If you have a pass-through entity, it might be time to optimize your tax strategies in 2018 in light of the new tax bill.
December 26, 2017
By: Diane Kennedy, CPA USTaxAid.com
If your taxable income is less than the threshold ($315K for married, filing jointly and $157,500 for single), you will have a tax break. Make one dollar more and your tax break becomes almost non-existent.
It’s a complicated formula and so let’s start at the beginning.
A pass through entity is a Sole Proprietorship, a Partnership or an S Corporation. (It also includes an LLC taxed as a Partnership or as an S Corporation.)
If you are a single taxpayer whose taxable income is $157,500 or less or married, filing jointly with $315,000 or less, you are exempt from the service/non-service qualifying tests and the calculation of how much is subject to the reduction. Your business net income will be reduced by 20% when calculating the tax. You win!
Over that, and your first test is whether you are a service or a non-service business. If you have a service business, you may still get a reduction. More on that later. This is NOT the same as the personal service corporation definition for C Corporations. It’s a brand new, clearly cut in stone, yes/no test. Are you a service business? You get nada, unless you are under the second threshold.
A service business is defined as any business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset of such business is the reputation or skill of 1 or more of its employees. In a last minute change, engineering and architecture were reclassified as non-service businesses. A service business also includes involves the performance of services that consist of investing and investment management, trading, or dealing in securities.
If your service business is less than the second threshold amount , $207,500 for single or $415,000 for married filing jointly, then you can do the calculation for the reduction of taxable business income under the same guidelines that follow for non-service business.
For non-service businesses, it still gets murky. The amount of business income reduction you can take is limited to the greater of 50% of wages (guaranteed payment or W-2 income) or 25% of wages plus 2.5% of the unadjusted basis of qualified property. Qualified property is depreciable property that is still in the depreciable period.
The lesser of those two calculations above mean that you can take that amount and reduce the taxable income amount by 20%
Let’s go through this one more time, step by step:
- Do you have a pass through business entity? If no, no need to read further. This isn’t applicable to you. If yes, go on to (2).
- Is your taxable income less than $157,500 (single) or $315,000 (married filing jointly)? If yes, you win! You get to deduct 20% of your business income for tax calculation purposes. If no, continue.
- Do you have a service business? If yes, go to (4). If no, go to (5).
- Is your taxable income less than $207,500 (single) or $415,000 (married filing jointly)? If yes, continue on to (5). If no, you’re done. You get no reduction in tax.
- If you have a service business under the adjusted threshold or a non-service, you can reduce your business income by the greater of 50% of wages paid or 25% of wages paid plus 2.5% of qualified property.
- If you have a partnership with a partner or another shareholder in an S Corporation, you will split the deduction amount based on how you split the profit of the company.
Some of the strategies to think about for 2018:
Make sure there are enough wages paid from your company to qualify for the loss. If you have a separate entity for payroll or are using a leasing company so that you actually have no wages, you may need to change that strategy for 2018. We’re currently waiting to see how leased employees will fit into this definition. For now, be aware.
If your income is lower than the threshold, you will likely get more of a reduction than someone with income just barely over. Plan carefully, make sure you’re taking into account all of the above the line deductions you can take, realizing that you may be losing your itemized deductions. A C Corporation used in conjunction with your flow through entity may be the best way to adjust your taxable income so you can qualify for the reduction in tax.
It has never been more important to have good and current financials prior to year-end. The year 2018 is when it all changes and it’ll be awhile before this feels natural. Don’t add to the stress by not having current financials.
Diane Kennedy is a fully certified CPA for USTaxAid.com who specializes in helping business owners and real estate investors protect their assets and keep as much of their money as possible. Let her help you create a tax and business strategy to maximize your benefits! Click here to get started in her coaching program.
This article was originally published on December 18, 2017 on USTaxAid.com, and is being republished here with the permission of Diane Kennedy.