Get To Know More About The Flow-Through Business Income Deduction
This brand new provision (not to be confused with the low tax rate of 21 percent awarded to C corporations) allows owners of pass-through entities – S corporations, partnerships and sole-proprietorships – to take up to a 20 percent deduction of their pass-through income on their personal tax returns.
This particular flow-through provision was ultimately added to the Tax and Jobs Act as a way to help mitigate the fact that, while C corps were given substantially reduced tax rates, the individual tax rates were only reduced by about two or three percent. And because the income an owner of a flow-through business receives is ultimately taxed at the personal tax rate (which is in most cases much higher than the 21 percent corporate tax rate), the flow-through business income deduction helps bridge the newly created gap.
Read Also: C Corp Tax Rate Drops To 21%
Previously, because there was no such deduction, every dollar that passed through to you, as the owner of an S corp, partnership or sole-proprietorship was taxed at your maximum individual tax rate. But now, thanks to the flow-through business income deduction, owners of flow-through entities can now offset the higher individual tax rate they have to pay by taking an up to 20 percent deduction on their pass-through income.
What is it?
The flow-through business income deduction is a 20 percent deduction of pass-through income on an individual owner’s personal tax return.
Who is eligible?
Business owners engaged in a partnership, S corporations, rental property owners, or sole-proprietors who conduct “active” trade or business are eligible for the flow-through business income deduction. In addition, trusts and estates are also eligible.
That being said, limitations exist. The threshold amount is $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. Phase-ins apply, meaning that the benefit will decrease as income increases. Ultimately, the deduction cannot exceed the greater amount of 50 percent of W-2 wage income from a pass-through entity (not applicable to sole proprietorships) or 2.5 percent of the cost of qualified business assets plus 25 percent of W-2 wage income. Additionally, the deduction cannot exceed 20 percent of modified taxable income.
At this time, there are a lot of details that have yet to be resolved. Stay tuned for updates as we continue to learn more or contact your tax advisor with questions.
Who is NOT eligible or only partially eligible?
For the most part, professional service-type businesses, such as lawyers, doctors, accountants, etc., are not eligible to take the flow-through business income deduction once the owners income exceeds the thresholds. Investment management/advisory/trading type businesses are also excluded from eligibility. Portfolio/investment income (e.g. investment interest, dividends, short-term and long-term capital gain income) are also not eligible for the flow-through business income deduction.
However, some exceptions exist. Talk to your tax advisor to learn more.
Next steps
The Tax and Jobs Act took effect Jan. 1, 2018, which means the new flow-through business income deduction will be a substantial consideration for owners of S corps, partnerships and sole-proprietorships when putting together their 2018 tax strategy. Plan to meet with your tax advisor to see how the flow-through business income deduction will impact your tax liability in the years ahead.
In the meantime, we will be on the lookout for additional guidance from the IRS regarding a variety of matters. Check our website and social media channels for important tax reform news and updates. In the meantime, email Rea & Associates to learn more or to set up a time to speak with one of our tax experts.
By Christopher Axene, CPA (Dublin office) and Cynthia Kula, CPA/PFS, CFP (Independence office)
Learn more about considerations associated with choice of entity. Check out these resources:
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