Do you qualify for the new 20% deduction for pass-through entities (S corps, LLCs, partnerships, sole proprietors)? Yes, no, partially, not sure yet – all possible answers. It turns out that this determination will depend on several things and may be anything but simple.
But there are a few substantial factors: (1) how is the income derived, i.e. is it from investments (capital gains, dividends, interest); (2) how much non-investment income did you make from the business, over and above a reasonable compensation/salary level; and (3) if you file a joint return and make more than $315,000 ($157,500 for individuals), what type of business do you own or have a share in?
If you’re under the $315,000/$157,500 threshold, business type doesn’t matter. If over $315,000/$157,500, but under $415,000 (or $207,500 for individuals), the deduction is limited for most service-based businesses industries, (e.g. health care, law, accounting, consulting and financial management). However, there are a couple big carveouts: engineering and architecture.
Furthermore, once your income crosses the $315,000/$157,500-line, additional limitations apply. Now, if your “taxable Income” exceeds $415,000 (or $207,500 for individuals), the deduction is limited to the greater of: 50% of your share of W-2 wages expense or 25% of your W-2 share, plus 2.5% of your interest in the business fixed assets.
This is the basic description of what we know now about how the simple new deduction will be applied; yes, simple may be a misnomer. Of course, there are many, many more details regarding how all this will work, and many yet unanswered questions about how it is to be applied. At least the IRS is trying to make things easier.
Earlier this month, the government agency published an introduction statement and 184 pages of proposed rules for applying the deduction. Also worth reviewing: a couple good outlines from the Journal of Accountancy and Tax Advisor with more detailed discussion and examples. Still, the best course may be to call your accountant (and probably attorney as well) to get an expert opinion on what you are really looking at.