When tax reform legislation was signed into law, a 20 percent deduction for owners of a variety of pass-through businesses, including limited liability companies, partnerships, so-called S corporations and sole proprietorships was created. The deduction effectively lowers a small business owner’s top rate to 29.6 percent from 37 percent.
However, when the legislation passed, there was ambiguity as to which “small businesses” would qualify for the preferential tax treatment. Well, the Treasury Department recently issued guidance that helps bring some clarity to this issue.
Those Who Qualify for the 20 Percent Deduction
The deduction can be claimed by business owners whose taxable income is $315,000 or less if you file your taxes jointly, according to a fantastic article published in the Wall Street Journal. This means owners of partnerships, S corporations, limited-liability companies (LLCs) and sole proprietorships with taxable income of $315,000 or less can get the 20 percent deduction for joint filers. If you are a single filer, you can get the 20 percent deduction if you make $157,500 or less.
Another benefit is that the 20 percent deduction is allowed under the Alternative Minimum Tax so the tax write-off will not be counted as a way of triggering the AMT.
If you own multiple business entities, you will have the option of aggregating those companies for tax purposes to claim the deduction. To qualify, you need to have (i) common ownership over the various entities, (ii) file in the same tax year and (iii) meet certain other requirements. This ability to aggregate will make it less burdensome for larger companies structured as pass-through businesses to take advantage of the benefit.
If your income is higher than $315,000, the break would be phased out over the next $100,000 of income for service-business owners such as doctors, attorneys and consultants. There are also restrictions associated with the level of wages paid and capital investment.
Those Who Do Not Qualify for the 20 Percent Deduction
Many owners of “specified service” businesses will not be able to claim the deduction, especially “high earning” owners. This means professionals such as doctors, dentists, pharmacists, lawyers, accountants, financial advisers, etc. will not qualify for the deduction.
The Treasury Department proposed a set of rules allowing business owners with gross receipts of $25 million or less to claim the tax benefit, but only if less than 10 percent of receipts are from one of the “specified service businesses.” Owners with gross receipts of greater than $25 million can claim the benefit if up to 5 percent of receipts are from such a business.
Can I Split My Business, or Businesses, to Get the 20 Percent Rate?
Generally, no. The concept of splitting up a business to meet the requirements for the 20 percent deduction has become known as the “crack and pack” strategy. The Treasury Department published proposed rules containing anti-abuse provisions meant to prevent firms from simply being split into pieces in order to qualify, or maximize, the 20 percent deduction.
Important Questions Remain Unanswered
The proposed rules from the Treasury Department are helpful for planning purposes, but there remain an array of important questions concerning the new tax law. For example, can a business owner claim the 20 percent deduction on their state income tax return? The answer is not clear and will depend primarily on the state.
Speak to an Experienced Business Attorney Today
As you can see, federal tax laws have become even more complex and it is extremely important, in the wake of new tax provisions, to have the best legal advice possible. That is why you should contact InSight Law today to schedule a meeting with one of our team members. We are here to help.