Most small businesses in the U.S. are ”pass-through entities” (partnerships, limited liability companies or S Corporations). Income from these business structures is taxed at individual tax rates, which are changing with the new tax bracket structure. Also, the new tax law is adding a new deduction on Qualified Business Income (QBI).
The Qualified Business Deduction
The new QBI deduction is generally 20% of the qualified business income of partnerships, S Corporations and sole proprietorships. It also includes pass-through income from real estate investment trusts, publicly-traded partnerships, and qualified agricultural co-ops.
If the taxpayer’s taxable income is less than the threshold amounts of $157,500 (or $315,000 if married and filing a joint return), there is no limitation on the QBI deduction. If the taxpayer’s income exceeds the threshold amounts, the deduction may be limited based on the amount of wages paid by the business and the unadjusted amount of qualified property in the business:
If your 2018 taxable income after adjustments to income and itemized deductions is over $157,500 ($315,000 for joint filers) your QBI deduction for each activity is limited to the greater of:
- 50% of the W2 wages timely paid on behalf of that activity, or
- 25% of the W2 wages plus 2.5% of the initial cost, immediately after acquisition, of all tangible property placed in service on behalf of that activity. (Tangible property includes real estate, equipment and machinery, vehicles, or robots that replace your employees.) You can count the initial cost property towards this amount for 10 years.
QBI and Professional Services Business Owners
Second, if your small business generates revenue through the professional services of one individual (think physicians, dentists, nurses, lawyers, accountants, actuaries, performing artists, athletes, consultants, individuals providing financial services and any trade or business where the principal asset is the reputation or skill of one or more of its employees) your eligibility for this deduction phases out for income between $315,000 and $415,000.
Carrying Over Losses with the QBI Deduction
Finally, the overall QBI deduction is limited to 20% of your taxable income in any particular year. There’s no provision for carrying over any unused deduction. However, if your QBI for the year is below zero you can carry the loss forward to the next taxable year.
Making Depreciation and Expensing Work for You
Traditionally, when you buy something durable, like a building, or a truck, or machinery for your business, you don’t get to deduct it right away. You have to deduct it over time, a period of time that approximates the useful life of the property. This process is called “depreciation.”
Under the new tax law, you’ll be able to write off 100% (“full expensing”) of the cost of your new or used equipment and certain qualified improvement property bought after September 27, 2017 through December 31, 2022. However, the bonus depreciation percentage will phase-down from 80% for property placed in service during calendar year 2023 to 20% for property placed in service during calendar year 2026, so you’ll need to be aware of that when planning ahead.
Some Deductions Take a Hit Under the New Tax Law
One of the negative impacts for small business owners is due to elimination of certain deductions, like entertainment expenses. Also, the Domestic Production Activity Deduction (DPAD) is being eliminated in the new tax law. This deduction was beneficial to small businesses that were doing domestic production, so that’s unfortunate.
Small Businesses Need Strategic Tax Planning–NOW!
Don’t wait until 2019 to find out what you should have done in 2018. This is the time to plan ahead and make a strategic tax plan that takes full advantage of the provisions in the new tax code. Small business owners like you have worked with Financial Gravity’s team members to save an average of $20,000 that they would have paid on unneeded taxes. Download our case studies of real business owners like yourself to read their stories and then contact Financial Gravity to request a free tax assessment. Let’s Talk!