New Deduction for Pass-Through Entities

The recently enacted tax act significantly changes the way businesses will be taxed.  The tax rate for C corporations was changed from a progressive-rate system with a maximum rate of 35% to a flat rate of 21%.  Combined with a Qualified Dividend rate of 15% for many taxpayers, the combined tax rate on corporate earning is now 36%*.  Pass-through entities such as S Corporations and partnerships (includes most LLCs) are not taxed at the entity level, rather the income is passed through to the owners and taxed at their individual rate.  Even though the top marginal rate for individuals was reduced from 39.6% to 37%, without changes to the way they are taxed, pass-through entities faced a possible tax disadvantage.  Enter Section 199A!

Section 199A provides owners of pass-through entities with a “below-the-line” deduction from taxable income.  For taxpayers with taxable income below the “threshold amount” ($157,500 for single filers and $315,000 for joint filers), the calculation is rather straight forward.  You essentially calculate 20% of your qualified business income and that is your deduction.  For taxpayers with higher income, the calculation is anything but straight forward.  You will need information regarding the company’s w-2 wages, the original unadjusted basis of company assets and a high-speed computer.  For those who enjoy complicated tax provisions, Section 199A does not disappoint.

Section 199A does not treat all businesses the same.  For pass-through entities engaged in professional services such as law, medicine, accounting, etc. (architect and engineers are specifically carved out of this category-they have really good lobbyists), the benefits are limited.  If an owner of a professional service business has taxable income below the threshold amount noted above there is no problem and the deduction is calculated the same as other businesses.  Once taxable income exceeds the threshold amount, the benefit is phased out and eventually eliminated.

Section 199A has the potential of providing significant tax benefits to owners of pass-through entities.  Rhoades McKee has the tools to help business owners predict the benefits and maximize potential tax savings.  If this is of interest to you, please contact Peter Lozicki or another member of our Tax Team.

*41% if Qualified Dividends are taxed at 20%.