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Unlock Tremendous Savings with the New 20% Small Business Pass-thru Deduction

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Unlock Tremendous Savings with the New 20% Small Business Pass-thru Deduction

Starting this year, under I.R.C. 199A, you can deduct 20% off of your bottom-line profits before paying taxes.  This deduction is very powerful because it applies to “net income” and not “gross revenue.”  Remember, this is not a tax credit.  It is a tax deduction.  But, it is the biggest new deduction available by far for small business owners.

The deduction is limited at $157,500 for single and $315,000 for married taxpayers.  Architects and engineers have special dispensation and can take the deduction even if they exceed these threshholds!  The TC&JA seeks to incentivize the builders and encourage people to put up buildings, roads and bridges and all things that require engineering.

LLCs, Sole Proprietors, and S-Corp’s can all take the deduction.  C-Corp’s do not get a benefit.

The deduction is limited to 20% of your net taxable income minus your net capital gains.  Investors and other taxpayers who don’t make much income from their operating business will be disadvantaged under the new rules.

The TC&JA incentivizes making money, not losing money.  Losses are also now a bad thing for small business.  If you try to carryover a loss, it will eclipse and eat up your 20% pass-thru deduction in future years.  So, you get a double whammy because you lose the 20% deduction and you would have to carryover your loss with no additional bang for your buck.

Are you a wage earner?  You will not qualify for the deduction… unless that is… unless you start another side business or begin freelancing.  This goes back to my advice in Volume 1 of this Newsletter to get a side gig as the advantages of having a home office deduction, mileage deduction (discussed below), and the 20% pass-through deduction begin to stack-up and offer huge opportunities for the entrepreneurial-minded in 2018.

A wide variety of business-owners can take the deduction: uber drivers, commissioned salesman with affiliate or exclusive relationships, coaches and consultants, and digital marketers to name a few.  Real Estate investors with income-producing property can also take the 20% Pass-thru Deduction for rental income.  Rental properties are even more tax advantaged than other operating business income, because there is no self-employment tax on rental income.

For operating businesses, it is possible to save even more on the self-employment income by using an S-Corp.  As the business owner using an S-Corp., you should split your compensation between salary and K-1/dividend income.  You will pay self-employment taxes on your wages (subject to FICA), but not on your K-1 income, where the taxes are reduced by the 20% pass-thru deduction.  In total, you are going to end up saving about $20K if you have about $150,000 of total income split out as $50K of wages and $100K of K-1 pass-thru income.  S-Corp’s are not a good idea in the 5 Boroughs for various reasons, including the state tax regime, but may work if you are in Suffolk County and are very advantageous throughout New Jersey.

There are differences between traditional businesses and personal services businesses for higher income earners.  In the range of $157,500 to $207,000 for single taxpayers or $315,000 to $415,000 for married taxpayers.  For personal services businesses with over $207,000 (single) or $415,000 (married) you lose the deduction—no deduction!  But, for those in between those figures who are over the limit, but in the phase-out range, the benefit of the deduction is reduced proportionally.  The tax gets a bit burdensome, but you just need to know these threshholds when engaging in tax planning.  For traditional businesses, you get 20% or 50% of the payroll in your business, whichever is less, when you are over the threshholds.  The actual rules are very technical and involved.  But, it is important to know that there is a distinction between personal services businesses (more limited) and traditional businesses (which have some limitations, but don’t use the deduction entirely).  If you want to think of a rationale, think “Jobs.”  Traditional businesses employ people and the TC&JA tries to incentivize jobs and hiring above all else.

Category: Tax

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