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Small businesses & taxes: A primer on pass through deductions

The Tax Cuts and Jobs Act (TCJA) led to the creation of a 20 percent tax deduction for pass-through businesses. The term “pass through” refers to businesses that account for tax obligations through the owner’s personal income tax filings. Although in theory the deduction appears to give small businesses an advantage against their much larger competitors, complications have become apparent.

The deduction is generally available for sole proprietorships, partnerships and S corporations. One of the biggest complications involves the various restrictions to the deduction. Two examples include:

 

  • Field of business. The law bars certain businesses from taking this deduction based simply on the field of business. The law bars the deduction for businesses that operate in athletics, consulting, accounting and health industries, for example.
  • Income level. Those who earn over a certain set income are also forbidden from using the deduction. The income is currently set at $157,500 for single filers and $315,000 for married.

Those who qualify get a 20 percent deduction off qualified business income (QBI). This includes the net income, gain, deduction and loss connected to the business. It does not, however, include compensation paid by an S corporation. An example from Brookings provides some clarification. The example involves a married couple, filing a joint tax return, with a QBI of $75,000. The couple in this example can deduct 20 percent of the QBI, or $15,000.

The tax law adjusts the deduction for business owners with a higher income level at either 50 percent of the W-2 wages paid to employees or 25 percent of wages plus 2.5 percent of qualified business property.

In light of these changes, it is wise for business owners to revisit their tax planning strategies. An attorney experienced in tax planning matters can review your strategy and provide counsel on the best course of action to better protect your business interests.

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