Pass-Through Deductions… Who Will Get Them?

In last year’s estimated $1.5 trillion tax reform overhaul, a twenty percent tax break was approved as part of the new ruling.  Specifically, the “Tax Cuts and Jobs Act of 2017” approved by Congress for taxable years 2018 through 2025 was the first major rewrite of the United States tax scheme since the Tax Reform Act of 1986.   For companies and small business owners, how the Internal Revenue Service now plans to interpret the ruling may be a huge victory.

Recently, the IRS issued a lengthy regulation document outlining the types of professionals and companies that qualify as “pass-through” entities and are eligible for the twenty percent tax deduction.  The ruling contains proposed regulations concerning the deduction for “qualified business income under section 199A” (enacted on December 22, 2017) of the Internal Revenue Code and how individuals, partnerships, trusts, and estates engaged in domestic trades or business will be affected.  The link to the actual IRS published document is here: https://www.irs.gov/pub/irs-drop/reg-107892-18.pdf.

Specifically stated, Section 199A provides a deduction of up to twenty percent of incomes from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate.  The enacted tax cuts help eliminate portions of income taxes for these pass-through entities where the business owners pay the business taxes through their personal tax returns.  For taxpayers whose taxable income exceeds a threshold amount, section 199A may limit the taxpayer’s section 199A deduction based on the type of trade or business engaged in by the taxpayer.  Additionally, the ruling takes steps to stop individuals and companies attempting to manipulate the regulations or channel revenue to other sources with the intention of reducing their tax bills.

Who will get the deductions?  This may be the $1.5 trillion-dollar question.  Since a pass-through tax method indicates that the taxes are passed through to the tax return of the individuals owning the business, pretty much any sole proprietor or single-member LLC business filing a schedule C to report business income will qualify for the deduction, as long as these entities are not be electing to be taxed as a corporation.  Owners of partnerships, multiple-member LLC’s, and S corporations may also qualify.  According to the 184-page ruling document, “qualified trade or business” including authors, small business firms, independent hair salon owners, or construction contractors may see a windfall.  On the other hand, doctors, lawyers, and dentists may be disappointed because the pass-through ruling excludes them.

Although many tax experts agree that it appears to be a large victory for small business groups, the new law gives the IRS broad leeway to interpret the key provisions of these deductions and how businesses may claim them.   The line is thin and the challenge ahead for the IRS is clear, concise, and consistent interpretation of rules.

                                                                                                                                                        – Susan Amsler

                                                                                                                                                                              – August 21, 2018

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