The new tax law (Tax Cuts and Jobs Act of 2017) made significant changes to the corporate tax rates. This includes a new deduction for “pass through” business entities like S Corporations, sole proprietorships, partnerships, and LLCs that are taxed as partnerships.
The new deduction is generally 20% of a taxpayer’s “qualified business income,” which is defined as the net amount of items of income, gain, deduction, and loss with respect to the trade or business. The deduction is taken “below-the-line” so it reduces taxable income, rather than being taken “above-the-line” which would affect adjusted gross income (AGI).
Taxpayers whose taxable income exceeds the threshold amount of $157,500 ($315,000 for a married filing jointly return) are subject to limitations, which are based on W-2 wages paid by the business and the business’ unadjusted basis in acquired qualified property. The new deduction applies for income tax purposes only. It doesn’t apply for purposes of determining self-employment tax – you’ll still have to pay that full amount.
Certain types of investment-related items are excluded from qualified business income, including capital gains or losses, dividends, and interest income (unless the interest is properly allocable to the business). Employee compensation and guaranteed payments to a partner are also excluded.
Some clients have asked if they should change their business entity selection in order to take advantage of this new pass through deduction. There are many factors which go into such a major decision. For example, the new tax law includes a reduced income tax rate of 21% for C Corporations, which could offer even higher savings for some companies and shareholders. Your choice will depend on the particular circumstances of your business and personal finances.
Before making any decisions you should consult with a qualified tax accountant. For more information or for answers to your tax questions, please contact our Tax Department at (781) 407-0300.