by David M Kendrick, CPA MST   

The new tax law (Tax Cuts and Jobs Act or TCJA) provides a tax deduction for qualified pass-through business entities and sole proprietorships in 2018. If the previous sentence leaves you uneasy, you’re in good company. Anytime the IRS makes up new terms like “qualified pass-through businesses”, you know a complex and confusing set of rules are sure to follow!

The new law allows a deduction of 20% of business income.  The deduction applies to most small businesses that were not invited to the real party- the new lower 21% C-corporate tax rate.

Here is a brief overview:
Most small businesses that are not operating as a C-Corporation will qualify for the deduction.  The deduction is equal to 20% of the lower of:

  • Eligible qualified business income or
  • Taxable income before the deduction & excluding any capital gain
While the law sounds pretty good so far, here’s where things get dicey. The law contains two provisions that may limit the deduction for taxpayers with taxable income above the low end of the phase out range. So if taxable income is below the lower end of the phase out range, you’ll get the full deduction.

Phase Out Range

Married taxpayers filing joint (MFJ) $315.00 - $415,000
All other taxpayerss  $157,500 - $207,500

If not, you’ll need to weave your way through the two limitations.

Rule #1:  The deduction is phased out for any Specialized Service Business or Trade (SSBT).  Fields such as law, accounting, consulting, healthcare, financial services….  generally fall into this Service category.  So once income exceeds the top of the phase out range, no deduction is allowed.

Rule #2:  The deduction is phased out to the extent that the business did not payout wages or invest ample amounts during the year as figured by this convoluted formula.

The deduction is limited to the lesser of the regular deduction or the greater of either of the following amounts: 

  • 50 % of wages paid from the qualified trade or business or
  • The sum of 25% of W-2 wages plus 2.5 % of unadjusted basis of certain qualified asset acquisitions (newly acquired depreciable property)
Anyone that falls within the phase out range will lose a pro-rata portion of the deduction.

Recommendation:  If you operate an active trade or business that is not a C-corporation and anticipate your taxable will exceed the low end of the phase out range,  you need to take action before yearend!

  Step #1-  determine if you operate a service business.  If not, move to Step #2.
  Step #2- You should estimate if the wage and investment rule will limit your deduction and if it does, make corrective adjustments now to maximize your deduction.

Either call our office and request the rules and be prepared to spend a weekend brushing up on the law or ask us for help.