The Small Business Pass-Through Deduction

Tax Reform: The Small Business Pass-Through Deduction

It would be hard to find a change in the recent tax bill that has generated as much interest, questions, and even confusion than the new small business pass through deduction. And for good reason. The IRS is currently writing regulations to give guidance to a business tax write-off that is fantastic for the small business-person, but currently has some unanswered questions.  

For this reason, the best way to approach it is to take a general simplified look at the differing pieces of this crucial small business tax write-off in the form of a Q&A .

How Long Is This Tax Break Around?  
 
Begins in 2018 and ends in 2025.

Who Gets The Deduction? 

The deduction is taken at the individual, personal tax, level but it is calculated based on the net business income of a flow-through entity.  NOTE: rules out hobbies.

What Is A “Flow-Through” Entity?  

Flow-through entities, or pass-throughs to use another common name, are defined as S corps, LLCs, partnerships and sole proprietorships. They are called “flow-throughs” because the income from these entities are passed-through to the owners (think K-1) who pay the tax on their personal tax returns. This eliminates C corporations from using the deduction.

Will I Have To Itemize To Take The Deduction? 

No, the  deduction is considered a "between the lines" deduction in that you don’t have to itemize to take the deduction. It won’t lower your adjusted gross income either.

What’s The Deduction?  

In general, the starting point of the deduction is equal to 20% of the net business income of a flow-though business adjusted for certain items such as  investment income and a “reasonable” portion (currently undefined) of your wages from the flow-through. 

 Are There Limits On The 20% Deduction?   

Yes, perhaps and maybe. How much of the 20% deduction can be used on your personal tax return is based on your level of individual taxable income from Form 1040. To keep it simple, there are three-tiers: 

• the full 20% deduction is allowed for those with personal taxable income below $315,000 ($157,500 single).  
• the write-off may be gradually reduced for high-earners over the $315,000 ($157,500 single) threshold when the 20% calculation exceeds certain levels. Not only could it be limited, it could also be phased-out entirely when taxable income exceeds certain levels, $415,000 ($207,500 single). 
• a final limitation says the deduction can’t exceed 20% of your overall personal taxable income. 

What About Professional Service Fields?  

Those in certain professional services such as accounting, law, medicine, consulting, financial and other related fields can take the 20% deduction subject to the “high-earner” phase-out rules noted above.   

What If I Own Multiple Flow-Through Entities?

Each qualifying flow-through’s net business income is eligible to be used in calculating the 20% deduction.  After separate computations they are combined into one collective number. 

Still In Process

As you can see, there are numerous moving parts to the small business flow-through tax deduction. The good news is that many small businesses will get some, all or part of the write-off.