Tax planning under the TCJA for pass through entities is a post for small business owners everywhere paying US income taxes.
Now that the Tax Cuts and Jobs Act (TCJA) is in full swing, many of you have been clamoring for tax planning strategies. This post addresses some essential aspects of the Act and suggest some strategic implications to be used for planning purposes.
One of the most significant changes coming out of the TCJA are the new tax rates:
- The individual tax rate is reduced to a maximum 37%.
- The tax rate for pass-through entities can be reduced by 20%.
- The corporate tax rate is reduced from 35% to as low as 21%.
As a result of these new tax rates there is a growing debate over whether a business should be organized as a pass-through entity or a full blown ‘C’ corporation.
Under the new tax laws (“TCJA”), there is a new deduction available to owners of pass-through entities. Section 199A of the Internal Revenue Code allows owners of pass-through entities to deduct up to 20% of their business income from their income taxes. The first portion of this article provides an overview on the various types of pass-through entities that are included under Section 199A. The second portion of the article provides an analysis on the conditions that the owners of pass-through entities must satisfy in order to qualify for the 199A deduction.
For purposes of Section 199A, the following entities are entitled to the deduction: sole proprietorships, partnerships, limited liability companies, S corporations, trusts, and estates. The most distinguishing characteristic of pass-through entities is that the entities themselves generally do not pay tax. Instead, all of the earnings and expenses are passed through to the owners who pay the taxes on their individual tax returns. The sections below provide an overview on the general characteristics of each type of pass-through entity.