The 2017 Tax Cut and Jobs Act created many new tax advantages for businesses.
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The 2017 Tax Cut and Jobs Act created many new tax advantages for businesses.
Among them is a 20 percent tax deduction available to owners of “pass-through” entities, including sole proprietorships, partnerships, S corporations, trusts, estates or LLCs. If you have rental properties, this deduction might also apply. Also under the new tax law, taxpayers may be able to deduct 20 percent of their real estate investment trust (REIT) dividends and publicly traded partnership income as well.
Because the income taxes of pass-through businesses are paid by the owner of that pass through, this new 20 percent deduction may allow a business owner to save a significant amount of money off their personal income tax bill.
Keep in mind though, this 20 percent tax deduction does not apply to wage income of the business owner, nor does it apply to C corporation entities. Under the new tax law, C corps (or “regular” corporations) now have a relatively low income tax rate of 21 percent, which is much lower than the highest personal income tax rate of 37 percent. This 20 percent deduction was a way for Congress to give certain pass-through business owners a tax break, too.
The 20 percent deduction is available in tax years starting Jan. 1, 2018 and it expires eight years later in 2026. This means you can take advantage of this tax deduction for the next eight years.
In order to claim the deduction, there are several hurdles that need to be cleared. As an owner of a pass-through entity, you first need to look at your income. If your combined income for the year is less than $315,000 (filing a joint tax return) or $157,000 (not filing a joint tax return), then you generally get to claim this 20 percent pass-through business deduction on your tax return.
If your income is greater than those thresholds, you can still move on to considering other hurdles, but you might not qualify for the entire 20 percent deduction.
The next hurdle is to see if your business is a “specified service business,” or “SSB.” SSBs are generally defined as professions in health, law, accounting, financial services, athletic and a few others. If you are practicing in one of those disciplines, then your 20 percent deduction will get phased out as you earn more income.
Since the upper limit for qualifying for any portion of this deduction for a SSB is $415,000, as your income approaches the $415,000 limit for filing jointly (or $207,500 for other tax filers), this 20 percent deduction gets phased down to 0 percent. In other words, if you have a SSB and you make more than $415,000 (filing jointly) you will lose this 20 percent deduction for your tax returns.
Another hurdle relates to wages paid to your employees. The deduction can be limited if you are practicing as a SSB as discussed above, and it can also be limited if you do not pay enough wages to your employees.
Once you cross over that $315,000 income threshold, the tax rules require you to consider how much you have paid your employees (including payroll paid to the business owner) as wages.
To make this calculation even more complicated, the tax law allows a business to use some of its assets to help meet certain thresholds.
In summary, Congress created this beneficial, but complicated, 20 percent deduction to give pass-through business owners a significant tax reduction.
Brenden Healy is a CPA and tax partner at Hartford-based accounting and consulting firm Whittlesey.
