Small Business Passthrough Deduction

So many tax changes, so much to consider – if you’re a small business, one of the biggest changes is the creation of the 20% passthrough deduction.  This new deduction (technically the Section 199A deduction) has so many moving parts that in order to get a full picture of how it may or may not benefit you I will have to suggest a tax planning appointment for sure.  But here are some of the basics, and in the coming weeks I will try to elaborate on some of the points to make it more understandable, but trust me….this code section is A LOT!

1)  General deduction explanation

   This deduction is for individuals who participate in business activities that create a bottomline profit for tax purposes.  The deduction for individuals who may qualify for the passthrough deduction of up to 20% of qualified business income.

2)  What is Qualifying Business Income

In general, this is domestic taxable business income from trade related sources including sole proprietors, s-corporations, LLCs and partnerships.  Of course, its tax law so there will be exceptions and exclusions.  Two exclusions that affect a number of my clients would be capital gains or dividends.  Also excluded is guaranteed payments to partners and wages (Reasonable Compensation) paid to owners.  Are you running a side hustle for extra money?  Sole proprietor net income is qualifying in most cases.

3)  Who qualifies

The IRS has divided business income as that being derived from “In Favor” businesses and “Out of Favor” businesses.  An “Out of Favor” business is simply a service business primarily in the fields of health, law, finance and brokerages, athletes and performing artists and in general, a business whose principal asset is the reputation or activity of the owners or specific employees. ]

If you don’t fall into the “Out of Favor” category you will be considered “In Favor”.  Different formulas and limitations apply to each category

4)  How do you report this deduction

The Section 199A deduction does NOT affect AGI, it appears after the itemized/standard deductions have been calculated so any limitations to itemized deductions based on AGI still apply like the threshold for medical deductions.  My current guess is that it will appear on the tax return around the area that the former “Exemption” deductions used to be in order to calculate taxable income.

Section 199A Decision Tree

Remember that taxable income is all income for the household.  Your ability to claim the deduction is limited as follows:

Out of  Favor Service Trade or Business

  • If taxable income is less than $157,500 / $315,000 then the 20% deduction is fully available.

 

  • If taxable income is greater than $157,500 / $315,000 but less than $207,500 / $415,000 then a partial deduction is available.

 

  • If taxable income is greater than $207,500 / $415,000 then you are get no deduction

 

All Others

 

  • If taxable income is less than $157,500 / $315,000 then the 20% deduction is available.

 

  • If taxable income is greater than $157,500 / $315,000 but less than $207,500 / $415,000 then a partial deduction is available with the W-2 and depreciable asset limit calculations phase in.

 

  • If taxable income is greater than $207,500 / $415,000 then the 20% deduction is compared to the full W-2 and depreciable asset limit calculations.

I know this post is quite wonky, but if you have questions or need help feel free to contact us to review, or consult your tax adviser for ways to plan to optimize your benefits.

I’ll be breaking down the talking points in subsequent posts so follow us and keep reading…

We’ll chat again soon!
Susan

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