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The new tax bill will affect pass-through businesses. These are entities that pay their business taxes through their individual tax returns. Other companies pay at the corporate level.
Examples of these entities are sole proprietorships, limited liability companies (LLC), S-corporations, and other partnerships. Sole proprietorship businesses are the simplest forms of business entities. A partnership is an enterprise under the association of two parties. It can be categorized into limited or general partnerships. LLCs or limited liability companies have the option to choose between being taxed as a partnership or as a corporation. A single member limited liability company is a form of LLC which is considered as a “disregarded entity”. It does not need a separate tax form but submits a similar form as with the sole proprietorship.

Their business taxes are based on the value of their share in their respective companies. These individuals pay their taxes according to the tax rate applicable to their income bracket. About 95% of US businesses are considered pass-through businesses. Among the major changes in the tax reform that will affect these enterprises are the tax deductions. This year, pass-through business owners may cut off 20% of their income from their taxable earnings. The largest 20% figure is not uniform because there are set guidelines, limitations, and exceptions.

The Capping Method for the Deduction
The primary consideration is the amount of the company’s total earnings as reported on its W-2 tax forms. The largest deduction should not exceed half of the company’s total wages. Not included in the wages cap are the guaranteed payment to partners and the income to S-corporation owners or shareholders.

Some businesses do not provide W-2s but they can still avail of the deduction. The income of the business owner’s investment in the company will be the basis for some deductions.

The Capital Investment Deduction
Another consideration for the capping method would be the capital investment of the investor. The largest deduction would be 25% of the wages reflected in the W2 plus 2.5% of the value of any qualifying property.

What is a qualifying property? A qualifying property is any property used for the company’s operation. It can be office furniture or even an entire factory building. It should be used at present and up to 10 years before the cut off of its depreciation.

How to solve the maximum capital investment deduction?
For example, if you are a sole proprietorship without any employee and you have an equipment valuing at $50, 000, the largest deduction from this property would be $1250. This is regardless of how much earnings the business has.

If you have a single employee who earns $50, 000, the largest deduction will increase to $13,750.
(25%* 50,000) + (2.5% * 50,000 property) = $12,500 + $1250 = $13,750

The Coverage of the Deduction
The tax reform’s new provisions on the largest deductions are not available for all business types. There are so-called “specified service trade or business” where the pass-through income deduction is not applicable.
Majority of those excluded from this provision are the professions including all business types “in the fields of health, law, 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 or owners.”

Another exemption to the tax reform deduction is based on the amount of the taxable income. Even if an individual is not under the category of the service providers, those individuals with taxable income above $157,500 or couples filing jointly who have more than $315,000 combined taxable income are excluded from availing the 20% deduction.

These individuals or couples who have reached the threshold amount will be subject to limitations and exceptions which depend on the occupation and the wage and capital limit.

The Categories of Service Providers that Are Included
The 20% deduction is available for businesses that are on the direct production of goods. However, there are exemptions. Other service providers like the ones listed above are excluded from the tax reform deduction. Those under architectural or engineering services are not included in the service providers category. But these professions are in line with reputation and skill.

It is important to be correct in identifying your business and coming up with the correct calculations. Tax experts are ready to provide guidance as needed.