For those of you who are self-employed or own pass though entities such as an LLC, partnership or S corporation, you undoubtedly have heard that you have a big tax break coming – 20%, right off the top of your pass through income is deductible from your earnings. This is on top of the normal business deductions that apply to running your business. This is called the “20% Pass Through Income Deduction.”
This deduction is a boon to small business owners because effectively your tax bill has just been cut by 1/5th. But here is the problem…
20% Pass Through Income Deduction
The 20% write off for pass through income does not apply to all owners of these structures. The rhetoric around this deduction was that the Treasury Department did not want someone like boxing giant Floyd Mayweather to set up a $400 LLC at the Company Corporation, just before he banked $285 million for a one night fight (truth be told, Floyd already owns Mayweather Productions which is undoubtedly “tax optimized,” but you get the point), taking $57 million of taxable income off the table in the process. The same idea held for ultra-high earning actors, singers, etc.
But, this is where the booby-trap comes in. Let’s just say you are not Floyd Mayweather, you are Floyd Jones. You’re not a world class boxer, but a highly skilled medical doctor that specializes in the treatment of lung cancer. You have saved the lives of hundreds of tobacco users over your career and will save the lives of hundreds more before you retire. Instead of making $285m in one night, you make $416k in one year. The medical game is litigious, and you need to protect yourself, so you too own an LLC and you want to take 20% off the top. Can you do it? Nope. Healthcare professionals lose the benefit completely at any income level over $415k. However, Dr Floyd Jones’, twin brother – let’s call him Bernie Jones, owns a successful tobacco farm in North Carolina and sells his crop to the cigarette companies. His business earns him $500k a year after expenses. Bernie can take the full 20% deduction off the top because his business was not “on the list.”
What’s on the list? Currently self-employed people who own pass through entities in the healthcare, legal, accounting, actuarial sciences, performing arts, consulting, athletics, financial, brokerage, investment management, securities trading and securities dealing are “on the list.”
For these people, the phaseout begins at $315,000 (married)/$157,000 (single) and ends completely at $415k and $207.5k respectively.
It’s worth pointing out that the 20% Pass Through Income Deduction reg, like so many this year, was put together without a lot of detail and is subject to modification in the future. Currently the documentation for this deduction is 184 pages in length and contains far more detail than we are discussing here.