In December 2017, Congress passed, and the President signed into law the Tax Cuts and Jobs Act. One of the major purposes of this law was to lower taxes on businesses, and the law reduced the corporate tax rate from 35 percent to 21 percent. However, this new rate applies only to C corporations and not to other “pass-through entities” like S corporations, partnerships, LLCs, and others. To make up for this discrepancy, Congress included a provision providing that pass-through entities could now deduct up to 20% of their business income when they calculate their taxes. Congress also amended another area of the code in response to changes made to the depreciation rule changes in the Act. Our veteran Tax Attorneys and CPAs at the Tax Law Offices of David W. Klasing have been closely following updates on how to navigate these and other new pass-through rules introduced in the Tax Cuts and Jobs Act, and the extensive IRS guidance that followed. We can help you ensure your business complies but also not missing any deductions for which you are eligible.
As noted above, this section was added to the tax code under the Tax Cuts and Jobs Act because many of these pass-through entities were not included in the corporate tax cut central to the law. Because these entities are taxed based on their income, the 20% deduction of their business income can be highly lucrative. However, this law is far from as simple as it sounds on its face. It is quite complex, with numerous exceptions and multiple, complicated steps needed to determine eligibility beyond the basic fact of being a pass-through entity.
For the purposes of the provision, it is far better to be a “Qualified Trade or Business” than a “Specified Service Trade or Business.” A qualified trade or business is eligible for the 20% deduction with fewer restrictions. However, it can be challenging to determine which one of these entities you are in some instances, and you must self-classify. Furthermore, the deduction is available only for business income, the definition of which does not include wage income. For these reasons and many others, it is always best to consult with a skilled Tax
Attorney and CPA like those at the Tax Law Offices of David W. Klasing, who can help you accurately determine how to classify your business and whether you qualify for the 20% deduction. We can also assist you in properly separating business income and calculating your deduction.
One recent podcast gave real estate as an example of an area where it was unclear after the passage of the law whether the industry could be classified as a qualified trade or business. Traditionally, real estate is disclosed on its own separate schedule, not on Schedule C, like most trades. The question for tax professionals, therefore, became whether buying and selling real estate is an investment activity or a trade or business.
The IRS issued some guidance in September of 2019, including a finalized “safe harbor rule,” allowing some real estate businesses to qualify as a trade or business under 199A. Some of the rules are: separate books and records must be kept for each enterprise, there must have been at least 250 or more hours of rental services provided for real estate enterprises under four years old, and there must have been 250 or more hours of rental services offered in 3 of the last five years for enterprises older than that. Some real estate ventures can qualify for the 20% deduction even without meeting the safe harbor rules, however, and again, it is vital to consult with an experienced tax professional who can help make a proper classification for you.
In response to other sections of the new law limiting the need for depreciation for a lot of taxpayers, § 163(j) limits the deduction for business interest to 30% of adjusted taxable income, plus business interest income and floor-plan financing interest expense. However, the law is full of exceptions and areas where lengthy IRS guidelines provided further clarity. For example, if your business has under $25 million of adjusted gross receipts over a three-year average, then you do not have to worry about the business deduction cap.
Then, there is another exception within this exception regarding entities considered tax shelters under the law. If you have, for example, a partnership that allocates over 35% of its allocations to limited partners, you can be considered a tax shelter, and the $25 million rule will not apply. There is also a provision allowing certain farmers and real property businesses to elect out of this limit. Still, they will be subject to the old depreciation rates before the Tax Cuts and Jobs Act changes were implemented.
Taxes regarding pass through-entities have always been a tricky area to navigate, and the changes under the Tax Cuts and Jobs Act has only increased this difficulty. At the Tax Law Offices of David W. Klasing, our skilled Tax Attorneys and CPAs have a great deal of experience helping clients with pass-through entities understand what deductions and exceptions do or do not apply to their business under § 199A and §163(j). We will make sure you are paying the least amount of taxes possible without exposing you to potential civil or criminal liability. To set up a consultation, contact us today at (800) 681-1295.
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Regardless of your particular business or estate needs, the professionals at the Tax Law Offices of David W. Klasing are here for you. We are open for business and our team will help ensure that your business is too. Contact the Law Offices of David W. Klasing today to discuss your business with one of our professionals.
In addition to our main office in Irvine, the Tax Law Offices of David W. Klasing has unstaffed (conference room only) satellite offices in Los Angeles, San Bernardino, Santa Barbara, Panorama City, Oxnard, San Diego, Bakersfield, San Jose, San Francisco, Oakland, Carlsbad and Sacramento. During the COVID-19 pandemic, our staff are working from home, but have full virtual meeting capability.
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