The Tax Cuts and Jobs Act of 2017 made broad changes to the U.S. tax code as it relates to taxable income. This law will impact your clients, especially regarding your clients’ choice of legal entity. Read on to learn about two major considerations.
First, most people are familiar with the act’s reduction of the corporate tax rate. For tax years beginning after 2017, the tax rate has now been reduced to 21 percent. Clients that operate as C corporations will likely realize tax benefits because they will retain greater profits after taxes.
The tax break also allows corporations to retain more income to invest in jobs or capital assets. According to one article, investments can take the form of corporate acquisitions and mergers, which have increased after the act’s passage. Due to these factors, some clients may be good candidates for conversion to a C corporation.
Second, to counteract the corporate tax rate reduction, the act creates a temporary eight-year deduction for taxpayers with income from pass-through entities (such as sole proprietorships, partnerships, S corporations, and LLCs taxed as partnerships). The deduction started January 1, 2018, and ends December 31, 2025.
The deduction is on 20 percent of business income earned and is open to taxpayers filing jointly with taxable income under $315,000 or other filers with taxable income under $157,500, regardless of trade or business. There are many exceptions—which focus on the amount of income and the type of business provided—for the deduction, so it is important to talk with clients about their activity to help them determine eligibility.
For example, if a client files jointly and earns taxable income over $315,000, or if they file under any other status with taxable income over $157,500, then the type of trade or business they have is factored into whether or not they are eligible for a deduction. A Specified Service Trade or Business (SSTB) is not eligible for the deduction at all if taxable income reaches $415,000 for joint filers and $207,500 for other filers.
Examples of SSTBs include trades or businesses involving the performance of professional services (such as health, law, accounting, financial), performing arts, consulting, athletics, or a trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. Businesses that are not SSTBs may qualify for a deduction of “qualified business income,” but the amount requires the application of a two-pronged test. Moreover, determining what is “qualified business income” may be complicated as well.
For assistance in forming, or converting, your client’s business, contact us today: