If you're like most small-business owners, you are scratching your head trying to figure out the new small-business tax deduction.
The Tax Cuts and Jobs Act, which went into effect Jan. 1, offers a 20 percent deduction for "pass through" entities, such as partnerships, limited liability companies and subchapter S corporations.
Like all tax benefits, the deduction is designed to accomplish social-engineering goals as well as raise tax revenue for the government, specifically:
1) The current administration wants to bring manufacturing back to the U.S. so such businesses will have the easiest time qualifying for the deduction.
2) The current administration wants to encourage small businesses to hire more people as employees so those small businesses will have an easier time qualifying for the deduction than others.
Here are the five questions you will have to ask to determine whether you qualify for the 20 percent deduction:
Step No. 1: Is Your Business a Pass-Through for Tax Purposes?
The 20 percent deduction applies only to pass-through entities, which are basically any entities (including sole proprietorships) other than C corporations. Hey, those guys got a HUGE reduction in their federal income-tax rate, so don't feel too sorry for them.
Step No. 2: Is Your Business Engaged in a "Specified Service Trade or Business"?
The 20 percent deduction applies only to small businesses engaged in manufacturing, retail, nonprofessional services (think restaurants and lawn care) and SOME professional services (such as architecture and engineering). Congress did not want the new deduction to enrich accountants and lawyers (but no fear — the extra fees they will earn from helping clients figure out the deduction will more than make up for not having the deduction).
A specified service trade or business is defined as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or "any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees." So, if you are a barber or hair stylist, are you a specified service trade or business ineligible for the deduction? The new law doesn't offer any guidance, but here are two rules of thumb:
1) If your state requires or permits you to form a professional corporation or professional limited liability company in lieu of a regular corporation or LLC, you are probably engaged in a specified service trade or business (ask your lawyer about this).
2) If your state requires you to obtain a professional license (as opposed to an occupational license) to do whatever you do, you are probably engaged in a specified service trade or business.
Step No. 3: Do You Make Less Than the Minimum Income Thresholds?
If you have less than $157,500 in taxable income (for a single taxpayer) or $315,000 in taxable income (for a married taxpayer filing jointly), then you can take the 20 percent deduction even if you are engaged in a specified service trade or business. Although, if you are a doctor making less than $157,500 a year, I'm wondering how good a doctor you are.
If you are a shareholder in an S corporation, your taxable income is based on what is distributed to you each year as an owner/partner in the business, not the amount you take out in salary for the services you render to the corporation.
Question: If you are slightly over the taxable income threshold, can you increase your deductions to bring your taxable income below the threshold — for example, by leasing a car through your company? You bet you can, as long as the deduction qualifies as an "ordinary and necessary" business deduction (forget the personal masseuse, unless you are a Hollywood actor).
Step No. 4: Does the Deduction Exceed Certain Caps?
Whether or not your taxable income exceeds the minimum income thresholds, your deduction cannot exceed 20 percent of the excess of your taxable income over your net capital gains.
If you are NOT engaged in a specified service trade or business AND your taxable income exceeds the minimum income threshold ($157,500 for a single taxpayer and $315,000 for a married taxpayer filing jointly), you can still take the 20 percent deduction. The bad news is that your deduction is further limited, or capped, to the greater of the following:
1) 50 percent of all wages paid to W-2 employees of the business.
2) 25 percent of all wages paid to W-2 employees plus 2.5 percent of the unadjusted basis (i.e. before any depreciation deductions) of tangible depreciable property that your company owns as determined at the end of the tax year.
Step No. 5: Should You Hire a Tax Professional?
Got all that? I didn't think so. Unless you are trained in accounting, you will probably need the help of a qualified tax professional to determine whether or not your business qualifies for the 20 percent deduction.
Pay tax professionals well. After all, they don't get the deduction.
Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.