Your Business May Get a Break from Uncle Sam in 2018
Rejoice if you operate your business as a sole proprietorship, partnership, S corporation, or LLC (unless taxed as a C corporation), because your 2018 income from these businesses may qualify for some or all of a new 20 percent deduction. The new Section 199A tax deduction that you can claim on your personal federal income tax return is a big deal. There are many rules, but your odds as a business owner of benefiting from this new deduction are excellent.
The new Section 199A deduction was created to help provide tax relief to business entities similar to that provided to C corporations, which saw their top tax rate go from 35% to 21%. To qualify for the 20 percent deduction with almost no complications requires two things:
First, you need qualified business income from a sole proprietorship, partnership, S corporation, or LLC. Qualified business income is defined as the net income a business produces from the operations in the United States.
Second, you need “defined taxable income” of
- $315,000 or less if married filing a joint return, or
- $157,500 or less if filing as a single taxpayer.
Example. You are single and operate your business as a sole proprietorship. It produces $150,000 of business income. Your other personal income and deductions result in defined taxable income of $153,000. You qualify for a deduction of $30,000 ($150,000 x 20 percent).
Once you exceed the income limits, your deduction is limited to the lesser of:
- 20% of your qualified business income; or
- 50% of the W-2 wages earned from your business.
Example. You and your spouse have $400,000 of defined taxable income for the year. Of this, your business produced $200,000 in qualified business income and that business paid you $120,000 in wages. Your deductible amount is the lesser of:
- $40,000 ($200,000 x 20%); or
- $60,000 ($120,000 x 50%).
So, your Section 199A deduction is $40,000.
Out-of-Favor Businesses
Some unfriendly rules apply to what Section 199A calls a specified service trade or business. The “specified service trade or business” group includes any business:
- involving the performance of services in the fields of health, law, consulting, athletics, financial services; or
- where the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners; or
- that involves the performance of services that consist of investing and investment management trading or dealing in securities or commodities.
When you operate a business that falls in the out-of-favor group, and your defined taxable income is less than $315,000 (married filing jointly) or $157,500 (single), you still qualify for the full 20 percent deduction on your qualified business income.
If your taxable income is above the thresholds above, the deduction begins to phase out, and the Section 199A deduction on your out-of-favor business is zero when you have taxable income of more than:
- $415,000 if married filing a joint return, or
- $207,500 filing as a single taxpayer.
That’s the bad news. The good news is that the new law provides some opportunities for tax planning. If you fall into this situation, I suggest that you contact your tax advisor to discuss those options.