The Tax Cuts and Jobs Act (TCJA) passed by the House and Senate on December 20, 2017 represents the most significant tax legislation in over 30 years. TCJA produced significant changes to business taxation, especially as it relates to pass-through businesses.
What is a pass-through business entity?
Many business owners choose a business structure such as a partnership, limited liability company (LLC), or S Corporation so that they can pass income through to the owners without paying tax at the company level. As a result, the income generated by a pass-through entity is ultimately taxed at individual tax rates.
Based on the Tax Cuts and Jobs Act that was recently signed into law, for 2018 owners of pass-through companies and sole proprietors will be taxed at their individual tax rates less a 20% deduction. This pass-through entity change effectively brings the rate lower for qualified business-related income, subject to certain wage limits and exceptions.
It is important to note that some high-income professional service businesses will not qualify for the new 20% deduction. However, even those businesses, if they earn less than $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly, will receive the new benefit in full.
However, all these provisions expire at the end of 2025. At that time, the law will revert to the way it was immediately prior to the new law unless Congress changes or extends the law.
Businesses that do not pass through their income pay tax on profits at the corporate level. These are typically C Corporations. Under TCLA, the corporate tax rate is lowered from 35% to 21% beginning next year. The corporate tax change is permanent.
- As a business owner, consider a pass-through entity for business income.
- If you own a professional service business, consider separating non-professional service income into other entities to obtain the 20% deduction.
- Running the numbers on using a C Corp may now be advisable, especially if you reinvest heavily in your business or are planning on going public or bringing in outside investors.