New Tax Law Helps and Hurts
95% of the 32 million businesses in the United States are what are called “pass-through” businesses and over 40 million taxpayers claim pass-through income on their personal income tax returns.[i]
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The Tax Cuts and Jobs Act (TCJA) was signed into law by President Donald Trump on December 22, 2017. The biggest change to our tax code businesswise that most people are familiar with is the reduction in the corporate tax rate from as high as 35% to a flat 21% in 2018. But, given that the overwhelming number of businesses are pass-through this article will focus on how the new rules will affect pass-through entities and small businesses.
Owners of pass-through entities (including sole proprietorships, partnerships, single or multi-member limited liability companies (LLCs), professional or personal service corporations, and S corporations) pay tax at their individual income rate. The table below illustrates the current and future bracket rate changes.
|Under previous law||Tax Cuts and Jobs Act|
|Rate||Income bracket||Rate||Income bracket|
|39.6%||$480,050 and up||37%||$600,000 and up|
Aside from changes to the individual tax rates, The TCJA reduces pass-through taxes via a 20% deduction, so that pass-through business taxes are competitive with the new C Corporation flat 21% tax. This benefit begins to phase out starting at $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly meaning that the benefit decreases as income increases. At that income level the 20% deduction is limited to whichever was higher – 50 percent of total wages paid or 25 percent of wages plus 2.5 percent of cost of tangible depreciable property.
The existing IRC Section 469 rules and IRC Section 1202(e)(3)(A) are still relevant.
- Single Taxpayer with a Painting Business (Sole Proprietorship)
Total Income of $40,000 and Business Income of $35,000.
Your deduction is $7,000, or 20% of your Business Income.
This Example is under the phase out threshold so no additional math is necessary
- Married Taxpayers with a Paper Shredding Business (non-service business S Corporation)
Total Income of $380,000 and Business Income of $102,000 with your W-2 wages of $40,000.
Your deduction is $20,400, or 20% of your Business Income limited by the wage limit of the phase-out (the greater of 50% of W-2 wages or the sum of 25% of W-2 wages + 2.5% of the unadjusted basis).
This Example deals with a non-service business above the phase out threshold so additional math was necessary
- Single Taxpayer with a Bookkeeping Business (service business Partnership)
Total Income of $175,000 and Business Income of $150,000 with your W-2 wages of $70,000.
Your deduction is $19,500, or 20% of your Business Income reduced by the wage limit and service business provisions.
This Example deals with a service business above the phase out threshold so additional math was necessary.
C corporations can deduct state and local taxes under new rules, while pass-throughs can’t. In addition,
you can no longer deduct for the following:
- an activity generally considered to be entertainment, amusement or recreation;
- membership dues for any club organized for business, pleasure, recreation or other social purposes;
- a de minimis fringe that is primarily personal in nature and involving property or services that are not directly related to the taxpayer’s trade or business;
- a facility or portion thereof used in connection with any of the above items;
- a qualified transportation fringe, including costs of operating a facility used for qualified parking, and
- an on-premises athletic facility provided by an employer to its employees.
The bill specifies requirements for the IRS regulations implementing this section.
The new tax law is expected to greatly affect pass-through businesses and the IRS is still creating resources and guidance. There are a million unique situations, but we can help.
Topics: Tax Law
[i] U.S. Treasury, Office of Tax Analysis, 2014 I.R.S. data, 2015 U.S. Census Data Legal Form of Organization