It’s my annual Taxes from A to Z series! This time, it’s Tax Cuts and Jobs Act (TCJA) style. If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss under the new law, you won’t want to miss a single letter.
P is for Pass-Through Deduction.
Perhaps no other provision made news under the TCJA more than the so-called pass-through deduction. Under the TCJA, corporations were treated to a flat 21% tax rate, while the rates for individuals were a bit higher. Congress grappled with how to reconcile the two and found a solution: business income from a pass-through entity (as well as income attributable to a sole proprietorship) would be taxed at individual tax rates less a deduction of up to 20%.
The deduction, called the Section 199A deduction, or pass-through deduction, generally applies to sole proprietors and business owners with pass-through businesses, as well as certain trusts and estates. Pass-through businesses are those that do not pay corporate income tax at the entity level but pass income and expenses through to the owners. The owners report their share of income and expenses on their own tax returns and pay any resulting tax at their individual income tax rates. Examples of pass-through businesses include sole proprietorships, partnerships, limited liability companies (LLCs), trusts and S corporations.
For 2018, the key income amounts to know for the pass-through deduction are $315,000 for joint returns and $157,500 for other taxpayers. These are the threshold amounts.
- If your taxable income is below the threshold amount, the deductible amount for each of your businesses is 20% of your qualified business income (QBI) for each business. For example, if your income is $50,000 and your QBI is $40,000, then your deduction is $8,000, or 20% of your QBI. You’re under the threshold amount so there’s no need to do any more math.
- If you are above the threshold amount, you are subject to limitations and exceptions determined by your occupation and a wage and capital limit.
The limits on occupations apply to those qualified as an SSTB (specified service trade or business). An SSTB is any business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.” The definition also includes a business where the performance of services consists of investing and investment management trading or dealing in securities, partnership interests, or commodities.
If your business is an SSTB and you exceed the threshold amount plus the phase-in range ($415,000 for joint filers and $207,500 for all other taxpayers in 2018), then you lose the deduction completely. In that case, the old pass-through rules apply meaning that you pay tax using your individual tax rate.
Otherwise, the pass-through deduction is generally equal to the lesser of:
- 20% of your QBI, plus 20% of your qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income; OR
- 20% of taxable income minus net capital gains.
There are a number of qualifiers and exceptions, which can make the formula tricky. You’ll find more info on the individual pieces, including the wage and capital limits, here. You can also find out more by reading Tony Nitti’s summary of the IRS Final Guidance here.
The pass-through deduction isn’t for the faint of heart. If you have questions, it’s best to check with your tax professional.
For more Taxes From A To ZTM 2019, check out the rest of the series:
- A is for Alimony
- B is for Bracket Creep
- C is for Credit For The Elderly Or The Disabled
- D is for Due Dates
- E is for Earned Income Tax Credit (EITC)
- F is for Fair Debt Collection Practices Act (FDCPA)
- G is for Gross Estate
- H is for Home Office Deduction
- I is for Innocent Spouse
- J is for Jackpot
- K is for Kiddie Tax
- L is for Long-Term Capital Gains or Losses
- M is for Medical Expenses
- N is for Notice
- O is for Opportunity Zone