\u2019t get a deduction on pass-through income earned \u201coutside\u201d the United States.\r\n

Thing #8: High Income Taxpayers Need Employees or Property<\/h2>\r\nThe law requires high-income taxpayers to either pay wages or hold depreciable property in order to get the Section 199A deduction.\r\n\r\nA \u201chigh-income\u201d taxpayer includes single taxpayers making more than $157,500 and married taxpayers filing joint returns making more than $315,000.\r\n\r\nThese extra requirements get complicated quickly, but basically the Section 199A deduction can\u2019t be more than the greater of either 50% of W-2 wages or 25% of W-2 wages plus 2.5 percent times depreciable property.\r\n

Thing #9: Some Service Businesses Disqualified<\/h2>\r\nThe law prohibits a handful of service businesses from taking the pass-through income deduction if the taxpayer enjoys a high income, so over $157,500 if the taxpayer is single and over $315,000 if the taxpayer is married filing a joint return.\r\n\r\nThe \u201chandful of service businesses\u201d includes most traditional professional service firms (but not engineers and architects), athletes, performing artists, investment managers, investment brokers, and then any “celebrity” that earns appearance fees, endorsement income, or licensing fees.\r\n

Thing #10: A \u201cPhase-In\u201d Range for High-income Taxpayer Limitations<\/h2>\r\nThe extra requirements that apply to high-income taxpayers and service business owners don\u2019t immediately \u201ckick in\u201d at $157,500 or $315,000 of taxable income.\r\n\r\nRather, complicated little formulas \u201cphase in\u201d the requirement to have wages or property as a single taxpayer\u2019s income rises from $157,500 to $207,500 or as married taxpayers\u2019 incomes rise from $315,000 to $415,000.\r\n

Thing #11: Better Bookkeeping a Requirement<\/h2>\r\nBecause the new deduction provides big savings and the law is complicated, the follow-up rules from the IRS require taxpayers and their accountants to do better accounting.\r\n\r\nThe pass-through entity\u2019s accounting system will need to track both the business income the firm earns and then the non-business income the firm earns (non-business income includes things like investment income and capital gains).\r\n\r\n
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Section 199A S corporation salary questions? Use our e-book.<\/a> Instant download. Money back guarantee. Free updates.<\/figcaption><\/figure>\r\n\r\nFor high-income taxpayers, the accounting system will need to track W-2 wages, depreciable property and then for specified service trades and businesses both service income and non-service income.\r\n\r\nNote, too, that the K-1s prepared by partnerships, S corporations, trusts and then estates will need to provide more details on all of this sort of stuff to their owners and beneficiaries so these folks can make the Section 199A calculations.\r\n

Thing #12: Watch for More Guidance<\/h2>\r\nSince the original law passed, taxpayers and their accountants have received hundreds of pages of additional guidance from Congress and the Internal Revenue Service: a conference report, technical corrections and then recently proposed regulations (August 2018) and final regulations (January 2019).\r\n\r\nAt this stage, we probably have the information we’re likely to “have” before needing to prepare the 2018 tax returns. But surely the IRS will continue to issue some incremental guidance.\r\n\r\nTaxpayers (or their advisers) will need to watch for those\u2026\r\n

Additional Resources You Might Find Useful<\/h2>\r\nSection 199A Pass-thru Deduction and the “Principal Asset” Disqualification<\/a>\r\n\r\nActual complete text of law: Tax Cuts and Jobs Act of 2017<\/a>\r\n\r\nInterested in more articles like this? You can subscribe to our monthly-ish free newsletter using the form that appears below. Note you can unsubscribe anytime.\r\n\r\n\r\n\r\n