Your Questions About the 20% Pass-Through Deduction Answered
January 25, 2019
If you’re a business owner, you’ve probably heard the buzz about the 20% pass-through deduction, also known as the qualified business income (QBI) deduction. Everyone discussing this deduction has proclaimed it to be a great perk for business owners. Still, it’s been hard to figure out how to claim it.
The IRS released some guidance on the QBI deduction on Jan. 19, 2019 in the form of 274 pages of final regulations. Sounds like it should have cleared things up, right? Actually, it only clarified that this is one of the most complicated changes that came with the recent tax reform. Let’s shed light on the basics of this intricate deduction by responding to some questions we’ve heard a lot since it was signed into law.
Answers to those burning questions about the 20% pass-through deduction:
What is the QBI deduction?
The QBI or 20% pass-through deduction refers to an individual provision (officially named Section 199A) in the Tax Cuts and Jobs Act. The provision is only effective for tax years after Dec. 31, 2017, and before Jan. 1, 2026.
Section 199A allows owners of pass-through entities to deduct 20 percent of the business income that is passed onto their individual return.
Why was it included in the tax reform?
The pass-through deduction was included to offer a tax benefit to businesses that help grow the U.S. economy. This tax break, however, is meant for a specific subset of business owners.
Who is eligible for the 20% pass-through deduction?
Pass-through organizations are eligible for the deduction. These organizations tend to “pass” the business’s profits “through” to owners or shareholders. The owners of pass-through organizations pay tax through individual rather than corporate returns. It’s estimated that about 95% of businesses fall into this category.
These are all pass-through organizations that could be eligible for the deduction:
- Sole proprietorships
- Limited liability companies
- S corporations
But there is a catch. Even if your business is a pass-through organization, it doesn’t mean you’ll qualify for the 20% pass-through deduction. There are some key limitations to this deduction that we’ll discuss in a moment.
What is a specified service trade or business (SSTB) and how does it apply to the deduction?
A specified service trade or business (SSTB) is defined in the legislative text of IRC Section 199A as:
“Any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees [or] any trade or business which involves the performance of service that consist of investing and investment management, trading, or dealing in securities.”
Any business that fits that definition only qualifies for the deduction if the owner’s taxable income is less than certain threshold amounts. Here’s a handy visual breakdown of the trades and business fields that fall into the category of SSTBs:
How do I calculate how much I could save with the 20% pass-through deduction?
Unfortunately, it’s not as simple as just multiplying your pass-through income by 20 percent. Even most tax professionals have to run complicated calculations through advanced tax programs. The best way to really find out how much you can save is to find a tax professional who is experienced in running these calculations.
Can I split my company into different entities to lower my tax bill?
No. Originally, some tax professionals believed that they could split firms into different entities to avoid limits on the new tax break (also known as “crack and pack”). However, the IRS swiftly blocked this tactical move.
What is the best business structure for me and will it qualify me for the 20% pass-through deduction?
This is a near-impossible question to answer without knowing the specifics of your business and income. The pass-through deduction will inevitably help some business owners. Meanwhile, others may benefit more by maintaining a C-corporation structure.
Your best bet is to find a qualified tax professional who can evaluate your business and then give you personalized guidance on business structure and the best tax breaks available to you.
If I do qualify for the QBI deduction, what are the limitations?
Here are the main limitations of the 20% pass-through deduction:
- The deduction cannot exceed 20 percent of your taxable income in excess of capital gains.
- You cannot deduct more than the lesser of QBI or the greater of:
- 50 percent of your allocable share of the wages paid by the business with respect to QBI, or
- 25 percent of your allocable share of wages plus 2.5 percent of the unadjusted basis of qualified property owned by the business.
- This limitation begins getting phased in at taxable incomes of $157,500 for single taxpayers and $315,000 for married taxpayers filing jointly.
- As mentioned before, the deduction is temporary and may not exist past 2026.
- The complicated nature of the 20% pass-through deduction makes it difficult to navigate for the average taxpayer.
If I don’t qualify for the deduction, are there other ways I can save on my taxes?
Don’t worry. The QBI deduction is not the only way to save on your business taxes. The tax reform also brought along a lower tax rate for C-corporations and repealed the corporate alternative minimum tax.
In sum, the 20% pass-through deduction could bring you a great tax break. But it’s also a complex and headache-inducing change. The good news is that there are tax experts like ours ready to help you decipher what Section 199A means for you and your business taxes.
Will the Ominous New Tax Bill Make You Owe the IRS Next Year?
September 14, 2018
With the biggest tax changes in over 30 years, the Tax Cuts and Jobs Act of 2017 (TCJA) brings a terrifying prospect for millions of Americas. The Government Accountability Office (GAO) recently issued a report warning that this new tax bill will make millions of taxpayers owe on their 2018 tax returns. Many of these taxpayers have never owed before, so it’s bound to be an unpleasant surprise.
Under the TCJA, many taxpayers will either under-withhold on their paychecks or underpay on their estimated tax payments. Across the country, CPAs are working hard to make sure that their clients will not owe on their tax returns next year. But the truth is, most employees currently lack correct withholding or have assumed that the W-4 they filed 5 years ago is still correct.
So, if you haven’t updated your W4 or reviewed your withholding, you may have an unwanted tax surprise coming in the new year.
What has the new tax bill changed?
The new tax bill has changed quite a bit since going into effect on Jan. 1, 2018. It has:
- Increased the standard deduction
- Removed personal exemptions
- Increased the child tax credit
- Limited or discontinued certain deductions
- Changed the tax rates and brackets
- Introduced a new 20 percent deduction for qualified business income
- Reduced the corporate tax rate from 35 to 21 percent
- Increased the interest rate on underpayment of taxes from 3 to 5 percent
And with all these changes, you need to know where you stand before it’s too late to make changes.
Who will be most affected by these changes?
If you fall into one or more of the following categories, you’ll want to make sure you get a paycheck checkup:
- Are a two-income family
- Work two or more jobs at the same time
- Only work for part of the year
- Have children and claim credits such as child tax credit
- Have older dependents, including children who are 17 or older
- Have changed personal circumstances (e.g., got married, moved, etc.)
- Itemized deductions on your 2017 return
- Received large tax refunds or had large tax bills for 2017
- Earn high incomes and have a complex tax return
If any of these categories above apply to you, you’ll want to take immediate action to ensure you’re not negatively affected by the new tax bill.
And if you own a business, you’ll want to have an expert review your business structure to ensure you are enjoying the new positive, business-specific changes from the tax reform.
What can I do to make sure I don’t owe?
Don’t wait! You’ll want to make sure you get a paycheck checkup, especially if you fall into any of the categories above. You still have time to adjust your withholdings or increase your estimated tax payments to make sure you’re covered in 2019.
The longer you wait to make these adjustments, the more likely it is that you’ll owe next year. If you owe this year, you may owe even more than you ever have before, especially with the increased interest rate on underpayment of taxes. So, contact a tax professional today to avoid any unpleasant surprises from the new tax bill come filing time.
The Basics of Taxes for Online Sellers
August 20, 2018
The internet is thriving now more than ever, which is good news for online sellers. If you’re a seller on eBay, Amazon or another online retail platform, you’re reaping the benefits of society’s online fixation. Just remember while you’re raking in that online cash: taxes for online sellers can be mandatory.
You need to pay income tax on profits from sales if they surpass a certain threshold. Beginning in 2011, online businesses such as Amazon are required to file 1099-K forms for those who earn beyond $20,000 in gross sales or have 200 transactions in a calendar year using their platform.
Have you only sold a few lower-priced items on a whim this year? Maybe you posted a Beanie Baby (and not even a rare one!) on eBay and got some cash for your troubles? You don’t need to worry about taxes for online sellers if you only sell occasionally and don’t make a substantial profit from your sales. And did you sell items for less than their purchase price? Then you need not report the sales on your return.
Who Needs to Pay?
Do you have consistent or recurring sales? And do you run the activity like a business with an intention to make a profit? Then you need to pay income tax on your sales!
The income you earn is considered ‘income from self-employment’. Therefore, you must file Schedule C, Profit or Loss from Business of Form 1040. You use Schedule C to report profit or loss from a sole proprietorship. If you don’t run a registered corporation, then you must use Schedule C to report your profits or losses.
Sales Taxes for Online Sellers
Along with income tax, you also need to pay sales tax. Especially when you sell in multiple states, you are responsible for collecting and remitting sales tax in each state. And the complex rules of each state can be wildly confusing.
Want to ensure you’re not making unnecessary payments or unknowingly neglecting your sales tax responsibilities? Our SalesNexusSolverTM is designed to analyze your sales tax responsibility and validate awareness of where in the U.S. you have nexus and the corresponding requirements.
Paying Estimated Taxes Quarterly
If you haven’t been paying taxes on your online income, you may pay estimated taxes quarterly to avoid IRS penalties and collection actions for non-payment of taxes. If you think that you’ll owe more than $1,000 in taxes in a year, the IRS prefers that you pay your taxes every quarter. The deadline for making quarterly payments for this quarter will fall on September 15. The remaining three deadlines will fall on January 15 (2019), April 15 (2019), and June 15 (2019).
To pay your estimated taxes quarterly, you may electronically file and pay your taxes through the Electronic Federal Tax Payment System (EFTPS), or fill Form 1040-ES and mail it to the IRS. You may also pay taxes over the phone.
If you have any questions about taxes for online sellers, contact one of our tax professionals who can help you optimize and save on taxes throughout the year.
The Dangers of Mixing Business and Personal Expenses
Mixing business and personal sounds like fun, but it can be pretty messy. When you’re mixing business and personal expenses, you’re putting yourself at major risk for an IRS audit, which is the opposite of fun. To ensure you don’t end up with a stressful audit, you should know how to define and separate business and personal expenses.
Business expense vs. personal expense
According to Publication 535 from the IRS, a business expense must be “both ordinary and necessary”. An “ordinary” expense is one that is common and accepted in your trade or business. A “necessary” expense is one that is helpful and appropriate for your trade or business.
For example, say you’re self-employed and running a cooking website as a small business. You can write-off the fancy cutlery you bought (if you’re using it for your business). But you couldn’t write-off a new television. You can deduct business expenses even if they are not indispensable to your business.
If you deduct personal expenses as business expenses, the IRS may conduct an audit. They may then ask you to remove the incorrect deductions and pay the balance.
Generally, you cannot deduct personal, living, or family expenses on your tax return. But what if you have an expense that is partly business and partly personal? You can divide the cost in half, and deduct one half as a business expense.
Avoid triggering an IRS audit
When you’re mixing business with personal expenses, your personal expenses can get confused with your business expenses. Sometimes it seems innocent, like extending a business trip for a week to include a vacation. But danger lurks when you are unsure of what you can deduct as a business expense, or you find yourself in a gray area.
In order to be certain you don’t trigger an IRS audit, consider the following:
- Never use your business credit or debit card for personal expenses.
- Keep business and pleasure trips separate. If combined, keep particular days for business and other days for family/friends.
- Don’t be tempted to write-off personal purchases (e.g., games, printer, computers, etc.) as a business expense unless you are using them to make a profit.
Other dangers of mixing business and personal expenses
Deducting business expenses as personal has another big danger: back taxes. If the IRS discovers that you deducted personal expenses as business expenses, they may charge a penalty for claiming false deductions and demand payment of the balance with penalties and interest if the filing deadline has passed. The unpaid balance after removing the false deductions will be treated as back taxes if you do not pay them before the filing deadline.
Instead of sorting out expense receipts later, it is advisable to separate your business and personal expenses for better organization and less stress at the time of tax return preparation.
Beware the Self-Employment Tax Trap
August 11, 2018
Self-employment seems like the perfect set-up. What could be better than reaching your dreams your way? However, there is one downfall. Wage earners who work for employers have their taxes withheld from their wages and deposited with the IRS. Meanwhile, the self-employed have to calculate and pay their taxes themselves. Self-employment tax rules are different from those for businesses, individual taxpayers and those working for employers. Generally, the IRS requires self-employed individuals to file a tax return if they earn $600 or more from self-employment.
Many times, you can underreport income and incur a tax debt due to not understanding IRS requirements or a lack of information. If you are self-employed, consider the tax rules below when calculating and paying your taxes.
Self-employed individuals must pay the self-employment tax in addition to federal income tax. Self-employment tax includes the individual’s Social Security and Medicare taxes. You also must pay an additional Medicare Tax of 0.9 percent. This additional Medicare Tax applies to wages, compensation, and self-employment income that is above a certain threshold.
Self-employed individuals may also be required to pay Estimated Quarterly Taxes. Estimated taxes include self-employment income and any other tax an individual must pay. As the name implies, these taxes are paid at specific intervals throughout the year. Generally, if you expect to owe more than $1,000 in taxes by the end of the year, you should be filing estimated taxes.
Many times, self-employed individuals do not pay estimated taxes quarterly and wait for the traditional filing deadline. This leads to tax debt, as correctly paying estimated taxes every quarter is necessary to remain compliant with the tax laws. The IRS even charges a penalty for underpayment of estimated tax.
Tax Credit and Deductions
There are many deductions that you can claim. You can deduct certain qualifying business expenses from income to reduce taxes. Many self-employed individuals who work from home use the Home Office Deduction.
Self-employed individuals can claim the Earned Income Tax Credit if they file Form 1040 Schedule C. This tax credit reduces the tax liability of those employed by an employer or work independently.
Want to avoid mistakes in calculating taxes and running the risk of a debt? Either seek the help of a tax professional or keep yourself up-to-date about the tax laws that impact you.
Dealing with Payroll Tax Debt
August 9, 2018
All businesses are required to deduct payroll taxes from their employees’ paycheck and deposit them to the IRS. Mistakes made with tax duties can lead to an audit, tax debt, and severe IRS penalties. In order to avoid the risks that come with non-compliance, you should review past payroll taxes. Understanding how to resolve a potential payroll tax debt can also help ensure your business grows as it should.
Payroll Tax Penalty
A payroll tax penalty or the Trust Fund Recovery Penalty (TFRP) is charged when employers do not collect and transfer payroll taxes to the IRS on time. Regardless of the type of business you operate, the IRS can penalize you on delinquent payroll tax deposits or filings. Examples of penalties for non-payment of payroll taxes are failure to file, failure to deposit, and failure to pay.
In order to calculate the TFRP, the IRS includes the unpaid income taxes plus the employee’s portion of the withheld Federal Insurance Contributions Act (FICA) taxes. If the IRS finds you to be non-compliant, you will receive an IRS letter regarding the penalty. You can make an appeal within 60 days from the date on the letter. If you don’t respond to the letter, the IRS will send you a Notice and Demand for Payment, after which they may initiate collection actions.
Payroll Tax Debt Resolution
Do you owe payroll taxes? Then, you need to make immediate efforts to resolve it, as owing payroll taxes can put your business at risk. In order to resolve your payroll tax debt, you may use a payment plan such as an Installment Agreement.
You may qualify for a reduction or forgiveness of penalties, depending upon the reason for the non-compliance. It may be helpful to enlist a licensed tax professional to determine if you qualify for penalty abatement and which payment plan you should apply for. Choosing the right resolution plan is an important primary step for successful resolution of tax debt.
Avoid Payroll Tax Debt
You must deduct payroll taxes from each employee’s paycheck and pay them within three days of the pay date. Employers cannot borrow from payroll taxes or reduce the payroll taxes amount. You may use Publication 15, Employer’s Tax Guide, and Form 941, Employer’s Quarterly Federal Tax Return to completely understand your tax duties as an employer.
How Pass-through Businesses Win at Taxes
July 16, 2018
Across the country, CPAs are crunching (and crunching, and crunching) numbers to assess how their clients can benefit from the new tax reform law. And for business owners, owning pass-through businesses is even more enticing than ever.
What Are Pass-through Businesses?
Nearly 95 percent of businesses in the U.S. are pass-through organizations and for a good reason. The structure is designed to reduce double taxation, or taxing a business both at a corporate level and at the owners’ level.
Instead of a twofold hit, company profits and losses are sent straight to owners/shareholders without a corporate pit stop. Business owners then file and pay taxes through their individual returns (not corporate returns). Sole proprietorships, partnerships, and S corporations all enjoy this no-double-taxation life. Most pass-through businesses are small, but a limited number of large businesses account for most of the profits and economic activity from pass-through entities.
Tax Reform Wins: How Business Owners Can Save Money
2018 is looking up for business owners all over the board thanks to the new bill. Pass-through entities can now deduct 20 percent of the business income that is passed to their individual return. This makes it a great option for low- to mid-income businesses. The single-filing threshold is $157,500 and the joint-filing threshold is $315,000.
Pass-through structure not in your cards? C Corporations will catch a break with the new tax bill, with a cutting the corporate tax rate cut from 35 percent to 21 percent.
Are you above the 20-percent deduction threshold? Is your business under a different tax classification? A tax professional can help calculate your breaks.
Not every situation has a cookie-cutter solution when it comes to business taxes. If you’re a business owner, a tax professional can also help you decide on the most cost-efficient business entity and what tax reform means for you.