How Are Pass-Through Entities Affected By The New Tax Law?

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Published by Jeff Beasley, CPA

The Tax Cuts and Jobs Act, signed into law by President Donald J. Trump on December 22, 2017, has created a list of questions from taxpayers.

One confusing segment of the law is the 20% deduction on qualified business income from pass-through entities – i.e. business that are not corporations. This deduction, found in new Internal Revenue Code § 199A of the new tax law, was put in place to approximate the new lower corporate tax rates for non-corporate entities.

What entities are considered “pass-through”? Sole proprietorships, partnerships, LLC’s and S-corporations are pass-through entities for federal tax purposes. That means that those entities are taxed at the individual level. Real estate investors, trusts, and estates are also included among those entities qualifying for the deduction.

Does this mean that anyone with pass-through income is entitled to the full 20% deduction? Unfortunately, no, it’s never that simple when dealing with the Tax Code. There are exclusions, phase-outs, and certain limits to the deduction.

If you are in a specified service trade or business, you will also be subject to possible limits on the deduction. These are professions such as doctors, accountants, attorneys, actuaries, athletes, financial services or consultants. Taxpayers will also have income thresholds that will also affect the ability to take the full 20% deduction.

To reduce the law to it’s simplest form is to say that it is equal to the sum of 20% of the qualified business income (QBI) for the taxpayer’s businesses. Think of QBI as your businesses net profits excluding investment income. There are a few other exclusions to QBI such as guaranteed payments to partners and reasonable compensation to taxpayers for services.

The deduction has a limitation based on wages and capital as well. The portion of the deduction attributable to 20% of the taxpayer’s QBI cannot exceed the greater of (1) 50% of the W-2 Wages paid with respect to the QBI or (2) the sum of 25% of W-2 Wages plus 2.5 percent of the unadjusted basis of qualified property determined immediately after its acquisition.

Space limits don’t allow for much detail here. Frankly, the rules are so specific to each individual tax payer that it really just takes you meeting with your tax professional to look at how this impacts you individually.

For now, just be aware of this; if you own a business don’t procrastinate. You should meet with your existing tax professional or financial advisor now to discuss your situation. If you do not have a current advisor or if you’d just like to get a fresh opinion, feel free to reach out to our office and I’d be happy to help you determine what, if any, impact these new rules may have on you.

 

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.

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