There was a HUGE tax bill passed last year – the Tax Cuts and Jobs Act of 2017 (TCJA). One part of that new bill has been widely promoted – Corporations (C-Corps) now have a flat 21% tax rate! However, that new flat tax rate does NOT apply to those who have chosen to be an S-Corp (Small Business Corporation), a Partnership, a Sole Proprietor or an LLC operating as any one of those entities. If your business is not a C-Corp, your profit or loss is reported on your personal schedule C or Schedule E, and you will pay the appropriate taxes on your personal tax return.
Let’s go back in history – Regular C-Corps historically have had a much higher tax rate than the personal rates. Partnerships escaped these higher rates because income was reported on their personal tax returns. Thus, the S-corp was born; a hybrid allowing the protection of a corporation but tax rates similar to those paid by partners. Those choosing to convert to an S-corp, had the benefit of lower tax rates compared to a C-Corp.
Now, under the new TCJA law, the personal rates are much higher than the corporate 21% rate. To equalize the benefit that was extended to C-Corps, Congress created a section of tax code. Code Section 199A proposes regulation that would allow for a POTENTIAL deduction of 20% of the business income that derives from a business that is NOT a C-Corporation such as S-Corp, Partnership or Sole Proprietor (also known as a disregarded entity if it is part of an LLC). Owners and investors in rental properties, Real Estate Investment Trusts (REITs) or Publically Traded Partnerships (PTPs) are also eligible to receive the deduction except when renting to yourself. If you rent to yourself, contact your tax professional to discuss how the rules and regulations can impact you.
To determine what income is eligible for the deduction, we are interested in the tentative taxable income; the net of adjusted gross income minus the standard or itemized deduction. This is the important number —- If you are filing a joint tax return with your spouse and this tentative taxable income is under $315,000, YOU GET A DEDUCTION! If you are single, your tentative taxable income must not exceed $157,500.
How much can you deduct? Now we have to do some calculation. First multiply your business income by 20%. Then multiply the tentative taxable income by 20%. You will use whichever is LESS.
For example, your qualified business income is $200,000. $200,000 x 20% = $40,000. If that is the only item on your tax return, your tentative taxable income will be $176,000 — $200,000 less standard deduction for a married couple of $24000 leaves $176,000. $176,000 x 20% is $35,200. You may deduct $35,200. Your true taxable income would now be $140,800 and that is the amount you will use to calculate your income tax due. ($200,000 – $24,000 – $35,200 = $140,800).
- Please note that in 2018, there are NO personal exemptions to further reduce taxable income.
What happens if your income is over $315,000? You are in a phase-out range that is based on the income shown on your tax return that may cause you to receive less than the 20% deduction. Talk to a tax professional!
Please note that incomes over $415,000 ($207,500 for single filers), under some circumstances you will not receive a deduction. Talk to a tax professional!
If you have questions on this or other tax topics, please feel free to call our Tax Hotline at (856) 779-2430 and ask for Sherry.