Tax Update: The New Pass-Through Deduction for Small to Mid-size Businesses

By Peter VanderWoude, MS, CPA, CGMA
President, Equus Advisors, Cortland, N.Y.

If you own a business or rental property where the income is taxed on your personal income tax return, you should get up to speed on the new “pass-through” deduction for 2018. It’s likely that you have heard about the pass-through deduction being up to twenty percent of your “qualified business income” from a sole proprietorship, partnership, limited liability company or S-Corporation. That’s true, but there are many caveats and complex provisions to this law that may reduce that amount. Before you get into the nitty gritty details with your tax advisor, you should understand a few general details of how this deduction will impact you.

Many people ask if the pass-through deduction will reduce one’s business’s income subject to self-employment tax? No dice. It will, however, shelter your ordinary income, apart from capital gain income that is taxed at lower capital gain rates. The calculated pass-through deduction will show up on your tax return below the adjusted gross income “line” where your standard or itemized deduction is taken to determine taxable income. Remember that for 2018 the personal exemption for you, your spouse and dependents no longer exists.

If your business is a service-type business, other than engineering or architecture, and your taxable income without the pass-through deduction exceeds $157,500 as a single person or $315,000 as a couple, the pass-through deduction will begin to phase out and the calculation can get complicated. The level of wages paid in your business and depreciable property will also impact the level of the pass-through deduction you can take.

The level of your itemized deductions that shelters your ordinary income from tax and the amount of your other income and losses you claim may also reduce the level of the pass-through deduction. In a simple example, John and Mary own a bake shop partnership that nets $100,000 of qualified business income. They take the standard deduction of $24,000 and have no other income. Their pass-through deduction will be based on 20 percent of taxable income of $76,000 or $15,200. If they had other income that exactly offsets their standard deduction, they may be able to take the full $20,000 deduction and pay income tax on $80,000. Each business you own will have a separate pass-through deduction calculated on it for your personal income tax return.

Have our firm prepare your taxes for 2017 and we will provide you with a tax projection for 2018, so you can see how tax reform will impact you personally. Give us a call at 607-756-5691 or email us at [email protected].