New Tax Provision: Plan to Optimize Tax Savings Through Organized Accounting Records
This article provides a general overview of the new Section 199A tax provision and its potential impact to small businesses. As of the date of this blog, business owners and their tax advisors are still seeking clarity about its application and the various limitations within the provision. However, there are some concrete tax-saving actions that you can take now.
The Tax Cuts and Jobs Act was enacted on December 22, 2017. It includes a new provision, Section 199A, providing a 20% business income deduction. Under Section 199A, sole proprietors, S corps, and partnerships may qualify for the 20% deduction of qualified business income in a qualified trade or business, under certain conditions. The intent is to provide a tax cut to these type of businesses, similar to the favorable tax cut provided to C corporations.
Does It Apply to Your Business?
The short answer is, it depends. You have to be a qualified trade or business, with qualified business income. Fair warning – the new provision is complex, with lots of limitations, but bear with me as I give you some of the highlights!
Qualified Trade or Business: Certain businesses won’t be able to take the deduction. According to IRS guidance, a “specified service trade or business” (SSTB) is not qualified to take the deduction – unless its income is below certain thresholds.
So for example, if you are the owner or co-owner of a business that performs services in the fields of health, law, accounting, or consulting unfortunately you’ll generally fit in this SSTB category, since your business involves the performance of services where the principal asset is the reputation or skill of one or more of its employees. Many other service professionals are in this SSTB category as well. However, if all of your taxable income on your Form 1040 is under the limits ($315,000 if married filing jointly, or $157,500 for all other taxpayers), the full deduction may apply.
Qualified Business Income (QBI):
According to IRS guidance, “QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.”
How Is the Deduction Calculated?
The total deduction amount may be limited based on your situation. If you are under the $315,000/$157,500 threshold mentioned above, you get the full deduction. For those over the thresholds, there are some deduction limits based on your W-2 wages and certain qualified property amounts. These limitations are phased in over specific ranges in tax year 2018. For details, refer to IRS guidance.
What About Income From Retail Sales?
For SSTB businesses who not only perform skilled services but also sell some type of product(s), I recommend speaking with your tax advisor about the ability to take the deduction for those lines of business, as it could make a significant impact to your finances. This leads to my advice on what you can do to facilitate good planning now, in order to help your tax advisor assist you with being in the best position to optimize your tax savings.
What Can You Do Now to Prepare?
You may be scratching your head right now, wondering what you can do before more guidance is issued on this provision and many others recently enacted. To understand the possible tax impacts to your business – both positive and negative, you and your tax advisor need a firm grasp of the following:
• How much income you’re making in each line of business within your practice
• What the costs associated with each activity are
• An accurate accounting of what you own and what you owe (i.e., your asset and liability categories)
Do your financial statements and underlying accounting records give you what you need to optimize your tax savings? If not, it’s time to consider working with a reputable and experienced accounting firm!
Questions? Need Help?
If you have questions and/or need help getting your financial records in order, please reach out to me, I’ll be happy to talk with you. Orin Schepps, Founder and CEO @consultanceaccounting https://www.consultancellc.com
Disclaimer: Consultance Accounting does not provide tax or legal advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for tax or legal advice.