Make the Most of the New Tax Deduction for Small Businesses

The Tax Cuts and Jobs Act of 2017 (the “TCJA”) comes with a number of changes that will impact your small business in the upcoming tax season. The TCJA gave a large tax cut to many corporations by changing the corporate tax rate from a progressive rate scale with tax rates from 15% to 39% to a flat rate of 21%. Entities that pass income through to their owners do not benefit from this tax cut because their owners are taxed at individual rates rather than corporate rates. To compensate for the change and provide a tax benefit to small business, the TCJA provides a deduction to small business owners of up to 20% of their “pass-through” income.

Pass-through income that may be eligible for the 20% deduction is income derived from:

  • Sole proprietorships
  • S corporations or LLCs treated as S corporations
  • Partnerships
  • Rental properties
  • Any S corporation, partnership, or trust that owns an interest in another pass-through business

This 20% deduction for pass-through income is subject to many exceptions and limitations:

  1. The deduction only applies to “qualified business income”. Qualified business income does not include: (i) capital gains or losses; (ii) dividends; (iii) interest income; (iv) income earned outside the US; or (v) certain wage and guaranteed payments made to partners and shareholders.
  2. The deduction is not available to income from a “specified service trade or business” unless the taxpayer’s total income is below $207,500.00 for single filers or $415,000.00 for joint filers. Specified service trade or business means any trade or business that relies on the skill or reputation of employees to provide services in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services, among others.
  3. More qualifications and limitations apply if the taxpayer’s total income, which includes business income and individual income, is above $157,500.00 for single filers or $315,000.00 for joint filers.

The provisions of the TCJA relating to this deduction are very complicated and tax professionals are working hard to prepare for tax season. As tax professionals work through the myriad exceptions, limitations, and qualifications of the pass-through deduction, it may take longer than usual for them to prepare tax returns. To make the most of the deduction, consult with your tax professional early this year, and provide as much information as possible about your small business and your individual income.

This article provides general information only.  Readers should consult with their own tax professionals for advice on their particular tax situation.