New Tax Breaks for Pass-Through Entities
The 2017 tax bill permanently cut corporate income taxes from a top rate of 35% to a flat 21%. However, about 95% of U.S. businesses are pass-through companies that do not pay taxes at corporate rates. Profits flow to the owners, who report the net income on their individual tax returns and pay tax at individual rates.1
Individual income tax rates were also reduced, but only for 2018 through 2025 and to a lesser degree than corporate rates. Fortunately, the legislation includes several provisions that could further benefit certain business owners, self-employed individuals, and taxpayers who receive rental or royalty income from pass-through entities.
Pass-Through Deduction
Taxpayers who receive pass-through income may be able to take a new deduction equal to 20% of their qualified business income. Those with taxable incomes up to $157,500 ($315,000 if married filing jointly) generally may claim the full deduction, and those with taxable incomes between $157,500 and $207,500 ($315,000 and $415,000 for joint filers) may be able to claim a partial deduction.
When taxable income exceeds $157,500 ($315,000 for joint filers), the deduction may be limited or eliminated altogether. For example, high-earning professionals in fields including health, law, accounting, actuarial science, performing arts, consulting, athletics, and financial services are generally not allowed to take the deduction.
Also, the deduction is generally limited to the greater of 50% of W-2 wages reported by the business, or 25% of the W-2 wages plus 2.5% of the value of qualifying depreciable property held and used by the business to produce income. This means larger businesses without employees could miss out on the deduction.
Like other tax law provisions affecting individual taxpayers, this deduction is scheduled to expire after 2025.
Investment Write-Offs
Section 179. Small businesses may elect to immediately expense the cost of certain short-lived capital investments ("qualified property") rather than recover costs over time through depreciation deductions. The new law increased the maximum amount that can be expensed in 2018 from $520,000 to $1,000,000, and the threshold at which the maximum deduction begins to phase out from $2,070,000 to $2,500,000. After 2018, both amounts will be adjusted annually for inflation. The range of property eligible for expensing has been expanded.
Bonus depreciation. For qualified property that's both acquired and placed in service after September 27, 2017, 100% of the adjusted basis of the property can be deducted in the first year the property is placed in service. The first-year bonus depreciation percentage will be reduced to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026, until it is eliminated altogether beginning in 2027.