Who’s In & Who’s Out in New Small Business Tax Break?

The New 20% Small Business Deduction

There is a new 20% small business deduction that everyone is talking about. In the tax and legal professions, it’s know at Section 199A. Here are some facts about this deduction:

The Basics
All pass-thru entities, such as Sole Proprietors, S-corporations and Partnerships that qualify may be able to take the 20% small business deduction. The deduction can be taken against qualified business income from sales/services, rental real estate (not W-2 income) and can help to reduce taxes. IRS has not published a final 2018 form, but the deduction will come after the itemized deduction amount and before the taxable income amount.

But it’s not easy or simple. The rules are complex as well as fuzzy, and there is still some waiting on IRS guidance to clarify the fuzzy parts.
First, the deduction is calculated differently for certain “specified service businesses.” We’ll talk about what that means in a minute. If the business is NOT a specified service business, the deduction is limited and must go through this calculation:

If the personal return of the owner of the specified service business has taxable income of LESS than $315k (married filing joint) or $157,500 (single), they CAN deduct 20%.
For taxpayers who have taxable income of MORE than $415k (married filing joint) or $207,500 (single), the amount of the deduction is limited to the LESSER of the qualified business deduction of 20% OR the GREATER of:

A. 50% of the W-2 wages paid by the business OR
B. 25% of the W-2 wages paid by the business PLUS 2.5% of unadjusted basis on qualified property!

If the taxpayer has taxable income BETWEEN $315k and $415k (married filing joint) or between $157,500 and $207,500 (single), they will get a PARTIAL DEDUCTION.

Specified Service Business
In order to qualify for the small business deduction, one of the questions that needs to be determined is if the business is a “specified service business.” What is a specified service business? This is any trade or business involving:
• Health
• Law
• Accounting
• Performing Arts
• Consulting
• Athletics
• Financial Services

…where the principal asset of the business is the reputation or skill of one or more of its owners or employees. This does NOT include architects nor engineers because they were specifically mentioned as excluded from this exclusion (confused yet?).

A specified service business small business deduction is calculated differently than all other businesses.
1. If the personal return of the owner of the specified service business has taxable income of LESS than $315k (married filing joint) or $157,500 (single), they CAN deduct 20%.
2. If the personal return owner of the specified service business has taxable income of MORE than $415k (married filing joint) or $207,500 (single), they get NO deduction!
3. If the personal return owner of the specified service business has taxable income BETWEEN $315k and $415k (married filing joint) or between $157,500 and $207,500 (single), they will get a PARTIAL DEDUCTION.

Entity Change Considerations
Now you can see why consulting your tax professional will be key so there will be NO surprises come tax filing time! Taxpayers will need to be PROACTIVE to seek counsel for their specific situation because the type of entity they file as will impact their eligibility for this deduction. In some cases, it may make sense to change entities, but there are far more than tax considerations for such a decision.

Please contact us if you’d like to discuss the 20% business deduction and how it applies to your business.

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