March 26, 2018

Tax Cuts & Jobs Act : Flow-through Specified Service Business

Richard Yelton & Laura Berry

Overview • Signed into law on December 22, 2017• Largest major tax reform since 1986• Highlights:

– Permanent reduction of C corporation tax rate to 21% – Significant changes to the treatment of foreign income– Overhaul of individual rates and deductions– Deduction for pass-through qualified business income

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Individual ProvisionsEffective 2018

• Highest rate reduced from 39.6% to 37%• Dollar thresholds for brackets increased• The 3.8% NIIT and 0.9% Medicare tax remain• State tax deduction limited• Individual provisions set to expire after 2025

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Individual Tax Rates - Single

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Single

2018 Taxable Income Prior Law New Law

$0 – 9,525 10% 10%

$9,525 – 38,700 15% 12%

$38,700 – 82,50025%

22%

$82,500 – 93,70024%

$93,700 – 157,50028%

$157,500 – 195,45032%

$195,450 – 200,00033%

$200,000 - 424,950

35%$424,950 – 426,700 35%

$426,700 – 500,00039.6%

$500,000 + 37%

Individual Tax Rates – (MFJ)

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Married Filing Joint (MFJ)

2018 Taxable Income Prior Law New Law

$0 - 19,050 10% 10%

$19,050 - 77,400 15% 12%

$77,400 - 156,150 25%22%

$156,150 - 165,00028%

$165,000 - 237,95024%

$237,950 - 315,000

33%$315,000 - 400,000 32%

$400,000 - 424,950

35%$424,950 - 480,050 35%

$480,050 - 600,00039.6%

$600,000 + 37%

Business Changes - Highlights

• Depreciation– Bonus Depreciation– Section 179 Expense– Luxury Auto

• Interest Expense• Entertainment Expenses

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Bonus Depreciation & Section 179 Expense

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Luxury Auto

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Interest Expense Limitation

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Net interest expense incurred by a business limited to 30% of adjusted taxable income.

Does not apply to businesses with average annual gross receipts of $25M or less.

Disallowed interest may be carried forward indefinitely.

Limitation applied at the entity level (partnerships).

Meals and Entertainment

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Pass-through Provisions

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Pass-through Deduction• For 2017 – pass-through income taxed at individual rates up to

39.6%.• Beginning in 2018 – Taxpayers who have “Qualified Business

Income” (QBI) from a partnership, S corporation or sole proprietorship entitled to up to a 20% deduction on QBI.

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Qualified Business Income• Business income other than investment income• Does not include

– guaranteed payments– wages earned as an employee– foreign earned income

• Determined separately for each separate business you own• Determine each business separately and then net them together

– (net income and losses together)

• Limited to your Net Taxable Income before the QBI Deduction

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Specified Service Business

• Includes health, law, accounting, performing arts, consulting, athletics, financial services, brokerage services

• Includes investing and investment management trading, or dealing in securities, partnership interests, or commodities

• Excludes architect and engineers

• Includes any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners

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Pass-through Deduction Thresholds For Specified Service Businesses

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Taxable Income Thresholds Deduction

< $157,500 (Single/MFS)< $315,000 (MFJ)

Full Deduction

$157-500 - $207,500 (Single/MFS)$315,000 - $415,000 (MFJ)

Limited Deduction (Danger Zone)

> $207,500 (Single/MFS)> $415,000 (MFJ)

No Deduction

Deduction before phaseout reduction is limited to the lesser of

– 20% of qualified business income or– Greater of

• 50% Allocable W-2 wages of the business (wage limitation) or

• 25% Allocable W-2 wages of the business plus 2.5% unadjusted basis of assets (wage/asset limitation)

Qualified Business Income in the Danger Zone

Lower threshold Upper thresholdSingle = $157,000 Single = $207,500MFJ = $315,000 MFJ = $415,000

Taxable Income - lower thresholdUpper threshold – lower threshold

($50,000 single / $100,000 MFJ)

Phaseout Reduction

Pass-through Deduction Flowchart

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20% deduction on QBI phased

out

Example Danger ZoneFacts:• Assume C is a married filing joint (MFJ) Taxpayer• C is a 100% owner of an S corporation – specified service business• C’s personal taxable income is $375,000• In 2018 the S corporation

– Generated ordinary income of $200,000– Paid total W-2 wages of $2,000,000– Had total unadjusted basis in qualifying property of $150,000

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Example 1 – Danger Zone

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20% deduction on QBI phased

out

Example 1 - Danger Zone• C’s personal taxable income is $375,000• In 2018 the S corporation

– Generated ordinary income of $200,000– Paid total W-2 wages of $2,000,000– Had total unadjusted basis in qualifying property of $150,000

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$40,000 – $24,000 = $16,000 QBI Deduction

Example 1 - Danger Zone

Example 2 - Danger Zone Wage Limitation

• C’s personal taxable income is $375,000• In 2018 the S corporation

– Generated ordinary income of $200,000– Paid total W-2 wages of $75,000– Had total unadjusted basis in qualifying property of $150,000

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$37,500 – $22,500 = $15,000 QBI Deduction

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Example 2 - Danger Zone Wage Limitation

Comparison – No Wage Limit

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20% deduction on QBI phased

out

Comparison - $0 Wages

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20% deduction on QBI phased

out

Planning is KeyPlanning ideas• Increasing Deductions

– Charitable contributions / Donor advised fund– Bonus Depreciation / Section 179 Expensing– Retirement Plan Contributions

• Analysis of Wages / Reasonable Compensation• Consideration of Guaranteed Payments • Carve-out of non-service segments of a business

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Flow-Through vs. C-CorporationAnnual Operations

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20% deduction on QBI phased

out

Flow-Through vs. C-CorporationSale of Business Assets

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20% deduction on QBI phased

out

Tax Reform (10 years, billions)

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Revenue Raisers

Personal exemptions $1,212

State income tax 668

Repatriation tax 339

Shared responsibility payment 314

Business interest deductions 253

Corporate NOL 201

Base erosion and anti abuse tax 150

Chained CPI 134

Research expense amortization 120

Other 131

GILTI 112

Domestic production deduction 98

Like kind exchange 31

Total $3,762

Revenue Losers

Corporate tax rate $(1,349)

Individual tax rates (1,214)

Standard deduction (720)

Individual AMT (637)

Child tax credit (544)

Qualified business income (265)

Corporate dividends received (224)

Depreciation write offs (112)

Estate tax exemption (83)

Corporate AMT (40)

Simplified accounting-small business (31)

Total $(5,219)

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Contact Us

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Laura Berry, CPA678-510-2790

lberry@windhambrannon.com

Richard Yelton, CPA678-510-2811

ryelton@windhambrannon.com