20% Pass-Through Entity Business Owner Deduction

November 10, 2022

The Tax Cuts and Jobs Act

We get questions on pass-through entities more often than you would guess. People who make a certain amount of money for themselves within their own small business will reach a point where expanding or changing the classification of the business with the IRS is prudent. Generally, at a certain point a business owner can turn their business into a different classifications where they are not subject to the corporate income or any entity-level tax. The Tax Cuts and Jobs Act created a deduction for households with income from three different types of businesses: sole proprietorships, partnerships, and S corporations. This new act allows taxpayers to exclude up to 20% of their pass-through business income from federal income tax. We will only be discussing taxable income is below $157,500 if single or $315,000 if married. For upper-income taxpayers, the deduction is subject to several limits which we will discuss in a later blog entry. Should your taxable income be above these thresholds, a complicated calculation will be used to determine the amount of this deduction. Luckily your tax professionals at Geyer & Associates will handle that for you.

Here are the types of businesses that qualify:

Sole Proprietorships: A business with a single owner does not file a separate tax return, but rather reports its net income on Schedule C of the owner’s individual tax return (Form 1040). Generally, all net income from sole proprietorships is also subject to payroll taxes under the Self-Employed Contributions Act (SECA).

Partnerships: Partnerships file an entity-level tax return (Form 1065), but profits are allocated to owners who report their share of net income on Schedule E of Form 1040. General partners are subject to SECA tax on all their net income, while limited partners are only subject to SECA tax on “guaranteed payments” that represent compensation for labor services.

S-Corporations: Eligible domestic corporations that elect S-corporation status file a corporate tax return (Form 1120S), but profits flow through to shareholders and are reported on Schedule E of Form 1040. S-corporations can have only one class of stock and cannot have more than 100 shareholders, who must be US citizens or resident individuals. (However, certain estates, trusts, and tax-exempt organizations are also allowed.) S-corporation owners do not pay SECA tax on their profits but are required to pay themselves “reasonable compensation,” which is subject to the regular Social Security or “FICA” (Federal Insurance Contributions Act) tax.

Once you verify your business is in one of these three categories, you can begin to look into The Tax Cuts and Jobs Act. If you need to file paperwork to have the IRS recognize your business as either of these three, we can assist you in this process. We believe the democrats of congress are looking to repeal or change how this act (which was passed under president Trump) works. To take advantage of this 20% tax break before it is ended, please give us a call and we can handle everything for you!