As the leading business tax service here in San Francisco, we’re getting a lot of anxious calls from the San Francisco business community about the new tax law. Remember: the tax changes affect 2018, not the current taxes being prepared for “last year” (a.k.a., 2017). In addition, remember that the new tax law is complicated. Many changes impact personal taxes, on the one hand, and then business taxes, on the other. Many San Francisco residents have different streams of income – some from employment, some from investments including homes or other tangible properties, and still others from compensation such as stock options. Indeed, we even have many clients who come to us as the #1 expat tax preparation service in San Francisco and really throughout all of Northern California.
It’s complicated! Our job is to help you understand the tax changes, but – more importantly – to do the heavy lifting for you, so as to minimize your taxes under the new law. With a little planning, we can work together – a top San Francisco accounting firm and you as the client – to minimize your taxes!
Let’s review some of the changes to businesses under the new law.
Deduction for Pass-through Income
Under pre-Act law, income from pass-through businesses (sole proprietorships, partnerships, and S corporations) was reported on the individual tax returns of the owners or shareholders, and therefore subject to individual income tax rates. Under the new law, for tax years beginning after December 31, 2017 and before January 1, 2026, a non-corporate taxpayer (including trusts and/or estates), would be allowed to deduct 20% of “qualified business income” from a sole proprietorship, partnership, or S corporation, as well as 20% of qualified real estate investment trust (“REIT”) dividends, qualified cooperative dividends, and qualified publicly traded partnership income.
The deduction is disallowed for specified service trades or businesses with taxable income above a threshold (taxable income in excess of $157,500 for all taxpayers other than married filing joint returns, which is $315,000). Furthermore, a limitation on the deduction is phased in based on W-2 wages above a taxable income threshold.
“Qualified business income” means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer. These items must be effectively connected with the conduct of a trade or business within the United States. Qualified business income does not include specified investment-related income, deductions, or losses.
“Qualified business income” does not include an S corporation shareholder’s reasonable compensation, guaranteed payments, or payments to a partner who is acting in a capacity other than his or her capacity as a partner.
“Specified service trades or businesses” include any trade or business in the fields of accounting, health, law, consulting, athletics, financial services, brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more of its employees.
The taxpayer is allowed to deduct 20% of the qualified business income for each qualified trade or business. The deduction is generally limited to 50% of the W-2 wages paid with respect to the business, however capital-intensive businesses may produce a higher deduction under a rule that takes into consideration 25% of wages paid plus a portion of the business’s basis in its tangible assets. But if the taxpayer’s income is below the threshold amount, the deductible amount for each qualified trade or business is equal to 20% of the qualified business income with respect to each respective trade or business.
Even a cursory reading of the above will bring the average taxpayer to realize that it’s complicated. What’s your W2 income? What’s your “pass through” income? What are the thresholds on deductibility? Indeed, many business owners can alter the way that that receive compensation, such as having some be W2 income and some be pass through. You need to look at the whole picture of your income – from wages, from “pass through” income, from passive income such as stocks or bonds, and even from items such as stock options (which are so popular in the San Francisco Bay Area technology sector). What’s the best tax strategy? Well, the answer if, of course, that “it depends.” Reach out to us, today, for a personalized consultation on your tax situation. We can help you adjust your income strategy to minimize the tax bite under the new law.