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New Tax Law FAQ: Can I Take the 20 Percent Business Deduction?

By Tyler Petzel, CPA

Tyler Petzel joined the firm in 2013 after graduating from Minnesota State University, Mankato in December 2012.  He works on audits, reviews, and compilations of private companies and prepares tax returns for individuals, partnerships, and corporations, primarily in the Agriculture industry.

Since the new tax law passed late last year, I've fielded several questions from business owners wondering how it will affect them. Many of these inquiries relate to the 20 percent business deduction for pass-through entities.

What should I know?

When we say "pass-through entities," we're talking about business structures that allow for the owner to pass their company's earnings, losses, and deductions through to their individual income tax return. These include partnerships, S corporations, and sole proprietorships.

In 2017, the U.S. corporate tax rate was 35 percent, which, for most business owners, was higher than their individual tax rate. In many cases, this made it advantageous for owners to use pass-through entities to take advantage of lower individual tax rates. 

Under the new law, however, the top individual tax rate is 37 percent, whereas the corporate rate is a flat 21 percent. This essentially removes any benefit associated with pass-through income. To remedy this, the new law allows owners of pass-through entities to deduct 20 percent of their qualified business income, or QBI, from their individual taxable income.  

What's the fine print? 

While this may sound fairly straightforward, like most things having to do with tax, it isn't. First, there are a couple of income limits that come into play. If your taxable income is less than $157,500 if single or $315,000 if married filing jointly, you can take full advantage of the deduction. If your taxable income exceeds these thresholds, the deduction you receive will depend on your income level as well as the type of work you do. You may also be impacted by limitations relating to the wages your business paid as well as the cost of its property. 

What should I do now? 

There are still a few uncertainties about how this will impact businesses in 2018 and beyond. The pass-through deduction, unlike the other corporate tax breaks, is not permanent; it is set to expire in 2025. The best thing you can do, at the moment, is talk to your tax advisor. We anticipate that some business owners may want to consider switching to a different entity or, if married, change the way they file their taxes. Because of this, it's important to determine what you should do as soon as possible.