Written on behalf of Feigenbaum Consulting
Earlier today, the Treasury Department and the Internal Revenue Service (IRS) released long-awaited guidance on a key element of the Tax Cuts and Jobs Act, answering the many questions that were being asked by small business owners hoping to take advantage of major tax breaks included in the Republican tax reforms.
Today’s announcement was intended to provide additional clarity about the 20% deduction on income for owners and partners in “pass-through” entities (i.e. LLCs, S-corps, partnerships, and sole proprietorships) which permits these businesses to significantly reduce their tax obligations.
The moniker “pass-through” comes from the fact that the profits of these firms are passed directly through the business to the owners and are taxed through the income tax return of those owners. Many businesses are organized in this way, passing profits through to the owners as personal income, rather than operating as corporations with shareholders.
When the new tax legislation was introduced, the pass-through deduction was one of the areas that business owners wanted the most guidance from Treasury and the IRS about. Not only was the deduction new, but it contained multiple complex elements.
Treasury Secretary Steve Mnuchin said in a statement:
The pass-through deduction is an important tax cut for small and mid-size businesses, reducing their effective tax rates to their lowest level since the 1930s…[p]ass-through businesses play a critical role in our economy.
A senior Treasury official stated that the department’s goal was to release a set of comprehensive rules that would apply to most pass-through businesses and “give small-business taxpayers everything they need to navigate these rules.”
Three Major Components Addressed
Treasury noted that there are three major components to the new guidance:
- Pass-through income below a certain amount
Americans with taxable income of no more than $157,000 (or $315,000 where filing jointly) automatically qualify for the deduction. The new rules reduce complications for pass-through business income below these amounts.
- The process for claiming the deduction
The process for claiming the deduction for those taxpayers who have an income above the threshold has been more fully explained.
Clarification was provided as to how companies with multiple income sources from various business lines can claim the deduction without having to restructure their business. Companies will be permitted to aggregate all pass-though income from more than one source as one single business income.
Additional information was provided on what businesses are excluded from claiming the deduction, including businesses in health, law, accounting, actuarial sciences, consulting, financial and brokerage services, athletics, and the performing arts.
- Preventing abuse of the deduction
Some of the new rules focus on preventing taxpayers who are hoping to use the deduction to avoid paying taxes from abusing the system (through, for instance, relabelling employees are independent contractors, or similar tactics).
Additional regulations and clarifications are expected to the be forthcoming. We will continue to monitor any further announcements and will provide commentary as more information becomes available.
In the meantime, if you have questions about your personal tax planning or corporate tax planning, contact Feigenbaum Law. We regularly assist business owners with tax returns and complex tax planning. We have been leaders in cross-border tax services for many years.
Prior to founding his firm, Mark Feigenbaum worked in the cross-border tax department of an international Big 4 firm, and accounting management positions in a range of sectors in both Canada and the US. He also taught full and part time at the undergraduate and graduate level at several universities. Mark brings practical business knowledge, gained through roles in the entertainment industry, manufacturing, retail, public accounting and education, to all aspects of his practice. We understand the issues our clients face in the real world and can often anticipate problems before they even arise.