More (oh joy!) GOP tax bill proposed changes
Calculators provide an idea of tax bills under GOP plan

How taxes on pass-through businesses would work under the GOP tax plan

Business taxes paperwork

Pass-through taxation has been one of the most contentious and confusing parts of the debate surrounding the Republican tax bill.ese businesses — sole proprietorships, partnerships, limited liability companies (LLCs) and S corporations — are not themselves subject to federal taxation the way traditional corporations are. Instead, the income earned from these operations is passed through on the owner's personal income tax filing.

As I and many, many other media outlets and bloggers have noted, the final version of H.R. 1, the Tax Cuts and Jobs Act, that House and Senate conferees approved Dec. 15 basically followed the Senate's taxing methodology .

Rather than setting a specific tax rate as the House suggested, the conference committee members opted for the deduction proposed by the Senate. But the Upper Chamber's original 23 percent deduction for pass-through income was reduced to 20 percent.

So how would this work? Rather that reinvent the wheel, I'm giving a delayed Monday Shout Out (since my weekend focus on the tax bill prevented a regular Saturday or Sunday virtual high five to another tax piece) to Alistair M. Nevius with the Journal of Accountancy.

In his review of the tax bill, Nevius provides a good section on the pass-through income deduction:

For tax years after 2017 and before 2026, individuals would be allowed to deduct 20% of "qualified business income" from a partnership, S corporation, or sole proprietorships, as well as 20% of qualified real estate investment trust (REIT) dividends, qualified cooperative dividends, and qualified publicly traded partnership income. (Special rules would apply to specified agricultural or horticultural cooperatives.)

A limitation on the deduction would be phased in based on W-2 wages above a threshold amount of taxable income. The deduction would also be disallowed for specified service trades or businesses with income above a threshold.

For these purposes, "qualified business income" would mean the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. These items must be effectively connected with the conduct of a trade or business within the United States. They do not include specified investment-related income, deductions, or losses.

"Qualified business income" would not include an S corporation shareholder’s reasonable compensation, guaranteed payments, or — to the extent provided in regulations — payments to a partner who is acting in a capacity other than his or her capacity as a partner.

"Specified service trades or businesses" include any trade or business in the fields of accounting, health, law, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more of its employees.

The exclusion from the definition of a qualified business for specified service trades or businesses phases in for a taxpayer with taxable income in excess of $157,500 or $315,000 in the case of a joint return.

For each qualified trade or business, the taxpayer is allowed to deduct 20% of the qualified business income with respect to such trade or business. Generally, the deduction is limited to 50% of the W-2 wages paid with respect to the business. Alternatively, capital-intensive businesses may yield a higher benefit under a rule that takes into consideration 25% of wages paid plus a portion of the business’s basis in its tangible assets. However, if the taxpayer’s income is below the threshold amount, the deductible amount for each qualified trade or business is equal to 20% of the qualified business income with respect to each respective trade or business.

See, I told you he did the heavy lifting! The shouting out definitely was worth the wait.

Right now, it's looking like both the House and Senate have the votes to approve the bill.

Both bodies are looking at votes on H.R. 1 on Wednesday, Dec. 20 Tuesday, Dec 19. That should allow them to get the bill to the White House for Donald J. Trump's signature by the end of this week.

You can read about other Tax Cuts and Jobs Act provisions in my two-part series on the bill: Part 1 (which has a tax rates/income brackets table) and Part 2.

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Comments

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Jason

Do you know if you pay self employment tax (15%) on income before or after the 20% deduction?

Kevin

@ Jeremy - The threshold would be on the $200K in profit. Its the net of income and allowable business deductions.

Kay Bell

Thanks, Vit, for your detailed example of what a mess this is and will be. I applaud your work and glad I just write about it! Kay

Vit Gulbis

A dental practice is a wonderful hypothetical for the passthrough changes because it raises so many questions. On the first pass, I suspect that a dental practice will not be able to take advantage of the deductions since it is likely a "specified service, trade or business" (in my view it falls within medical). But maybe there is an opportunity to restructure the business. For example, what if the dentist restructures his practice into the following components (i) an equipment leasing company organized as a passthrough (which leases his dental equipment to the practice), (ii) a dental appliance manufacturing/distribution company organized as a passthrough (which makes, or buys and resells, items such as crowns, bridges, fixtures, etc), and (iii) a real estate rental company, which owns the office and leases it to the practice. All of these other entities would have businesses eligible for the passthrough deductions, and the dentist could bleed the profits from his overall practice into these related entities and away from the entity which provides professional dental services. As a tax lawyer, I think I I will have a lot on my plate next year as healthcare professionals, among others, restructure their practices.

This is not tax simplification. There will need to be pages upon pages of additional regulations and guidance.

Jeremy

How will a dentist’s taxes be affected as a LLC? If the practice profits run through the dentist’s personal tax returns of close to a million dollars, will the dentist see any tax relief? The overhead/expenses account for 80% of the profits claimed. The actual take home income of the dentist would be $200,000. Is the threshold for earnings related to the overall profit of the business, 1 million, or the take home profit of the dentist, $200,000.

Eric

will I have to itemize to take the 20% deduction?

Lmaris

If your postcard is the size of Montana, sure it will fit.

Kay Bell

Oh, Nick, you are such a [post]card!

Nick

Will I be able to do this on a postcard?

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