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V. Raymond Ferrara, CFP®
Chairman
Chief Executive Officer
TAX REFORM AND SIMPLIFICATION? “NO”: TAX REDUCTION? “YES” (PART 1)
MARCH/APRIL 2018 | TAMPA BAY MAGAZINE 91
Eric R. Ebbert, MBA, CFP®
President
Chief Operating Officer
What was originally to be a bill about tax reform and simplification
might be more appropriately called the “full employment act for CPAs
and tax advisors”. It is far from simple. Nonetheless, when President
Trump signed the Tax Cuts and Jobs Act into law it represented the
biggest change in taxes since the Reagan years. Over the next few
issues we will delve into some of the opportunities.
One of the biggest and most important changes was the creation of
a special 20% deduction of pass-through business income (profits, not
salary), which if used will effectively make this deduction tax free
income. Pass-through businesses include S corporations, limited
liability companies (LLC), partnerships and sole proprietorships
which generally do not have “salary” income and thus, should be
able to deduct all business income. But the deduction comes with
complicated rules which restrict which taxpayers can actually
use it. Because the rules apply at the taxpayer level and not the
corporate level, it is entirely possible that some owners of the same
business will not be able to take advantage of this deduction, while
others do.
Interestingly, the deduction is not an itemized deduction (below
the line), nor is it used as a deduction for reducing Adjusted Gross
Income (AGI) (above the line). Thus, it can be taken even if one uses
the standard deduction instead of itemizing, but it will not help lower
AGI which potentially affects other parts of the tax return. If AGI
were used instead, it would likely reduce the deduction substantially.
The baseline rule says that the deduction is applied to the lesser
of qualified business income or the taxpayer’s taxable income minus
any capital gains, but before taking the pass-through deduction.
This baseline rule applies to single taxpayers with taxable income
below $157,500 and marrieds filing jointly below $315,000. A few
examples may help.
Susan is a widowed college professor with a salary of $120,000.
She writes novels at night as a sole proprietor who after business
expenses nets another $60,000. She itemizes her deductions and
has taxable income of $140,000. Because her pass through income
is less than her taxable income she can deduct 20% of her business
income or $12,000, saving $2,880 in taxes.
Now consider Don who is single and has a small tax and accounting
business that is also structured as a sole proprietor and earns a net
of $120,000 exclusively from the business. He uses the standard
deduction and has taxable income of $108,000. Thus, because his
taxable income is lower than his income, he can only deduct 20%
of $108,000.
Finally, let’s take Hal and Sal who own a manufacturing plant
where they take a combined salary of $100,000 and have $80,000
of profits from their S corporation. After itemizing their deductions
they have taxable income of $150,000. The salary portion is not
eligible business income and therefore not deductible; only the
$80,000 of profit counts. Thus, they deduct $16,000 and save $3,520
in taxes.
Additionally, below the aforementioned thresholds, the occupation/
profession of the taxpayer is irrelevant. But for taxpayers above
the thresholds, there are even more rules and this is where is gets
complicated. First, a specialized trade or business which includes
healthcare, accounting, law, financial services, etc. can no longer take
100% of the deduction. Architectural and engineering firms were
exempted from being called a specialized trade or business. There
is a phase out of the baseline rule from $157,500 to $207,500 for
singles and from $315,000 to $415,000 for marrieds. After this there
is no deduction for a specialized trade or business owner.
What about other businesses? There is another set of rules which
we will discuss in the next issue. Be sure to visit with your tax advisor
and financial planner to understand how this provision will affect
your personal tax return. If you would like to discuss the planning
opportunities with us, please schedule a complimentary meeting.
About ProVise Management Group, LLC: ProVise is a financial planning and investment management firm registered with the Securities and Exchange Commission (SEC)
and has been in business since 1987. Our 13 professional advisors serve approximately 1100 clients in over 30 states. As of 12/31/17 we were managing approximately
$1.45 billion for our individual, corporate, not-for-profit and 401k retirement plans. Please visit our website at: provise.com. Investment Advisory Services offered through
ProVise Management Group, LLC. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations
are complex and are subject to change.