One of the most talked about changes under the Tax Cuts and Jobs Act is the new 20% deduction afforded to qualifying businesses. This deduction applies to income from pass-through entities and may provide a substantial tax benefit to individuals that qualify for the deduction.
What exactly is the pass-through business income deduction?
The deduction is up to 20% of your "qualified business income (QBI)" from a partnership, LLC, S corporation, or sole proprietorship, defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business. It reduces your taxable income but not your adjusted gross income and is available regardless of whether you itemize deductions or take the standard deduction. In general, the deduction cannot exceed 20% of the excess of your taxable income less any net capital gains. If QBI is less than zero it is treated as a loss from a qualified business in the following year.
Does your business qualify?
The business must be conducted within the U.S. to qualify, and specified investment-related items are not included, e.g., capital gains or losses, dividends, and interest income. The trade or business of being an employee does not qualify. Also, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership's business.
For taxpayers with taxable income above $157,500 ($315,000 for joint filers), an exclusion of QBI from specified service trades or businesses is phased in. These are trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assists, or any trade or business where the principal asset is the reputation or skill of one or more employees or owners.
Additionally, for taxpayers who are not engaged in a specified service trade or business with taxable income more than the above thresholds, a limitation on the amount of the deduction is phased in based on either 50% of the taxpayer's allocable share of the W-2 wages paid with respect to the qualified trade or business, or the sum of 25% of such wages plus 2.5% of the unadjusted basis of tangible depreciable property used in the business.
Other limitations may apply in certain circumstances, e.g., for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
The mechanics of this new deduction can be formidable, especially if your taxable income exceeds the thresholds discussed above or you own multiple pass-through entities. As always, R&A is here to consult with you and navigate the complexities of this new deduction.