Tax reform created a new 20 percent tax deduction for select pass-through entities. Will your business operation create the 20 percent tax deduction for you?
If not, and if that is due to too much income and a lack of (a) wages and/or (b) depreciable property, a switch to the S corporation as your choice of business entity may produce the tax savings you are looking for.
To qualify for the full 20 percent deduction on your qualified business income under new tax code Section 199A, you need defined taxable income of less than $157,500 (single) or $315,000 (married).
If your taxable income is greater than $207,500 (single) or $415,000 (married), you don’t qualify for the Section 199A deduction unless you have wages or property.
Example. Sam is single, not in the out-of-favor specified service trade or business group (doctors, lawyers, consultants, etc.), operates a sole proprietorship that generates $400,000 of proprietorship net income, and has taxable income of $370,000. In this condition, Sam’s 20 percent Section 199A tax deduction is zero.
Here’s how the S corporation helps Sam. The S corporation pays Sam a reasonable salary, let’s say that’s $100,000. With this salary, Sam pockets
- $10,871 on his self-employment taxes, and
- $17,500 on his new-found 20 percent deduction under new tax code Section 199A.