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TAX REFORM AND SIMPLIFICATION? “NO”: TAX REDUCTION? “YES” (PART 2)
90 TAMPA BAY MAGAZINE | MAY/JUNE 2018
V. Raymond Ferrara, CFP®
Chairman
Chief Executive Officer
Eric R. Ebbert, MBA, CFP®
President
Chief Operating Officer
In our previous article, we talked about the basics of the new
20% pass-through tax deduction on certain business income. This
deduction is available to all pass-through entities (sole proprietor,
S corporation, partnership, LLC, etc.) as long as the taxpayer’s
taxable income (not Adjusted Gross Income) is below $157,500
for singles and below $315,000 for joint filers. The only caveat is
that the deduction will be applied to the lesser of the taxpayer’s
qualified business income or taxable income before the deduction
less net capital gains. The taxpayer’s profession is not important
at this conjuncture.
So as a practical matter, to the extent that a taxpayer can lower
taxable income to below these limits, it generally creates a positive.
How can you do that? Find ways to increase your itemized
deductions. Prepay expenses where applicable or buy equipment
at the end of the year and/or defer income into the next tax year
are three more ways. Consider putting as much money as possible
into a retirement plan which could be as much as $55,000 in 2018
or $61,000 age 50 and over. With a cash balance plan, it might
even be higher.
But what if the taxpayer’s income is still over the above limits?
First, for any profession there is a phase out of the deduction for
singles with taxable income between $157,500 and $207,500 and
between $315,000 and $415,000 for joint filers. Above these upper
levels those in a “specialized trade or business” (think accountants,
lawyers, financial planners, athletes, performers, consultants, etc.)
or any business where the reputation or skill of its employees is the
primary asset, they are not eligible for the pass-through deduction.
Interestingly, engineers and architects were exempted from the
specialized trade or business definition under the tax bill.
For everyone else, there are additional rules to consider and they
are complicated. In these cases the deduction cannot exceed the
greater of 50% of the W-2 wages paid by the business, or 25% of
the W-2 wages paid by the business plus 2.5% of the unadjusted
basis of depreciable property owned by the business (think real
estate). “What?” you say.
An example might help at this point. Sally works for a company
that pays her a wage of $350,000. She is married and her husband
makes $250,000 in W-2 wages. She owns a small strip mall through
an LLC which produces a net profit of $150,000 per year. She pays
her brother a salary to manage the property of $30,000 per year.
The unadjusted basis in the depreciable property is $1,000,000.
She has $80,000 is deductions.
There are two tests that need to be done. First, we need to determine
her taxable income which is $670,000 ($350,000 +250,000+150,000-
$80,000). The eligible business income is $30,000 ($150,000x20%).
She must use the lesser of these two which is $30,000. Next, we
have to calculate the greater of 50% of the eligible wages which
is $15,000, or 25% of the eligible wages ($7500) plus 2.5% of the
unadjusted basis ($25,000) or $32,500. Then she must use the lesser
of the two calculations or $30,000 as the pass-through deduction.
Why does Congress always have to make it so complicated?
This is just a brief analysis of the pass-through provision and by
no means should anyone rely on this simple example. In addition
to consulting your tax advisor, please be aware that we are awaiting
rules and regulations from the Internal Revenue Service who must
interpret the new tax law. If you would like to consult with us about
your financial planning you are entitled to 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.