As many business owners might tell you, there are times when business income and individual income can feel like two parallel universes co-existing in the cosmos. While they are closely related, passing through income from one to the other can seem as complicated as space travel itself. Lucky for you, recent changes within the Tax Reform may have just opened that wormhole you were searching for…
Traveling through the Basics
One of the most significant changes to come from the recently passed Tax Reform is the qualified business income (QBI) deduction for pass-through entities. Under previous law, the taxable income from pass-through entities was taxed at the individual taxpayer’s rate. While this is still true under Tax Reform, individuals may receive a deduction on pass-through income to help lower the rate.
Many small businesses are wondering if they will receive the deduction—and what limitations exist. The types of entities eligible for the deduction are sole proprietorships, partnerships, LLCs, and S-corporations. The Tax Reform provides a 20% deduction of QBI, which is defined as the net amount of items of income, gain, deduction, and loss with respect to your trade or business. Reasonable compensation paid from an S-corporation and guaranteed payments from a partnership are not included in calculating QBI. The deduction can be taken whether the individual itemizes or uses the standard deduction. It is a “below-the-line” deduction meaning that it reduces taxable income, not adjusted gross income (AGI).
Flying through the Details
While the deduction calculation may seem simple, it is subject to certain limitations and restrictions.
Taxable Income Thresholds
- If taxable income is below a certain threshold ($157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly), then the deduction is simply 20% of the QBI for each business.
- Above that threshold, taxpayers may have some of that 20% deduction capped. Various factors that have to be considered are
- Wages paid,
- Real estate and equipment owned, and
- Whether the business producing activity falls under one of the disqualified professional services.
- Once the upper threshold ($207,500 for individual taxpayers and $415,000 for married taxpayers filing jointly) is reached, those factors above may fully phase out the pass-through deduction.
- For all taxpayers with taxable income above the upper threshold amount, there is a limitation on the deduction amount based on 50% or 25% of wages paid—and 2.5% of tangible property (including real estate).
- Further limitations can exist for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly-traded partnerships.
Choose CRI’s Tax Team for Your Navigation
Just like space travel, Tax Reform is complicated, and there are many variables and complexities to consider. This article is a high level overview of the new pass-through deduction and its mechanics. CRI’s tax professionals can help you navigate how the deduction may impact your taxes and develop tax planning strategies to help maximize your deduction. Contact us to set-up an appointment and talk it over with one of our tax professionals.