How Taxes on Business Income are Calculated Under Tax Reform

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As the Tax Reform bill inches closer to the President’s desk, the latest version of the bill still leaves more questions than answers, particularly in the area surrounding pass-through business deductions.

On December 15, 2017 many Americans were surprised to learn the agreed upon method of applying a lower tax rate to business income includes a flat-tax method on C Corporation income, while a deduction method is used for all LLCs, Partnerships, S corporations, and Sole Proprietorships. 

Although the Senate had passed a similar version of a deduction method in implementing tax reduction for pass-through businesses, the new version of the bill includes several new departures from the Senate’s proposal leaving many practitioners confused about the new formulas and how to calculate the applicable deduction.

For C corporations, the Republicans in House and Senate agreed upon a flat tax rate of 21% for corporations, this was slightly higher than the expected rate of 20%, and much higher than the plan released by Trump of 15%.  Also a surprise, a change of heart related to personal service corporations. Originally thought to be taxed at the highest current corporate rates, Senators and Representatives instead opted for a flat tax of 25%, which is still a significant savings over current tax rates for PSCs.

Pass-through entities, however, are not so easy to calculate. Ordinarily taxed at the individual level after separately stated items are “passed-through” via Forms K-1, current pass-through income can be taxed as high as 39.6%, the current highest tax rate.

The provision in the latest version of the bill provides for a deduction in the amount of 20% of certain pass-through company income. However, the provision calls for a phase in of a wage and capital limitation for taxpayers with taxable income over a threshold of $157,500 for individuals and $315,000 for joint filers. 

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About Dominique Molina

Dominic Molina

Dominique Molina is the President and Founder of the American Institute of Certified Tax Planners.With over 15 years of experience as a CPA, Molina has worked with many top business owners and investors using proactive tax planning to help them keep more of what they earn.


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Dec 21st 2017 20:46

Wow!! Busy Season will surely be a very, very busy season!

Thanks (1)
Dec 21st 2017 22:11

Does it apply to Sch E filers with passive rental activity? or do they now need to form LLC

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to lisagibs
Dec 22nd 2017 19:16

Yes it also applies to Schedule E. Passive activities are not an issue in this area.

Thanks (2)
By beckkl
Dec 22nd 2017 16:50

A couple of things still aren't clear to me. I'm a 1099 IT contractor with earnings of 200K. Would I be able to deduct 40K? I pay no salary. Its not clear to me if the salary calculation/limitation is phased in at 315K for everyone, or just the service-based business?

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to beckkl
Dec 22nd 2017 19:23

It can be confusing because both the personal service issue as well as the wage limitation for high income earners use the same thresholds. To simplify the concept visualize 5 scenarios. First, for anyone under the bottom threshold (157,500 and 315,000)- just take 20% of qualified business income. 2. For personal service businesses who are between 157,500-207,500 single or 315,000-415,000 joint) you will apply a phaseout formula to reduce the 20% deduction. 3. For non personal service businesses who are between 157,500-207,500 single or 315,000-415,000 joint) you will phase IN the wage and capital limitations. 4. For personal service businesses over 207,500 and 415,000 no deduction is permitted. 5. For non personal service businesses over 207,500 and 415,000, apply the wage/capital limitation.

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to Dominique Molina
Dec 22nd 2017 20:34

Above, in scenario 4, you reference personal service businesses. Is that the same thing as a "specified service trade or business" (e.g. lawyers, doctors, accountants, etc.)? If so, it seems you are saying lawyers, doctors, accountants (e.g. specified service trade or businesses) can take the deduction as long as their income is less than the phase out amount. Is my understanding correct?

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to johngoing
Dec 22nd 2017 21:48

Yes it is the same definition, however they have modified it to exclude engineers and architects.

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Dec 23rd 2017 05:21

Will a shareholder/taxpayer's wages be included or excluded from the total wages paid by the company for purposes of calculating the limitation on the pass-through deduction?

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to Jkallenbach
Dec 23rd 2017 05:24

The wages paid will be included. You would probably be able to take your 940 totals I assume.

Thanks (2)
Feb 16th 2018 06:09

Hi, I have a question regarding the income definition that determines the bottom threshold, is it the total income from all resources (AGI), or the income from W2, or just the net income from the passthru business? For example, if I have an S Corp and I am taking an annual salary of $300k, then my Scorp’s net income at the end of the year is $200k, and assuming I am in a personal service business, and I file MFJ, would I qualify for the 20% tax deduction? Thanks

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