The Tax Cuts and Jobs Act – Pass-through Entities - Part 2

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In Part 1 of this article we looked at the specifics of the provisions of the Tax Cuts and Job Acts of 2017 as they regard Pass-through Entities (PTE).  In this Part 2 we will look at some specific 'real world' examples of these provisions. I'm providing four examples of situations when a taxpayer’s income is either above or within the Threshold Amount so that you can get a feel of how the Pass-through Entity deduction is calculated.

Scenario 1 – PTE is Service Business (SSTB)

Jane is a partner in a law firm and makes $450,000 per year. Because of other deductions on the joint tax return she files with her husband, their joint taxable income for 2018 is $315,000.

Even though Jane makes well in excess of the Threshold Amount, she is entitled to the PTE deduction because the taxable income on her joint tax return does not cross the $315,000 threshold ceiling.

You may be thinking that Jane’s PTE deduction is $90,000 ($450,000 x 20%), but that is incorrect. The new law applies the PTE deduction to the QBI of Jane’s interest first (her $450,000 interest in the law practice), and then again to the taxable income on her joint tax return ($315,000). Her PTE deduction is the lesser of the two values. Jane’s PTE deduction is $63,000 ($315,000 x 20%).

Scenario 2 – PTE is Service Business (SSTB)

Let’s take the same facts as Scenario 1, but now assume Jane and her husband don’t enjoy the same deductions as Scenario 1. Instead, Jane’s income from her law practice is still $450,000, but the taxable income on the joint tax return she files with her husband is $385,000.

Jane and her husband are not entitled to the PTE deduction because the taxable income on her joint income tax return exceeds the threshold ceiling of $315,000. Her PTE deduction is $0.

Scenario 3– PTE is NOT a Service Business (has W-2 wages; no Qualified Property)

Jack’s 2018 joint tax return with this wife shows $500,000 of taxable income. A part of that income comes from his printing business in which he makes $100,000. Jack leases all his equipment, which means he does not own any depreciable property. In addition, Jack has employees at his printing business that were paid $45,000 in W-2 wages.

Because Jack’s taxable income is in excess of the threshold ceiling, the CQBI calculation comes into play here. Therefore, the calculation of Jack’s PTE deduction is the lesser of 20% of his QBI ($100,000 from his printing business) or 50% of the W-2 wages paid in the printing business (the Qualified Property component of equation doesn’t apply here since Jack doesn’t own any depreciable property). So –

20% of the printing business QBI = $20,000 ($100,000 x 20%)

OR

50% of the W-2 wages paid in the printing business = $22,500 ($45,000 x 50%)

Jack’s PTE deduction is $20,000, the lesser of the two products above.

Scenario 4– PTE is NOT a Service Business (has W-2 wages and owns Qualified Property)

Jack’s 2018 joint tax return with this wife shows $500,000 of taxable income. A part of that income comes from his printing business from which he makes $200,000. Jack owns the equipment used in his printing business, which had an original cost of $400,000 when he purchased it four years ago. In addition, Jack has employees at his printing business that were paid $30,000 in W-2 wages.

Because Jack’s taxable income is in excess of the threshold ceiling, the CQBI calculation comes into play here. Therefore, the calculation of Jack’s PTE deduction is the lesser of 20% of his QBI of$200,000 from his printing business or the greater of 50% of the W-2 wages paid in the printing business or 25% of the W-2 wages paid in the printing business plus (+) 2.5% of the Qualified Property. So –

20% of the printing business QBI = $40,000 ($200,000 x 20%)

OR

The greater of:

50% of the W-2 wages paid in the printing business = $15,000 ($30,000 x 50%)

OR

25% of the W-2 wages of the printing business plus 2.5% of the Qualified Property of the printing business = $17,500 ($30,000 x 25% = $7,500 PLUS $400,000 x 2.5% = $10,000)

Jack’s PTE deduction is $17,500. Remember, in this calculation, you have two levels, and the taxpayer receives the lesser of the two. So, since $17,500 is the greater of the second calculation, Jack receives the lesser of the two products above, $40,000 or $17,500.

Even though there are other limitations and provisions, the explanation above will apply to most Pass-through Entities.

I fully expect a slew of regulations quantifying, qualifying, clarifying, and basically creating more havoc to be issued in the coming months. As these regulations are issued and if they materially change or clarify the way the PTE deduction is calculated, we'll get back to you.

About the Author:

Rob Shaff is a partner in the accounting firm of Colton & Associates, PC which is based in Oklahoma City. Rob serves as the contributing tax author for Insightful Accountant.

DISCLAIMER:

This article is for informational purposes only and does not constitute tax or legal advice. If you want tax or legal advice, please contact a qualified tax professional or attorney.