One of the most confusing parts of the new Tax Act is the law regarding the pass-through tax reduction. At its best, the pass-through tax reduction will allow you to reduce the pass-through income from a flow-through entity by 20%.
For example, let’s say that you have an S Corporation with net income of $150,000. You take out a salary of $75,000, which is deduction from the corporation. The $75K salary is taxable for you and ends up giving you pass-through income of $75,000. If you qualify, you can reduce the income by 20%, so that you end up with $60,000 of taxable income instead of $75,000. The $75K W-2 income you took as a salary is still taxable at the full rate.
That’s how it is supposed to work. But if your taxable income (the total amount) is higher than $350K (married filing jointly) or $157,500 (single), the amount of pass-through income that is subject to the limitation is limited.
Rather than get into all the rules about the limitation, let’s look at how instead you can keep your income under the threshold so it’s much simpler.
The easiest way I know to keep your income under the threshold is to use a C Corporation to reduce your flow-through income. Some of the income is held inside the C Corp that is taxed at the C Corp level. It’s still your money, but you need to have plans for it other than just taking it out in salary or dividends. That will add to your income.
Over the next week, we’re going to look at tips and traps for C Corporations. I don’t often recommend that it is your only business structure, but it can be a wonderful tool as your second structure.