Small businesses set up as pass-through entities might be able to take a 20% tax deduction thanks to the 2018 tax law, but the rules can be complex. Here's a general overview.
Have you struck out on your own to open a new business, or are you considering it? Maybe you’re looking at a large-scale entrepreneurial venture, or something more modest, like a part-time gig. Either way, the revenue you generate may be small enough to be considered pass-through income. And the money you owe Uncle Sam may fall under the category of pass-through tax. If you’re not familiar with this tax category, then read on.
Under the new 2018 tax law, the corporate tax rate has been reduced from 35% to 21%. But the law also added a perk for small business owners: a potential deduction of 20% of “qualified business income” for any pass-through entity. This deduction may be good news for small business owners. The bad news is that it might make your tax filing just a bit more complicated.
But first, you should understand the general overview of this type of tax structure. But be warned: the rules can be rather complex. This article can’t cover every aspect, and the details are important. So when you’re done reading, you might want to pay your lawyer or tax advisor a visit to learn more about pass-through tax rules and how they might affect your business.
Pass-through income refers to any business revenue that must be reported on an individual return as personal income. This means that your business will not be taxed separately. Instead, the tax burden will be “passed through” from your business to you as an individual.
These tax rules apply only to companies that are considered pass-through entities.
Generally speaking, your deduction is typically 20% of your qualified business income (QBI) as long as your deduction amount does not exceed 20% of your taxable income (minus any net capital gains you may have accumulated).
The key to filing taxes is being prepared. TD Ameritrade provides information and resources to help you navigate tax season.
As with most tax rules, there are income thresholds above which a pass-through tax deduction may phase out. If your QBI is above the threshold—$315,000 if you’re filing jointly, or $157,500 if you’re a single filer—a few complications will kick in, namely a wage limit and a phaseout that limits your deductions if you operate what’s called a “specified service business.”
What do all these terms mean? Here’s a quick rundown, according to the American Institute of Certified Public Accountants:
In general, taxpayers with QBI below the threshold could be eligible for the full 20% deduction. Some professions with historically higher incomes, such as attorneys and physicians, may be subject to the phase-in rule.
We’ve just scratched the surface of pass-through tax rules. There are exclusions, exceptions, and additional limitations that can make an individual situation differ considerably from the general information offered here.
Again, the rules surrounding pass-through entities and taxation can be complex. But if you own a small business, and think you might be eligible for a 20% reduction in your tax burden, it may be worth a call to your tax consultant.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
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