A New Gift from the Tax Cuts and Jobs Act

A new deduction under the TCJA (Tax Cuts and Jobs Act) gives a break to noncorporate owners of pass-through entities on a portion of their qualified business income. The deduction can reach as much as 20% of qualified business income, though a wage limit does phase in. Generally, this deduction is available to sole proprietorships, partnerships, S corporations, and limited liability companies (LLCs).

How the wage limit applies

The wage limit begins to phase in when taxable income reaches $157,500 for most filers and $315,000 for married couples filing jointly.

The wage limit fully phases in at $207,000, or $415,000 for joint filers. Once this limit is reached, the qualified business income deduction generally cannot exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified business property (QBP).

The amount of the limit is reduced when the wage limit begins to apply but is not fully phased in. The final deduction is calculated like this:

  1. The difference between taxable income and the applicable threshold is divided by $100,000 for joint filers or $50,000 for other filers.
  2. The resulting percentage is multiplied by the difference between the gross deduction and the fully wage-limited deduction.
  3. The result is subtracted from the gross deduction to determine the final deduction.

The second option is more complicated. Say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

It is also important to note that income from “specified service businesses,” the qualified business income deduction is reduced if an owner’s taxable income falls within the applicable income range and eliminated if income exceeds it.

For example:

In the situation where a married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers, computing the deduction is fairly straightforward. For example, if Adrian and Martha have a taxable income of $600,000, and this includes $300,000 from Adrian’s pass-through business, which pays $100,000 in wages and has $200,000 in qualified business income. The deduction would be $60,000 (20% of $300,000), but the wage limit applies in full because the married couple’s taxable income exceeds the $415,000 top of the phase-in range for joint filers. In this situation the computation is as follows:

The first option for the wage limit calculation is $50,000 (50% of $100,000). The second option is $30,000 (25% of $100,000 + 2.5% of $200,000). So the wage limit, as well as the deduction, is $50,000.

If Adrian and Martha’s taxable limit falls within the phase-in range the calculation becomes a bit more complicated. Say their taxable income is $400,000. The full wage limit is still $50,000, but only 85% of the full limit applies:

($400,000 taxable income – $315,000 threshold)/$100,000 = 85%

Calculating their deduction requires first calculating 85% of the difference between the gross deduction of $60,000 and the fully wage-limited deduction of $50,000:

($60,000 – $50,000) x 85% = $85,000

That amount is subtracted from the $60,000 gross deduction for the final deduction of $51,500.

We can help

We can help to determine if your company is a specified service business, and how the wage limit will affect your deduction. We can also answer any other questions you may have. Contact us at 949-860-9902 or click here and we will contact you.

 

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