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Tax Reform - Impact on Pass-Through Businesses

Perhaps the biggest item capturing the headlines about the Tax Cut and Jobs Act is the drastic reduction in corporate tax rates. In an attempt to level the playing field for pass-through businesses, such as Partnerships, S Corporations and Sole Proprietorships, the Act contains a complicated, intricate and convoluted exclusion for a portion of the annual business profit. Here's what we know.

The Pass-Through Profit Exclusion

The Tax Cut and Jobs Act will allow owners of certain pass-through business entities to exclude 20% of their annual business profit from taxation starting in 2018. Sounds simple enough, however, the details of who qualifies and for how much is still being studied. Here's what we can tell you:
  1. The changes don't go into effect until next year, so there is plenty of time to figure things out, and make the right decision for each business.
  2. The pass-through rules will apply to a business that operates as a S Corporation, Partnership or Sole Proprietorship. So if you run a business using one of these forms, changing to a different pass-through won't help any. 
  3. Generally, all service businesses will not be eligible for the exclusion unless the taxable income on the owner's personal return is less than $157.5K for single or $315K for joint.
  4. There was a last minute change on Friday to allow engineering and architectural service firms to be eligible.  Other service businesses, though, such as law, health, accounting and consulting were not so lucky.
  5. The ultimate decision will likely be whether to remain a pass-through to benefit from the single layer of income tax and the 20% pass-through exclusion, or switch to a C Corporation where the tax rate will be a flat 21%, but then the shareholders are exposed to a double tax when they sell or liquidate the business.
Since nearly all of our business clients operate in some form as a pass-through entity (including ourselves), this is a hot topic for us. We'll be committing the resources to learn the concepts and the nuances of these new rules.

That will help us in developing several broad strategies based on common profiles we can then apply to your unique situation to help you make an informed decision.

Much more to come.