2018 New 20% Deduction Rules for S-Corporations
Trump’s tax bill, the Tax Cuts and Jobs Act, passed at the end of 2017 includes a significant tax deduction available to owners of S corporations as well as a partnership, LLC, or sole proprietorship.
Included in the new tax reform bill was the reduction of the corporate tax rate to 21% while an S-corporation is taxed at one of the individual tax rates spread across 7 tax brackets with the highest being 37%. This created a disparity between the top tax rates and accordingly, a pass-through entity is now allowed a deduction of up to 20% on “qualified business income” (“QBI”). QBI for an S-corporation is net income excluding wage compensation and investment income earned through your S-corporation. In addition, QBI is calculated separately for each business (not combined per taxpayer).
There are two (2) hurdles to claim the full 20% deduction. The deduction may be reduced or even eliminated under a test for “specified service business” and a “wage and capital” limit.
Specified Service Business-this includes virtually every occupation that provides personal services (lawyers, doctors, accountants, consultants, etc.) other than engineering and architecture. The 20% deduction amount starts reducing at a proportional rate for those with taxable income above the threshold, $157,500 for single and $315,000 for joint. Once taxable income reaches $207,500 for single or $415,000 for joint, the deduction amount begins to phase out. If your income is above the $207,500 or $415,000, respective threshold levels there’s no deduction available.
Wage and Capital Limit- The deduction is limited to the greater of:
-50% of the W-2 wages with respect to the qualified trade or business; or
-The sum of 25% of the W-2 wages paid with respect to the qualified trade or business plus 2.5% of the unadjusted basis of all qualified business property (i.e., depreciable property available for use in your business). This limit is phased in pro-rata based on the same income thresholds as #1 above for a specified service business. Once you exceed the $207,500 single or $415,000 joint upper threshold limit, your phase-in of the limit is complete.
Therefore, taxpayers below the thresholds can take their deduction. Also, to note that the deduction cannot exceed your taxable income for the year (reduced by net capital gain). If the net amount of your QBI is a loss, you can carry it forward to the next year.
We anticipate additional guidance released by the IRS and look forward to examples later in 2018.
The above information is of a general nature only and should not be relied upon for specific situations. Click here for additional tax services information.
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