Pass Thru Deduction Explained

[docnews]

So super impatient nerd who couldn't wait for someone in the media to actually explain these details. Preface: this my amatuer read. Looking for Kitces to chime in. If you scroll through the bill this is part 2 with key stuff on this exception to exception on page 35.

So the service industries are excluded except if your TAXABLE income is less than $315k (half if single) and phases out over next $100k ($50k if single).

TAXABLE is the key word. This is not your net profit from schedule c. It specifies that this deduction does not help you reach this deduction income limit which doublely confirms to me that all other deductions do! Charitable giving, 401k, HSA, mortgage interest, self employment tax deduction definitely drop me personally below this limit. I suspect most IC physicians could/do drop their taxable income at least $100k from their gross income.

I also see no language that makes sole proprietorships are excluded from this exception.

The 20% deduction is also applied to taxable income, not net profits (as long as that is less than your net profits which should be the case unless you have other bigger sources of income other than your business). In a sense any of my deductions (especially optional ones like charity) effect is reduced by 20% once I reach the $315k number.

[docnews]

Also the max amount of tax saved is calculated as: $315k*20% at 24% rate = $15,120

These limits will be indexed to inflation.

[PhysicianOnFIRE]

If you'd like to develop this further, I'd love a guest post on the topic!

[Mantis Toboggan]

Thank you for this. I’ve been searching for a good explanation all weekend. This makes sense. Will be curious to see how the AMT numbers work out.

[Zaphod]

Thanks for the work on this.

So are you saying that the pass through tax that was first floated as a rate is now a deduction instead? Is that correct?

[Dr. Mom]

Zaphod wrote:

So are you saying that the pass through tax that was first floated as a rate is now a deduction instead? Is that correct?

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Yes

[The White Coat Investor]

This is the hardest part of the tax bill to understand. I'm still trying to wrap my head around what this means for me. I have a service business which will make less than $315K next year, but I have a taxable income well above that thanks to another non-service business, of which I am an owner and an employee.

Here's the link to the bill by the way:

http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT-466.pdf

I'm still totally lost on what this is actually saying on pages 23-26 and how it applies to my situation.

As near as I can tell, I get a deduction of 20% of 50% of what I pay myself as salary. If that's the case, I have an incentive to pay myself a much larger salary than I otherwise would. Previously, I paid myself just enough to max out my retirement accounts in order to minimize payroll tax. But that deduction is way bigger than what I'm saving in Medicare tax. I think the incentive is now to make sure that my salary is precisely 50% of my business income. Whereas this year I think we're only paying ourselves about 25% of the business income as salary.

But I think this could potentially be a $150K deduction, or about a $55K tax cut for WCI, LLC. But it would cost me another $10-15K in Medicare tax to get it. I don't think I would get to take the deduction at all from my practice partnership though.

[Dr. Mom]

I am having a hard time wrapping my head around it also.  I read that if you are an owner and draw a salary from the business that the deduction will not apply.  So, it favors passive over active owners. IDK if that is true.  Like docnews, I am hoping for some clarification from Kitces and others once it is passed.  We have both active and passive options available to us and can play with the amounts that go into either.  Years ago this setup was very beneficial.

[spiritrider]

WCI: As pointed out by docnews the deduction is limited by your (MFJ in your case) taxable income on Form 1040 Line 43 not counting the deduction. It is not based on any individual businesses that you own.

Also, it is a 20% deduction not a credit (as I also first thought) on a maximum of $315K for maximum deduction of $63K. At the maximum MFJ taxable income ($315K) this deduction falls entirely within the new 24% tax bracket. The maximum tax savings is as docnews stated is $15,120.

[VagabondMD]

I am also confused by the wording, and I expect that there will be some clarification moving forward.

I understand that my professional income from my professional corporation is not eligible for this "deduction".

I am wondering if our imaging center business, in which we are investors with other parties in a separate corporation, which passes through income through an LLC, to the tune of about $50k/investor per year, would be eligible for this deduction. Currently, we pay ordinary income tax on these distributions. (Our salaries are otherwise above the $315k number, but I do not know if I am mixing apples and oranges).

[Complete_newbie]

Very interesting thread

So dumb questions:
1. 20% deduction applies to which entities? LLC is oass through so if business is generating 300k I can just slap 20% deduction ?
2. What are the restrictions/phase outs ?

[Zaphod]

Im glad its not just me.

[Hatton]

Confused!

[Complete_newbie]

Yea hoping for dumbed down tl;dr version. Either way if I'm interpreting this right that 20% deduction is pretty huge for serial business owners

[NJDoc]

Vagabond MD wrote:

I am wondering if our imaging center business, in which we are investors with other parties in a separate corporation, which passes through income through an LLC, to the tune of about $50k/investor per year, would be eligible for this deduction. Currently, we pay ordinary income tax on these distributions. (Our salaries are otherwise above the $315k number, but I do not know if I am mixing apples and oranges)

Click to expand...

I have the same question as it applies to my Surgery Center income.