Tax Reform and Its Effect on Pass-Through Entities

The Tax Cuts and Jobs Act is now officially law. The changes in the tax code affect individuals, entrepreneurs, and corporations all in different ways, but a brand-new provision called code section 199A will have a major impact on deductions for small businesses and entrepreneurs whose businesses are considered to be pass-through entities

The new law will now give a pass-through tax deduction to individuals who own a business that is a partnership, S-corporation, LLC, sole proprietorship – basically, all taxpayers OTHER than a corporation. To use the new formula, you will now need to compare two numbers, qualified business income (QBI) and W-2 wages paid out. The reduction you receive on taxable business income is based on QBI and the amount of W-2 wages the business has.

A limitation on the deduction does exist. It will be phased in when W-2 wages extend above a threshold amount of taxable income. In addition, there are specified trades and businesses for which the deduction is disallowed when the income extends above a threshold.

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Please be aware that there are many rules, conditions, and tests that you need to conduct to determine your exact tax deduction. Tax advisers everywhere are trying to understand the complexities of this new code section, but a recent article in Forbes provides some examples of how you might apply the code to your situation.

This new deduction will reduce your taxable income, also known as a “below the line” deduction. It is available whether you itemize or use the standard deduction.

These changes result in making some of the consequences of your business decisions show up on your personal return. The pass-through deduction will be calculated in your business and move to your personal return. However, high income earners face an income threshold under the new law. The cutoffs start at taxable income of $157,500 for individual tax payers and $315,000 for joint filers.

The impact of tax reform for entrepreneurs may now be a significant factor when making business decisions such as hiring. You will need to know if it is prudent to use more independent contractors or employees. Depending on your specific situation, the decisions could greatly increase or decrease your future tax bill.

Many business owners are likely to be confused by the changes, so it makes good sense to consult a tax professional to ensure your business complies with the new law.  

While a tax preparer can help you with your tax returns or give you a few tips on how to reduce your income tax liability, a tax adviser can deliver personalized strategies to help you navigate tax laws. He or she can help you understand how your decisions can impact your bottom line, now and into the future. In addition, your adviser would likely work with you all year to help you make better business decisions, not just during tax season.

To take advantage of the opportunities available in the Tax Cuts and Jobs Act you need to engage a tax adviser right now. Trying to make changes when your taxes are due means you are already too late.

At AMDG Financial, we integrate tax, financial and investment strategies to provide our clients with a holistic approach to financial advice. If you would like to discuss tax planning for your business, please contact us. We’d love to help you – and your business – succeed.

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