The new tax law fundamentally shifted the taxation of businesses by making three significant changes:
- Decreasing the corporate income tax rate,
- Creating a new deduction for certain qualified business income (QBI) from pass-through business, like LLCs, partnerships, S-corporations and even sole proprietorships, and
- Lowering individual and trust tax rates.
Decrease in Corporate Income Tax to 21%
Beginning in 2018, C-corporations will pay a flat rate of 21% (down from 35%). Additionally, the corporate alternative minimum tax has been repealed. Businesses that elect to retain earnings for future growth are subject only to the 21% income tax rate while they may also defer the tax on dividends into the future.
Income Tax Break to Pass-Through Owners
The new law provides a new deduction for QBI most often received from pass-through entities like a partnership, LLC or S-corporation. QBI generally includes the net amount of ordinary income generated from a taxpayer’s business during the year. A partner or shareholder is eligible for a deduction of up to 20% of the QBI reported on his or her individual return. However, investment income, such as interest, dividends and capital gains, do not qualify for the deduction.
The QBI deduction is also limited for certain service business, like legal and medical practices. With these types of service-based business, the deduction is only available if the individuals overall taxable income does not exceed $157,000 ($315,000 if married filing jointly).
The QBI deduction is also limited for all other businesses, based on certain wage and capital limitations if the taxpayer’s income exceeds $157,000 ($315,000 if married filing jointly). A taxpayer’s deduction is limited to the greater of:
- 50% of the taxpayer’s allocable share of W-2 wages paid by the business or
- 25% of the taxpayer’s allocable share of W-2 wages plus 2.5% of the taxpayer’s allocable share of the unadjusted basis of certain assets held by the business.
For all taxpayers, the deduction is limited to 20% of the amount taxable income exceeds net capital gain.
Lower Individual Tax Rates
Finally, the income allocated from a pass-through entity will also be subject to lower individual income tax rates. The top individual rate decreased from 39.6% to 37%.
The Tax Cuts and Job Act has created a lot of planning opportunities, some of which may not be understood at this time, and this article is not intended to be a complete analysis of the Act, but merely a summary of some of tax planning opportunities that are available. Each taxpayer’s situation is unique, and you are encouraged to discuss your personal situation with an experienced advisor.
Paul Kellogg is an attorney in Cincinnati with the Phillips Law Firm, Inc. Paul’s practice focuses on providing comprehensive estate planning and probate services to families and business owners, as well as serving as outside general counsel to entrepreneurs and businesses where he provides guidance and advice on a wide variety of transactions and disputes. He can be reached at (513) 985-2500 or via email at [email protected]. Please explore Paul’s other articles on estate planning and business on the Phillips Law Firm Blog page.
The article is for educational and informational purposes only and does not constitute legal or tax advice. Anyone contemplating taking legal action is urged to obtain proper legal and tax advice from an attorney licensed in your particular jurisdiction.