Small businesses set up as pass-through entities might be able to take a 20% tax deduction thanks to new tax law. Learn more at TD Ameritrade.
Have you struck out on your own and opened a business, or are you considering doing so? Maybe it’s a full-time entrepreneurial venture, or just a part-time gig. Either way, you may receive what’s known as “pass-through income,” and you may benefit from the new tax law.
Under the new law, the corporate tax rate has been reduced from 35% to 21%. But the tax law also added a perk for small business owners: a potential deduction of 20% of “qualified business income” for a pass-through entity. If you own your own business, that deduction may be good news. The potentially not-so-good news is that, depending on the kind of business you operate, your tax filing may have gotten just a bit more complicated.
What is a pass-through business, or pass-through income? We’ll sketch a general overview of pass-through entities, what might qualify as pass-through income, and a few other things you may need to know if you’re considering such a business structure. But be warned—pass-through structures, and the rules that apply, can be complex. This article can’t cover every aspect of the new tax reform law. The details, including how the new law might affect your situation, may be best handled by your lawyer and/or tax advisor.
Pass-through income refers to any business revenue that must be reported on an individual return as personal income. This means that your business will not be taxed separately. Instead, the tax burden will be “passed through” from your business to you as an individual.
This form of taxation applies only to companies that are considered pass-through businesses.
According to the IRS, if you own your own business, it will likely be formed as one of the following four entities:
In general, your deduction is typically 20% of your qualified business income (QBI), as long as your deduction amount does not exceed 20% of your taxable income (minus any net capital gains you may have accumulated). And as with many tax rules, there are income thresholds, above which a pass-through tax deduction may phase out. If your QBI is above the threshold—$315,000 if you’re filing jointly, or $157,500 if you’re a single filer—a few complications will kick in, namely a wage limit and a phaseout that limits your deductions if you operate what’s called a “specified service business.”
What do all these term mean? Here’s a quick rundown, according to the American Institute of Certified Public Accountants:
In general, taxpayers with QBI below the threshold could be eligible for the full 20% deduction. Some professions with historically higher incomes, such as attorneys and physicians, may be subject to the phase-in rule.
We’ve just scratched the surface regarding the ins and outs of pass-through income. There are exclusions, exceptions, and additional limitations that can make an individual situation differ considerably from the general information offered here.
Again, the rules surrounding pass-through entities can be complex. But if you own a small business, and think you might be eligible for a 20% reduction in your tax burden, it may be worth a call to your tax consultant.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
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