Update on the New 20% Pass-through Deduction

The Tax Cut and Jobs Act created a new 20% pass-through deduction for qualifying business income from partnerships, S-corporations, and sole proprietorships. The deduction is subject to a 50% wage limitation or a 25% wage limitation plus a 2.5% of qualifying property limitation. Partnerships allocate qualifying business income, the wage limitation, and the cost basis limitation in accordance with the terms of their partnership agreement. The deduction is computed at the individual level in arriving at taxable income. Qualified business losses are carried forward to offset future qualifying business income. The legislation and the interplay with existing federal and state rules raise a number of issues that need to be considered to maximize the deduction and minimize the business owner’s tax burden.

Choice of Entity

LLCs and sole proprietorships should consider checking the box to become S-corporations to maximize the wage limitation, maximize the amount of the federal tax deduction, and to reduce self-employment taxes. Sole proprietorships should also consider an S-corporation conversion to take advantage of the new Connecticut pass-through tax deduction that ultimately permits a deduction for state taxes on pass-through income. Planning should begin now to determine whether making an S-corporation election can reduce the business owner’s tax burden and increase cash flow. 

Estimated Taxes

The 20% pass-through deduction will reduce a qualifying business owner’s federal tax liability in 2018. The ultimate savings is dependent upon the complex interplay of qualifying business income, the wage limitation, and the basis limitation. Computations should be started now to reduce fourth-quarter estimated tax payments and to increase discretionary cash flow for the business owner. Partnerships and S-corporations with multiple owners should provide preliminary benefit computations to their owners so that the owners can make corresponding reductions in their fourth-quarter estimated tax payments.

Large Equipment Purchases

A company that purchases expensive equipment in 2018 will probably have an immediate deduction for the cost of the equipment under the enhanced Section 179 and bonus depreciation rules. The purchase could also have a subsidiary benefit for purposes of the 20% pass-through deduction because the cost can be used to increase the cost basis limitation.

The legislation is complex and will require detailed analysis to maximize your deduction. You should contact a member of your engagement team to learn more about how the new legislation can reduce your taxes and increase your after-tax cash flow. 

Contact your Whittlesey Advisor for more information.