The rules for this deduction (Pass-Through Entity Deduction) can be very complex but here are some facts to help.
1) What businesses qualify? Generally businesses where the income is taxed on the individuals returns are eligible for the deduction. This includes S-corps, Partnerships, LLCs and Sole Proprietorships.
2) For single taxpayers making less than $157,500 and joint taxpayers making less than $315,000 the full 20% deduction is available. So for many small businesses it is not too complicated.
3) This amount is not the business income it is total taxable income from all sources (wages, interest, dividends ,etc) without taking into account the 20% deduction.
4) For taxpayers who are below this limit the deduction is relatively simple. It is 20% of their qualified business income (QBI). QBI is the net income (profit) your pass-through business earns during the year. You determine this by subtracting all your regular business deductions from your total business income. There are some exclusions to QBI the main being reasonable compensation paid by the entity to the owner. For example if a business has $100,000 of income, $30,000 of regular expenses and $40,000 in wages paid to an owner of the business QBI will be $70,000.
5) For taxpayers who earn above $157,500/$315,000 thresholds there are more considerations. First is what type of work the business performs. If the business falls into any of the following categories it is a “specified service trade or business” and subject to stricter rules. The main categories are health (such as doctor, dentists, etc), lawyers, accountants, consulting, athletics and more. A catch all is added “any trade or business where the principal asset of such trade or business is the reputation or skill…” . Engineering and architecture are excluded from being a “specified service trade or business”.
6) These “specified service trade or businesses” start to lose the 20% deduction above the $157,500/$315,000 threshold and lose it completely above a $207,500/$415,000 limit.
7) For the other types of businesses new limitations apply when the income is above the $157,500/$315,000 threshold. This is called the wage and capital limit. Under these limits the deduction is limited to the greater of 50% of W-2 wages for the business or (b) the sum of 25% of W-2 wages and 2.5% of the unadjusted basis of all qualified business property. These calculations can be become very complicated and we are here to help
The experts at Republic Tax Relief can help with this, give us a call today.