You’ve probably heard about the new tax law – the Tax Cuts and Jobs Act (TCJA)– signed in late December 2017. If you’re a business owner, you’re likely wondering how the new law will affect your business taxes. One of the most significant and complex changes to the law deals with pass-through businesses and the pass-through deduction.
Most U.S. businesses aren’t corporations. About 95% of U.S. businesses are considered pass-through entities, such as sole proprietorships, partnerships, LLCs, or S-Corps. When it comes to taxes, large corporations are taxed at a flat tax rate. Currently, the corporate tax rate is 35%, but, with TCJA, it’s now been reduced to 21% in 2018. Small businesses aren’t taxed at the corporate rate. Instead, under the old tax code, the profits from these businesses are passed through the entity. The owner(s) claim these profits on their personal tax return and pay tax at the individual tax rates – sometimes as high as 39.6%.
New Changes for Pass-Through Businesses
Under TCJA, if you have a pass-through business, your income will still be taxed at the normal income tax rates, which have been lowered beginning in 2018. However, you may be able to deduct up to 20% of your qualified business income (QBI). QBI is the net amount of ordinary income and gains minus ordinary deductions and losses. This pass-through deduction is in addition to all your other business deductions, such as mileage and office expenses. In other words, some pass-through businesses may only pay taxes on 80% of their pass-through income.
Pass Through Deduction Rules
As with many new laws, the pass-through deduction is subject to certain limitations.
You must operate a business as a sole proprietor, LLC owner, partner in a partnership, or S corporation shareholder.
You can claim the pass-through deduction if your total taxable income for the year is below $315,000, if you’re married and filing jointly. If you’re single, your annual income must be below $157.500.
If a business’s income is above these figures, the amount of the pass-through deduction decreases, depending on the income amount. For the most part, the deduction disappears entirely if your total income exceeds $415,000 for marrieds filing jointly, or $207,500 for single individuals. However, if your income exceeds $415,000 married/$207,500 single, some exceptions do apply. Talk to your tax accountant or attorney for more information.
Service Business Restrictions
Special rules apply for businesses that provide services in the areas of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, or in trading and dealing in securities or commodities, or if the principal asset of your business is based on the reputation or skill of one or more of its owners. In other words, if you’re selling a service based on something you do, and not an actual product, you’re likely considered a service business. The exception to this rule is businesses providing engineering and architecture services.
If you’re a service business making below $315,000 (married, filing jointly) or $157,500 (single), you’re entitled to the 20% pass-through deduction. If your income exceeds this amount, but is below $415,000 (married, filing jointly) or $207,500 (single), you may be entitled to a reduced deduction. If your income is above these upper income amounts, you’re not eligible for the deduction.
2018 Tax Planning
It’s important to note that TCJA doesn’t apply to your 2017 taxes – the ones you must file in April 2018. It does, however, apply to your 2018 and beyond taxes.
Since TCJA went into effect on January 1, you may have little time to make any needed adjustments to your 2018 business plans and budgets. Plus, the IRS hasn’t clarified all points concerning the changes to the pass-through and other business deductions. However, The Payroll Department expects the IRS to issue more clarifications within the next month or two. If you’re a small business owner, you may want to talk with your tax accountant or lawyer about these new changes and what they may mean for you as an individual and a business owner.
If you’re still attempting to handle your company’s books by yourself, 2018 may be the year to consider outsourcing your bookkeeping responsibilities. Grace Walker at The Payroll Department is an experienced bookkeeper, who can help you navigate your way through the new TCJA changes and how they can affect your business and your books. For more information about our bookkeeping services, contact Teresa Ray at 317-852-2568.
Just know that the new pass-through deduction is intended to help small businesses compete with larger businesses and global competitors who have a smaller tax burden. The thought is you’ll be able to use your tax savings to invest back into your business – or to give yourself a raise.
– Ariane of The Payroll Department blog team