Can You Deduct 20% of Your Pass-Through Income in 2018?

The Treasury recently released proposed guidance in regard to the 20% reduction of pass-through income, which tax nerds casually refer to as the Section 199A deduction. Many business owners have heard that any profits from their business that pass-through to them in the form of a K-1 (or net profit for sole proprietors) could be reduced by as much as 20% in terms of it’s taxability. A simple example would be receiving a K-1 with $100K of taxable income from an S Corporation that you own. Instead of this income being taxed as, well, $100K, the 20% reduction would mean that it is taxed as if it were $80K. Pretty nifty.

The Treasury’s guidance clarified 2 key points. The first is that if you were previously an employee and wanted to switch to become a contractor to take advantage of the Section 199A deduction, it probably ain’t gonna work. The Treasury said it would disallow the deduction for anyone who converts from an employee to a contractor who is performing substantially the same scope of duties. Further, you may invite an audit if the IRS decides to match the EIN of the employer with the EIN of the payor of the 1099. In other words, you’d better be sure that you qualify as a contractor under current regulations and aren’t making an arbitrary switch.

The other point clarified pertains to the businesses that are disqualified from the Section 199A deduction. If you own a specifically named service business that was disqualified from the deduction for taxable income above the $157,500/$315,000 thresholds, nothing has changed, Uncle Sam still wags his finger disapprovingly at you. If, however, you are almost any other type of business, then you have a chance at being able to qualify for the deduction at taxable income levels above $157,500/$315,000 (the mechanics to see how much of your income qualifies is mind-numbing, so I’ll save you the pain). This is because the previous verbiage that included any business where the principal asset is the “reputation or skill” of the people who run the business as a disqualified business was SUBSANTIALLY NARROWED. It now only includes income from:

• Endorsing products or services,
• Monies earned from the use of an individual’s image, likeness, name, signature, voice or trademark
• Appearing at an event or any media format (radio, television, etc)

So, if your business doesn’t do that, which most don’t, then you’re NOT a disqualified business. In order to make sure you can qualify based on the aforementioned mind-numbing mechanics, you should get in touch with a Dark Horse CPA.

About Dark Horse CPAs

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