Under the new Tax Cuts and Jobs Act, those who have made qualified business income from a business may be able to take advantage of a new type of deduction.
Under new tax laws taking effect in 2018, individuals with qualified income from a partnership. S corporation, LLC or sole proprietorship may be afforded a substantial tax benefit—as much as 20 percent of such income, which is often referred to as “pass-through income.”
The qualified income is defined as “the net amount of items of income, gain, deduction and loss with respect to the person’s trade or business.” All such business must be conducted in the U.S. to qualify.
Certain types of income do not qualify. Those include certain investment-related items such as capital gains or losses, dividends and interest income, unless the income is earned by the business itself. Take note, the “business” of being an employee does not qualify, nor does reasonable income earned from an S corporation, or guarantee payments received from a partnership for services provided to a partnership’s business.
How does one take the deduction?
The deduction is taken “below the line;” meaning it adjusts one’s taxable income but not one’s adjusted gross income. However, one can choose to take it regardless of whether he or she itemizes deductions, or decides to simply take the standard deduction. In general, the deduction must just not exceed 20 percent of the excess of your taxable income over net capital gain.
If your qualified business income (QBI) is less than zero, it can be treated as a loss from a qualified business the following year.
High-income taxpayers should take care before attempting to covert wages or other compensation for personal services into income eligible for the deduction. The Act has put thresholds into place to discourage this from happening.
The threshold is $157,500 for single filers, or $315,000 for joint filers. If your taxable income is at least $50,000 above the threshold amount, or $100,000 above for joint filers, then all of the net income from a specified service trade or business is excluded from the QBI.
For those whose income is between the threshold and $50,000/$100,000 over, then the exclusion from QBI is phased in.
For those whose QBI is above the amount of the threshold plus $50,000/$100,000, there are limitations placed on the amount of the deduction he or she can take.
For example, if your income is at least $207,500 ($157,500 + $50,000) or $415,000 ($315,000 + $100,000) for joint filers, your deduction for QBI cannot exceed whichever of the following two is greater: 1) 50 percent of your allocable share of the W-2 wages paid with respect to the qualified trade or business; or 2) the sum of 25 percent of such wages plus 2.5 percent of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business, including real estate.
Additionally, for taxpayers with taxable income more than the above thresholds, there is a limitation on the amount of the deduction that is based either on wages paid or wages paid plus a capital element. Here’s how it works: If your taxable income is at least $207,500 ($415,000 for joint filers), your deduction for QBI cannot exceed the greater of (1) 50% of your allocable share of the W-2 wages paid with respect to the qualified trade or business, or (2) the sum of 25% of such wages plus 2.5% of the unadjusted basis immediately after acquisition of tangible depreciable property used in the business (including real estate).
Again, for taxable incomes that are between the threshold amounts and the $207,500/$415,000 amounts, a phase-in of the limitation applies.
Other limitations may apply in certain circumstances, such as for taxpayers with qualified cooperative dividends, qualified real estate investment trust (REIT) dividends, or income from publicly traded partnerships.
Obviously, this is all extremely complex, especially for those whose taxable income exceeds the thresholds. We at Wendroff & Associates are more than happy to help your business navigate new territory under the Tax Cuts and Jobs Act, or take care of any other tax planning matters you may need assistance with. Please call us anytime at 703-553-1099.