Back in December, President Donald Trump signed the Tax Cuts and Jobs Act. Congress had included in the act a “20 percent of X” tax deduction for owners of pass-through businesses, and most small businesses owners celebrated.
“This is the first broad brush deduction available only to businesses owners since the inception of the Federal income tax in 1913,” tax attorney Robert Schwartz of Lindabury, McCormick, Estabrook and Cooper, P.C. in Westfield explained recently. Nevertheless, it is complicated; attorneys such as Schwartz expect to spend a lot of time counseling business owners about 2018 tax return positions concerning the deduction.
Complexity aside, small businesses have a lot to celebrate. After all, while S-corporations, LLCs, partnerships and proprietorship business owners weren’t going to benefit from the tremendous reduction in the corporate income tax from 35 percent to 21 percent, the “20 percent of X” deduction could possibly reduce their business’s income taxes below a 21 percent rate. The “Section 199A”deduction could not possibly be enacted in such a way as to address in advance each and every pass-through business owner situation with clarity, such as exactly which kinds of businesses would be eligible for the deduction and how to calculate it. Schwartz explained this is partly due to the fact that Congress was intent on incentivizing businesses that lend themselves to the full-time hiring of larger numbers of employees and buying plant, property or equipment. At the same time, Congressdid not want to allow such a large tax deduction to highly educated or uniquely skilled individuals who might or might not, given their particular business operation style, be incentivized to increase full-time employee hiring or to buy plant, property or equipment.
Need more? Robert Schwartz will provide a detailed analysis in a March 28 webinar called Understanding the Tax Cuts and Jobs Act
Small businesses can take steps now to prepare for taking the deduction when they file their 2018 tax returns next year.
First, if you’re unsure what your current estimated tax payments should be, you may wish to keep them in the same amount you did for 2017. Congress intended to at least limit owners of high skill or reputation service businesses, like doctors, lawyers and hedge fund managers, from getting the full deduction, but left it up to the IRS to more carefully define exactly which business owners qualify and how much. The edges of the legal definitions are not crisp and straight right now. They are unlikely to be entirely clear, even after IRS guidance, and some intrepid business owners will eventually do battle with the IRS. But Schwartz says no high income “reputation/skill”’ service business owner will be subject to estimated tax underpayment penalties if he or she continues their 2018 estimated tax payments like 2017.
Second, understand that the 20 percent of X tax deduction will not reduce your entire taxable income to zero. With the help of your accountant and/or counsel of a tax lawyer, you should make the necessary estimated calculations, such as determining your “combined qualified business income amount” (“CQBIA”). For owners of several different businesses, ascertaining “combined” amounts is daunting.
There are as many different scenarios as there are deduction eligible business owners, but to simplify, you should be able to deduct the lower of either 20 percent of your CQBIA or 20 percent of your taxable income determined just before the Section 199A deduction is taken—a 20 percent tax deduction.
No doubt, businesses that are pass-throughs should get expert tax advice by tax attorney so they can make some informed decisions about the 2018 tax year. For some business owners, converting the business to a corporate income taxable “C Corporation” will be even more income tax efficient than claiming the Section 199A deduction. The C corporation 21 percent tax rate is one thought by even tax experts and economists as entirely impossible until just over one year ago. Planning ahead of time will pay off, and give small business owners reason to be finally relieved that their federal government thought so favorably of them .