Do you receive a 1099 or K-1? If so, the new tax rules under the 2017 tax reform effort could have a significant impact on your tax returns.
The tax reform bill made significant changes to several parts of the tax code. One of the most talked about (not to mention confusing) applies to the owners of “pass-through” businesses, with a new 20% tax deduction on qualifying business income.
What many people don’t realize is that you can deduct up to 20% depending on your business income and even the type of business you operate. Owners of service businesses will face important restrictions on their deductions.
Given that many of my clients are business owners themselves, I’ve put together some basic information about the new tax deduction and how it might apply to your service business.
Of course, I need to lead with an important disclaimer: I am not a tax attorney or an accountant, and this article is not intended to give tax advice or to replace the advice of a qualified attorney or accountant. Before you make any decisions about your own tax return or business, be sure to seek the help of a professional.
Are you subject to the new rules?
If you operate a business or earn income as one of the following types of entity, the tax law changes could apply to you:
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Sole proprietor
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Partnership
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Limited liability company (LLC)
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S Corporation
One of the key features of these business structures is that you do not have to file a corporate tax return. Instead, you get a K-1 from your company’s accountant or 1099s from your clients and include that income on your personal income tax return.
Now, if you own a service business – that includes many, doctors, lawyers, consultants, financial advisors, athletes – you won’t just get to lob 20% off your business income on your tax return. Depending on your income, you may need to make some additional calculations, or forget about the deduction at all.
Figuring out your deduction
Service businesses are subject to income restrictions on deductions. In a nutshell, if you earn more than $207,500 from your business as a single filer or $415,000 as a joint filer, the new pass-through tax deduction will have phased out completely and you will not receive the benefit.
More specifically:
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If you earn less than $157,500 from your business as a single filer (less than $315,000 for joint filers), you’ll likely be able to take the full deduction.
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If you earn between $157,500 and $207,500 as a single filer ($315,000 to $415,000 for joint filers), you’ll be subject to a scaled phase-out and your deduction will be reduced – talk to your accountant about how to figure out the exact number.
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If you earn above $207,500 as a single filer ($415,000 as a joint filer) and you operate a service business, you won’t be eligible for the deduction.
The word qualified is important. If you earn both wages and pass-through income from your business, you can only take a deduction for the pass-through income.
In other words, the deduction applies only to business income, not wages or compensation. That means if you earn $400,000 in wages and $125,000 in pass-through income, you’ll still be able to take the full deduction on the $125,000.
Start early
Hopefully by reading this you have a rough sense of whether this deduction will apply to you – and how much math you’ll have to do to figure out your potential deduction at the end of the year.
But there are a number of complicated issues that still need to be addressed, especially if you have a complex business, several businesses, or other unique tax factors. In my opinion, the best thing you can do is to start early with navigating the new rules so that you have time to get help, answer questions, and figure out what you need to do to get the most benefit from the new rules.
Also keep in mind that if you do qualify for the pass-through tax break, you may have lost out on others (for example, with state and local tax deductions). That’s why it’s important to put this calculation together with the other updated rules, which may or may not apply to you – this will give you a more complete picture of your 2018 tax position.
In other words, don’t wait to reach out to your tax advisor. It could save you a lot of stress and confusion later on!
Written by Bradford Pine with Anna B. Wroblewska
More information about the pass-through deduction:
Limits to the deduction: http://www.cpapracticeadvisor.com/news/12389903/2018-tax-reform-pass-through-income-deduction-more-complex-than-thought
Calculating your deduction, the simple version: https://www.forbes.com/sites/kellyphillipserb/2017/12/22/what-tax-reform-means-for-small-businesses-pass-through-entities/#1b5a262c6de3
Section 469 issues: https://www.crowehorwath.com/insights/tax-alert/tax-news-highlights-pass-through-entity-deduction-calculation.aspx
Impact on state taxes: https://taxfoundation.org/pass-deduction-wont-flow-states/
AGI: https://www.irs.com/articles/adjusted-gross-income-agi-vs-modified-adjusted-gross-income-magi
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Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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