Pass-through Entities
Most people have heard that Congress recently passed extreme tax reform laws (commonly referred to as the “Tax Cuts and Jobs Act”) that will significantly reduce “corporate” tax rates (from a maximum graduated rate of 35% to a flat tax of 21%) beginning in 2018. This tax reduction applies to “C corporations,” which is the type of entity most often used by larger (often publicly traded) corporations. Most small business entities are created as limited liability companies (LLCs), S corporations, partnerships, or sole proprietorships. These four types of entities are each considered “pass-through entities” that may also qualify for relief under the new tax reform laws.
How Does This Affect Most Business Owners?
Under the new laws, an individual taxpayer who is an owner of a pass-through entity may generally deduct 20% of that taxpayer’s “qualified business income.” Qualified business income does not include W-2 wages or various investment incomes that the taxpayer may receive from the business enterprise. Qualified business income is generally thought of as the ordinary net income that is allocated to the owners on a K-1 at the end of each year.
But It’s Complicated
As with most laws, the Tax Cuts and Jobs Act is complicated. There is much more involved in determining your deduction than simply multiplying qualified business income by 20%. At a minimum, you must also consider the following questions:
- Is your personal taxable income greater than $157,500 (or $315,000 if married)?
- Do you own an interest in a service trade or business (e.g. lawyers, doctors, accountants, financial service providers, athletes, and other service trades as defined by the Internal Revenue Code)?
- How much does your business pay in W-2 wages?
- What type of business structure (e.g. S corporation, LLC, partnership, or sole proprietorship) is being operated?
What Should You Do?
Depending on the answers to these questions (as well as others), you may want to pay more in W-2 wages, change your business structure (e.g. from an LLC to an S corporation), or restructure your business in a number of other ways to minimize taxes.
The Tax Cuts and Jobs Act provides some significant tax savings to many types of large and small businesses. As with any tax issue, business owners should plan as early as possible to make sure that business operations are properly structured during 2018 and beyond.
For additional guidance on these tax matters or other legal inquiries, please contact attorney Scott A. Breen at Willingham & Coté, P.C. Scott is an attorney with a Master of Laws degree (LL.M.) in taxation and specializes in corporate and partnership taxation.
