Are you a business owner? The Tax Cuts and Jobs Act of 2017 could have some very good news for you. If you report your business income on your personal tax return — as do owners of sole proprietorships, partnerships, LLCs, S Corps. — you may qualify for a 20% tax deduction on that income. So on business income of $500,000, a $100,000 deduction — not bad!
This is how Congress opted to reward businesses that are not corporations. There are, however, many exceptions and gotchas. So let’s run through who qualifies and who does not.
There are three big limitations on the 20% business income deduction:
#1. Type of Business
NOT ELIGIBLE: Personal service providers, including: Lawyers, doctors, accountants consultants, actors, athletes, financial advisors, and many others. These are typically businesses whose principal asset is reputation or skill.
ELIGIBLE: All other types of businesses: engineers, architects, manufacturers, retailers, wholesalers, etc.
#2. Wages paid by the business. The amount of the 20% deduction cannot be higher than:
***50% of the wages the business paid to its workers (as reported on Form W-2); OR
***25% of the W-2 wage costs PLUS 2.5% of the cost of the business’ tangible property (real estate, machines, etc.)
#3. Capital gains limitation. If you have any net capital gains income, your deduction may be limited. That’s because capital gains income is already taxed at preferential rates (0%, 15% and 20%).
Doctors, lawyers and actors: Do not throw in the towel yet! There is an exception to the above exceptions (how legalese is that!):
THE LIMITATIONS DO NOT APPLY IF YOUR INCOME IS BELOW A CERTAIN AMOUNT:
Taxable income below $315,000 (married filing jointly) and $157,000 (unmarried).
What This Means: Lawyers, doctors, accountants, actors, therapists can take the full 20% deduction, IF the owners’ taxable income is below $315,000 (married); $157,500 (unmarried). Above these thresholds, the deduction decreases. And it is totally eliminated for those with income above $415,000 (married filing jointly) and $207,500 (unmarried).
WHO GAINS THE MOST
***Eligible business owners (not in personal services) with high income, few net capital gains, and a business that pays a lot in wages.
EXAMPLE: Owner of an architectural firm with $1 million in business income, gets a $200,000 deduction (20% of biz income), as long as the wages paid are at least $400,000 and she has no net capital gains income.
***Any business owners whose taxable income is under $315,000 (married filing jointly); $157,500 (unmarried) and who have minimal net capital gains.
EXAMPLE: A married therapist with $400,000 in business income, $300,000 of taxable income and no net capital gains. She would get an $80,000 deduction (20% of biz income).
WHO LOSSES OUT
Owners of a personal services business (doctors, lawyers, accountants) with high taxable income and/or considerable net capital gains.
EXAMPLE: A partner in a law firm with taxable income of $500,000 would not qualify for the 20% deduction.
IMPORTANT THINGS TO KEEP IN MIND
***The 20% deduction on qualified business income will expire at the end of 2025, if not renewed.
***The deduction applies to income from real estate businesses, as well as to estates and trusts.
For more on the 20% deduction, please listen to the webinar I recorded: