There is good news for taxpayers who own interests in pass-through entities.
Effective for the 2018 tax year and ending Jan. 1, 2026, a new income tax deduction known as the "Qualified Net Business Income Deduction" is available to owners of certain pass-through businesses—such as partnerships, limited liability companies taxed as a partnership or sole proprietorship, S corporations and sole proprietorships.
In general, the deduction equals 20 percent of the company's qualified net business income reportable by the owner and is calculated on the owner’s tax return. The calculation is then subject to several modifications and limitations.
Qualified business income is generally taxable income generated by a U.S. trade or business, but does not include investment income, such as dividends, interest and capital gains.
A qualified trade or business is any trade or business other than a specified service business. Most service businesses such as healthcare, law, accounting, actuarial and financial services are specified service businesses and are not eligible for this deduction unless the taxable income of the owner is under a certain ceiling: $157,500 for single taxpayers and $315,000 for married joint taxpayers. Engineering and architectural firms are an exception to this exception, so the taxable income ceiling does not apply to the owners.
The purpose of the deduction is to provide owners of pass-through entities with a tax break similar to the reduction in rates for corporate taxpayers.
The deduction is claimed by the owner as a deduction in arriving at taxable income, much like an itemized deduction. However, the deduction is available whether or not the taxpayer otherwise itemizes deductions.
The deduction is available to non-corporate taxpayers, including estates and trusts.
Unfortunately, very little about this deduction is simple. There are many limitations, phaseouts, thresholds and special definitions.
Owners of interests and pass through entities need to consider this deduction when evaluating whether adopting a corporate tax structure to take advantage of the lower corporate tax rates in 2018. Consulting with your attorney and financial advisor can help to determine the best structure for tax planning purposes under the new law.
John C. Lucas is a partner at Isaac Wiles in Columbus. In addition to being a lawyer, he has a background as a CPA at a large accounting firm. He often counsels family businesses in his role as chair of the Estate Planning, Trust & Probate and Tax Law practice groups at Isaac Wiles. He may be reached at (614) 340-7436 or firstname.lastname@example.org.