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2018 Tax Law Changes- Pass-Through Enttities

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Pass Through Entity Taxes

  • An individual taxpayer may deduct 20% of domestic qualified business income from partnership, S corporation or sole proprietorship.
    • The amount of the deduction will be limited to the greater of:
      • 50% of W-2 wages paid by the business or;
      • The sum of 25% of W-2 wages paid by the business and 2.5% of business capital.
      • The wage limitation does not apply if taxable income is less than $157,500 (single) or $315,000 (joint) and applies fully if taxable income exceeds $207,000 (single) or $415,000 (joint).
    • Trusts and estates will qualify for this deduction.
    • The deduction is a post adjusted gross income item.
    • The deduction is not affected by whether the owner is passive or active.
    • For specific service businesses, such as those in accounting, law, consulting, and investing, but not engineering or architecture, the 20% deduction will apply only if the taxpayer's taxable income is less than $157,500 (single) or $315,000 (joint). No deduction will be allowed if the taxable income exceeds $207,000 (single) or $415,000 (joint).
  • The act changes the long-term capital gains holding period for certain assets held in partnerships engaged in investment and real estate activities (carried interest). After 2017, a three-year holding period is created for long-term capital gain treatment of gains for a carried interest (instead of the typical one-year requirement).

Observations

The final bill generally follows he Senate's approach to the taxation of pass-through entities (S corporations, partnerships or sole proprietorships) and creates a rather complicated deduction for "qualified business income" for tax years 2018 through 2025. The final bill clarifies that the deduction will not be taken in reaching adjusted gross income, though it is available to both itemizers and non-itemizers. In a positive change, the final bill permits this deduction to be used by owners of pass-through entities which are trusts or estates.

The act creates preferential treatment for certain pass through entities by basically permitting a non-itemized deduction of 20%. The reduced amount would then be subject to the new marginal rates. Owners of larger, more profitable, service businesses will likely not be eligible for this deduction.

 

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