On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act, ushering in the most comprehensive tax law changes in thirty-one years.
A significant benefit afforded to business owners is new §199A which provides a 20% qualified business income (QBI) deduction and has the potential to effectively reduce the highest income tax rate from 37% to 29.6%.
While this alert provides a high-level overview of §199A and its limitations, clients should work with their tax advisor to navigate the complex analysis surrounding this planning opportunity.
For starters, the deduction applies to pass through entities and not C corporations. For a business structured as a sole proprietorship, partnership, LLC taxed as a partnership or subchapter S corporation, the deduction will depend on the nature of the business and the owner’s taxable income.
Personal service businesses that provide, for example, health, law, accounting, consulting, financial or brokerage services can take the full deduction if the aggregate taxable income of the owner and spouse (if married filing jointly) is less than $315,000 ($157,500 for all other filers).
The deduction then phases out until it completely disappears for taxable incomes of $415,000 for joint filers ($207,500 for everyone else). So if Linda Lawyer generates $300,000 of taxable income from her real estate practice and her husband’s taxable income is $120,000, their combined income of $420,000 eliminates Linda’s business deduction.
Owners of non-service businesses can also take full advantage of the 20% QBI deduction if taxable income is below $315,000 ($157,500) but unlike service providers, the deduction is not lost once these income thresholds are crossed. Instead, the deduction is capped at the lower of 20% of QBI or the W-2 wage limitation.
To further complicate matters, the W-2 wage limitation is calculated as the greater of (i) 50% of the owner’s share of W-2 wages paid by the business or (ii) 25% of the owner’s share of wages plus 2.5% of the owner’s share of the unadjusted basis of the business assets. Consider the case of John, a 30% owner in a non-service partnership that in 2018 generates $1.2 million of qualified business income, pays $400,000 of wages and has qualified business assets with an original basis of $250,000. John’s QBI deduction is $60,000, calculated as the lesser of:
- $72,000 [20% of ($1.2 million x 30% partnership allocation)]; OR
- $60,000 [greater of (a) 50% of ($400,000 x 30% allocation) or (b) 25% of ($400,000 x 30%) plus 2.5% of ($250,000 x 30% allocation).
If John is involved with more than one qualified business, the deduction is computed separately for each business line, with the combined amounts limited to 20% of taxable income.
Takeaway. The 20% QBI deduction is a tremendous planning opportunity that should be explored with the assistance of tax counsel.
If you are interested in learning how to take advantage of the changes in the new tax bill and set yourself up for retirement you can attend one of our FREE private briefings.
DISCLAIMER: Sal Salvo, of the Salvo Wealth Group offers securities and investment advisory services through Summit Equities, Inc., Member of FINRA/SIPC, and financial planning services through Summit Equities Inc.’s affiliate Summit Financial Resources, Inc. This memorandum was produced by Summit Financial Resources, Inc., which provides financial planning services. Securities and investment advisory services are offered through Summit Equities, Inc., Member FINRA/SIPC. 4 Campus Drive, Parsippany, New Jersey 07054. Phone: 973-285-3600, Fax: 973-285-3666. This memorandum is for your information and guidance and is not intended as legal or tax advice. Legal and/or tax counsel should be consulted before any action is taken. 20180110-0032
Approval Code. 20180113-040