Understanding the New Business Pass-Through Deduction

Understanding the New Business
Pass-Through Deduction

Late last year, Congress passed the most sweeping changes to the federal tax code since the mid-eighties. One of the legislation’s major benefits is a 20 percent deduction on qualified business income (QBI) for pass-through entities, effective in tax year 2018. This has the potential to reduce a business taxpayer’s maximum federal tax exposure from 37 percent to 29.6 percent.


Do you qualify?

Pass-through entities are those in which business profits are taxed at an owner’s individual rate─sole proprietorships, partnerships, S corporations and LLCs. Eligibility for the deduction depends on both the type of business and its taxable income.

QBI is defined as net domestic business taxable income. It disregards investment income, guaranteed compensation for a partner’s services to a partnership, payments for services rendered to the business, REIT or cooperative dividends, and income from publicly traded partnerships.

Service firms are entitled to the deduction if the owner’s qualified business income (QBI) is under $157,500, or $315,000 for joint filers. The deduction phases out over time, eventually ceasing for taxable incomes over $207,500 and $415,000, respectively.

For non-service businesses, the deduction is capped at the lower of 20 percent QBI or a threshold determined by the owner’s share of W-2 wages and the unadjusted basis of business assets. Eligible business assets are defined as tangible, depreciable property used by the business during the taxable year and owned at year’s close. When an owner has multiple qualified businesses, the deduction is calculated for each, with the aggregate limited to 20 percent of overall taxable income.


Opportunities

The new tax law provides businesses with numerous planning opportunities which, given the complexity, should be analyzed in collaboration with a tax professional. It should also be noted that, while the maximum tax rate for pass-through entities will now be 29.6 percent, the top corporate rate for non-pass-through entities (C corporations) has dropped from 35 percent to 21 percent. Consequently, many business owners are analyzing whether it makes sense to restructure to C corporation status.


This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. H V & Partners recommends that you consult professional tax, legal and accounting advisors before engaging in any tax, legal and accounting action or transaction.

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