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IRS Finally Clarifies Rules for the 20% Small Business Tax Deduction

One of the biggest and most talked-about benefits from the $1.5 trillion tax overhaul passed in late 2017 was also the most shrouded in mystery:

The 20 percent tax deduction for pass-through business owners.

Fortunately, the IRS recently clarified the rules on this small business tax deduction, as well as on a few other aspects of the new tax rules. So here’s a quick look at what matters most to small business owners.

The Rules for Small Businesses

If you are single and make less than $157,500, or are married and the two of you collectively make less than $315,000, you can deduct a fifth of any income derived from pass-through businesses from your total taxable income. Those figures are a bit different if you’re a service professional – then it becomes $207,500 for single taxpayers, and $415,000 if you’re married.

The law is directed at small business owners within certain types of business structures where income “passes through.” Instead of income being taxed at both the corporate and personal levels, income simply is taxed at the individual level. This applies to structures such as limited liability companies, master limited partnerships, S corps and sole proprietorships.

Other Qualified Business Income Updates

The IRS also outlined a few other clarifications and rules for qualified business income.

For instance, the IRS cleared up an ambiguity pertaining to rental real estate. In August, the IRS said a real estate activity had to equal the level of a “trade or business,” but it acknowledged recently that there was too much room for interpretation.

“The Treasury Department and the IRS are aware that whether a rental real estate enterprise is a trade or business is the subject of uncertainty for some taxpayers.” To clear this up, they created a procedure that allows a company to be treated as a “trade or business” to qualify for the 20 percent deduction. That includes several requirements, but first and foremost, a business has to log 250 hours of rental services annually between 2018 and 2022.

The new rules also cap ways in which some business owners hoped to reap the new tax benefits. Some companies were looking at a “crack and pack” strategy in which a business would split itself to concentrate qualified income in one place, making it possible to take advantage of the full deduction. The new rules don’t allow for this, but instead allow companies to use certain accounting methods to separate its lines of income for purposes of the deduction.

Sound complicated? It is. And those are just a handful of the “clarifications” sent down by the IRS – there are several more, including what particular types of businesses can and can’t qualify for the deduction (veterinarians, for instance, cannot).

The tax rules have been seemingly simplified … but they’re still far from simple. That’s why small and midsize businesses should look to the pros for help. McManamon & Co. offers a full suite of tax services and can help you determine what you’re qualified for in this new tax environment.

Don’t tackle the tax man on your own – especially when the stakes are significant. Call us at 440.892.9088 or contact us online today.

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