Pass Through Special Deduction under the New Tax Law

Prepared by Jason Ashley, CPA- Tax Manager

One of the most important changes in the recently passed Tax Cuts and Jobs Act (TCIA) relates to the Section 199A deduction for Qualified Business Income (QBI).  For those who are not tax accountants, this refers to the new 20% deduction for pass through income received.

This law applies to sole proprietors who report their income on Schedule C, single and multi-member LLC’s, partnerships, and S corporations and should be a boost to tax savings for many business owners and investors.  However, it is quite complex with many different rules and limitations.  In general, you will receive a deduction on your 2018 tax return for 20% of the income from the pass-through entity.  For example, if you earned $100,000 in pass through income, you will receive a 20 percent deduction for this ($20,000) and this deduction will be reported on your individual tax return. If your income tax bracket is 24% for example, the federal tax savings would be $4,800 ($20,000 multiplied by 24%).

So long as your taxable income does not exceed $315,000 for married filing jointly taxpayers and $157,000 for all others, this is the calculation.  Once your taxable income exceeds the threshold, various phase outs begin.  If your pass-through income is from a specified service trade or business including health, law, accounting, financial services, performing arts and athletics, you are subject to the phase out. Regardless of the industry, one other limitation to consider if your taxable income exceeds the threshold is wages paid.  In an effort to encourage more profitable business owners to pay wages to employees, this deduction cannot exceed 50% of W-2 wages paid with respect to the QBI.

As you can see, due to the new tax law there is great potential for tax savings starting in 2018.  However there are many complexities involved and the new tax law is hundreds of pages long.  It is highly advisable that you speak with us further as 2018 progresses to know what effect, if any, this will have on you.