IRS Offers More Guidance on Pass-Through Business Tax Break

One of the less talked about but potentially lucrative aspects of the Tax Cuts and Jobs Act that passed through Congress last year was a 20% tax deduction for pass-through businesses. Meant to give sole propreitorships and the self-employed a tax break similar to what larger corporations saw with the bill, the explanation of and qualifications for the deduction were confusingly vague, leaving many to wonder if they would actually be able to take advantage of this sizable benefit. Meanwhile other small business may have taken steps such as spinning off part of the businesses in attempts to qualify. This week, the IRS is looking to clear thing up a bit by proposing new rules on the tax break.

As CNN reports, the proposed rules reiterate some of the previously outlined restrictions of the tax deduction while clarifying some eligibility requirements. First it was confirmed that those business owners with taxable income less than $157,500 or $315,000 if married filing jointly would be able to deduct up to 20% of their qualified pass-through income on their taxes. However there are some professions that are excluded from this offer, including law, health, accounting, athletics, financial services, performing arts, and others.

Given those restrictions, some business had attempted to make changes to their business structures in order to nab the deduction. CNBC notes that some had considered “crack and pack” strategies where, for example, a law firm that wouldn’t be eligible for the deduction might spin-off elements of their operations into a business that would qualify. Now Troy Lewis of the American Institute of CPAs says this tactic won’t be tolerated, stating, “If you have common relationships between the two organizations, the arrangement is now collapsed and the whole thing is tainted.”

Another nixed scenario CNBC details is where employees of certain companies may wish to become contractors in order to get this 20% deduction. That might sound like a decent move but, as Michael D’Addio notes, “If you worked for the employer and became an independent contractor for the same person, performing the same work, you’re presumed to retain your status as an employee.” Because of this, such an arrangement where employees voluntarily converted their status would likely prove disadvantageous considering self-employment tax obligations and other expenses they’d be subjected to — all without the benefit of the tax break.

Although it took more than half a tax year to have some these questions answered, at least we now have a better idea of how the 20% pass-through business tax deduction will be applied. That said, hopefully not many small businesses and individuals went through the trouble of restructuring their businesses or status to take advantage of the break, only to find out their efforts may have been in vain. With most of the confusion behind, hopefully these clarifications can help small business owners, self-employed individuals, and other entrepreneurs make the most of this major tax deduction.

Also published on Medium.


Jonathan Dyer

I'm a small town guy living in Los Angeles looking to make solid financial decisions. I write for a number of finance websites, including HuffingtonPost and Business2Community. I founded in 2015 to focus on personal finance and the emerging FinTech markets.

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