What's Up with the New Pass-Through Tax Cut?

Pass-through. It's a term that has been tossed around a lot lately, primarily because of the new tax law. Until this year, the only businesses that paid taxes directly were corporations. Other business organizations typically work as pass-through businesses, with the owner claiming the profit or loss on their taxes. For all intents and purposes, the business was ignored and the income was treated as personal income. However, the tax reform bill passed in December provides a solid tax cut to pass-through income. Here's a quick look at how it works and what to expect for your 2018 tax season.

First off, what kind of income is considered pass-through income? It's typically income that is not otherwise distributed to the individuals who own the company. For example, if John Q. Carpenter receives a guaranteed payment or payments made to him in his capacity as a partner in John and Joe's Carpentry Service, those would not be considered pass-through income. The company's profits above and beyond the payments that are otherwise made which are then passed through and reported on John and Joe's individual taxes would be considered pass-through income.

The tax cut covers up to 20% of that income, but cannot exceed 50% of the company's W-2 wages. That means if the construction company makes $250,000 in pass-through income and has W-2 wages of $100,000, they could deduct 20% of that pass-through income, or $50,000. If they only have a receptionist making $30,000 a year, they can only deduct $15,000, or half of those wages. If the company is a sole proprietorship, the W-2 wage rule applies to the owner's taxable income. That means if John's taxable income is $200,000 and the pass-through income is $250,000, he can only claim $40,000, or 20% of his taxable income.

One thing to bear in mind is that these deductions are only currently set up until the 2025 tax year, so for the next eight years. By knowing how the pass-through tax cut works, you can better plan your company's financial strategy to take advantage of the new tax laws. If you're not sure whether a particular strategy would work or if you need help developing a plan, we're here to help. Please feel free to contact the experienced tax professionals at AccountRely today to get started.