By Stephanie F. Long, Esq.
Recent tax reform can significantly impact your business and investment operations, but it is imperative that you understand how the rules work. I have been speaking to clients for weeks about how their business can save money under these new changes and for some clients, we need to adjust their business operations in a certain way so as to make sure they can maximize tax savings. If you run a business or have real estate investments, you need to have at least a 5-minute conversation with your tax professional so you can understand what you need to do moving forward.
As with anything that happens within the tax code, understanding the changes isn’t easy. This is especially true with the new 2018 Section 199A tax deduction that you can claim on your “pass thru” income. This new potential 20% deduction is a big deal. For most of my clients, this new deduction is going to positively affect their businesses and the taxes they pay.
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Let’s discuss the basics. If you operate your business as a sole proprietorship, partnership, or S corporation (i.e. as a “pass thru” business), you qualify for this new 20 percent deduction. If you operate as a C-Corporation, you do not qualify to take this deduction as a C-Corporation is not a “pass thru” business.
You also can qualify for the new 2018 tax deduction on the income you receive from your real estate investments, publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives.
To qualify for the 20 percent with almost no complications, you need two things: First, you need qualified business income from one of the sources above to which you can apply the 20 percent deduction. Second, to avoid complications, you need “defined taxable income” of
• $315,000 or less if married filing a joint return, or
• $157,500 or less if filing as a single taxpayer.
Example: You are a real estate investor and have qualified business income of $100,000. Your taxable income is $150,000. You are married. You can deduct $20k. If your effective tax rate is 30%, this saves you $6k per year in taxes.
Sounds good, right? Unfortunately, the rules get more complicated for higher income taxpayers. If your taxable income is over $315,000 as a married couple or over $157,500 as a single taxpayer, you then need to review how much you are paying in wages through your business as well as your depreciable property. This is where it is essential that you meet with your tax professional, if you earn over these amounts, so that you can determine whether you need to make adjustments to the wages you pay, etc. to maximize this tax deduction.
The rules also get even more complicated than the above if you are a higher earner (i.e. earn over $315,000/$157,500) and you are a service professional. Service businesses include businesses that are in the following industries:
o Actuarial science
o Performing arts (authors, artists, writers and bloggers, actors)
o Financial services
o Brokerage services
o Or any trade or business where the principal asset is the reputation or skill of 1 or more of its employees or owners (i.e. real estate brokers, IT consultants, programmers)
o Engineers and architects are exempt
Only if the doctor, lawyer, actor, or accountant, etc. has defined taxable income less than the thresholds above, does he or she qualify for the full 20 percent deduction on his or her qualified business income. Once income hits $315,000/$157,500, the phaseout of the 20 percent deduction begins. Once taxable income hits $415,000/$207,500 the phaseout is complete. This means that if you are a lawyer, for example, and have $430,000 of taxable income (and are married), you will not qualify to take the 20% deduction at all.
Once you are above the thresholds and phaseouts, you can qualify for the Section 199A deduction only when:
• you are not in the out-of-favor service group (accountant, doctor, lawyer, etc.), and
• your qualified business pays W-2 wages and/or has property.
As you can see, there’s much to this new 2018 tax deduction. You may want to spend some time with planning for this deduction. If you want to discuss further, please send me an email at firstname.lastname@example.org and we can talk.