Pass-Through Income Tax Deduction
By Jason Yanes | 414 Services, Inc.
February 27, 2019 - We are now one month into tax season this year and hopefully you’ve gotten your taxes done already (or are at least planning to do them soon). For those of you who own small businesses, you might be wondering how these new tax laws are going to affect you. To make a long story short, yes, you may benefit from the new tax code. This is a sign that our government is encouraging us to start our own businesses. They want us to pay less taxes and be in control of our own income, not work for a paycheck from your boss. This new tax law will benefit nearly all small businesses by allowing you to take an automatic 20% deduction if you meet the requirements.
Before we dive into how the deduction is calculated and applied, let’s go over what requirements you need to meet. First, you need a “pass-through” entity. This a business that you own where you report the business income on your personal taxes. Basically, a business that the income passes through before it goes in your pocket. The types of entities that qualify as a “pass-through” entity are as follows:
Sole Proprietorship
Partnership
LLC
S-Corporation
Trust
Estate
If you own a C-Corporation or are an employee of a company you don’t own, then you will NOT qualify for this deduction.
Second, you need to have “qualified business income” (QBI). QBI is basically any profits you make in your business that are included in your taxable income. This does not include capital gains/losses or certain dividends and interest income. It also does not matter if you itemized your deductions or if you took the standard deduction, both can still qualify.
Third, you must be within the income requirement to receive the full deduction. You must make less than $157,500 (single filer) or $315,000 (joint filer) of taxable income to receive the entire 20% deduction. However, if you make between $157,500 -$207,500 (single filers) or $315,000 - $415,000 (joint filers) you may still be able to receive a partial “pass-through” deduction. To qualify for the partial deduction (if you are within the income range) you must be in a qualified trade or business. Essentially, only certain types of businesses can qualify. If your business is a Specified Service Trade or Business (SSTB), then you can receive partial deduction if you make more than the income limit, but less than the extended limit. Businesses that are considered an SSTB provide service in the following fields:
Health
Law
Accounting
Actuary Sciences
Performing Arts
Athletics
Consulting
Financial Services
Investing
Investment management
Trading
Or any business where the principal asset is the reputation or skill of one or more of its employees
The IRS also takes into account the amount of W-2 wages paid by the business and the unadjusted basis of property used by the business to determine how much partial deduction you can receive.
Finally, if you meet all these requirements then you will most likely see this deduction on your 2018 taxes. How exactly is this deduction calculated? The way it works is they calculate:
20% of the taxpayer’s QBI (plus 20% of qualified dividends and publicly traded partnership income)
20% of the taxpayer’s taxable income minus net capital gains
The lesser of the two calculations above becomes the 20% deduction. For future tax years, the income threshold amounts will be adjusted based on inflation, so they will be slightly different every year.
To learn even more about the “pass-through” tax deduction and all the other small exceptions, visit the IRS’s website for the complete code or talk to your tax professional.
If you still need to get your taxes done this season, CONTACT US to see our pricing and to see how we may be able to help you!