While the new tax law hasn’t exactly made the tax code easy, it’s simplified it a bit. One of the simplifications is the reduction of the corporate tax rate to 21%— it was at 35% before— for C-Corps. Another change is the increase of depreciation, from 50% to 100%. This became effective 9/26/17, and it’s appropriate through 2022.
Yet another vital change is the 20% deduction for pass-through businesses— aka any of the 95% of businesses that don’t pay corporate income tax, including sole proprietorships, partnerships, or S-corporations. (Of course, if your business is considered to be a professional service, such as CPA, doctor, dentist, or consultant, this deduction is not applicable.)
Confused? It’s complicated. With that in mind, we’ve created a method of explaining the nuances of the new tax law— with food.
#1: The Banana
Bananas are among the simpler fruits to eat-- just peel it and you’re enjoying a delicious snack. With that in mind, we’re comparing the business with the simplest to figure taxes to its fruity counterpart. For our purposes, we’re calling our client Barney the Banana Bread Maker.
Barney’s business is successful; he’s making $300,000 per year. His expenses come in at $150,000/year, and his qualified business income is $150,000. To determine Barney’s deduction, all you’ll need to do is multiply the QBI by 20%.
Example: $150,000 x 20% = $30,000
By far, cases like Barney’s are among the simplest to figure the deduction. Any pass-through business earning $157,000 or less and filing as a single person or earning under $315,000, married and filing jointly is able to use this same simple formula.
#2: The Orange
While oranges are just as tasty as bananas, they’re not quite as easy to peel. You can do it, but it’s going to take a little bit more effort. Businesses who generate more income and pay qualified wages— W2s, not 1099s— take a little extra effort, too.
Our “orange” is Owen the Outdoor Advertising Owner. He’s working in his family billboard business, and he and his spouse have $1.2 million of defined taxable income. His QBI is $350,000, and his business paid $120,000 in qualified wages.
For Owen, his pass-through deductible amount is the lesser of: 20% of QBI and 50% of W2 wages OR 25% of W2 wages + 2.5% of his assets. Let’s look at Owen’s numbers:
Qualified Business Income: $350,000
W2 Wages: $120,000
|QBI x 20%= PD||$350,000 x 20% = $70,000|
|W2s x 50%= PD||$120,000 x 50% = $60,000|
#3: The Onion
Imagine yourself holding a large onion. Now, think of the effort it would take to strip this onion of its layers— it would be a challenging job that would stink and make you cry. Unfortunately, businesses that fall between Barney and Owen are in much the same position— determining their deductions is a job that takes determination and patience.
Meet Orville the Onion Farmer. In terms of income, he’s smack in between Barney and Owen; his onion farm generates $345,000 each year in qualified business income. Orville and his wife file jointly, which means that their income falls between $315,000 to $415,000, placing them in the most difficult category to cipher. (Single filers with income between $157,000 and $207,500 are also placed in this category.) Orville also pays W2 wages, to the tune of $100,000 per year.
There are several steps that you must take to determine this deduction. Let’s look at Orville’s numbers.
|QBI: $315,000= QBI Excess||$345,000 - $315,000 = $30,000|
|QBI x 20%= QBI PD||345,000 x 20% = $69,000|
|W2s x 50%= Wage Limit||$100,000 x 50% = $50,000|
|(QBI PD - W2s) x 30% = PD Limitation||($69,000 - $50,000) x 30% = $5,700|
|QBI PD - PD Limitation = Final PD||$69,000 -$5,700 = $63,300|
After it all shakes out, Orville’s deduction will be $63,300.
Still confused? That’s okay. The tax code is complex. Fortunately, we can help. At Sean Hugo, CPA, we’re proud to offer up-to-the-minute financial advice to businesses big and small. Just call us at 405-759-2796 or schedule a free consultation today.