The new Section 199A, pass-through income reduction, works on an individual level. You may have an equal partner in a partnership, but one of you gets the tax break and one of you does not.
Here is an example from “Taxmaggedon 2018”:
Let’s say you and Jennifer are partners in a product-based business. You are married and have taxable income above the threshold. Jennifer is also married, but her taxable income is not above the threshold.
There are no employees in the business, which nets $500,000, or $250,000 each.
Since Jennifer’s taxable income is under the threshold, she and her husband will receive a Section 199A reduction of $50,000 (20% * $250,000).
In your case, though, your taxable income is above the threshold, so you will be subject to the wage limitation. Since your partnership doesn’t pay any wages, you will not receive any Section 199A reduction.
The determination for the pass-through income reduction is done individually. Each partner’s taxable income will determine how much benefit they can receive.
Guaranteed payments made to a partner count the same as wages. Let’s assume that you and Jennifer both take guaranteed payments of $100,000 each. That would mean you each have an individual pass-through income of $150,000 now ($250,000 – $100,000).
In Jennifer’s case, her income is still below the threshold since the change does not impact her taxable income. However, she only has a Section 199A deduction of $30,000 now (20% * $150,000). This is because her flow-through income was reduced.
In your case, you now have an amount that will qualify for the wage limitation. Your flow through income is $150,000. Your preliminary Section 199A deduction is $30,000. Your wage limitation would be 50% of guaranteed payments (plus any wages, which is zero). The amount would be $50,000 (50% * $100,000). That means you now have $30,000 of reduction.”
In this case, if you apply the rules equally, one of you will pay more taxes than if there were no guaranteed payments. Which is fair?
It gets even more complicated when we look at partnership agreements that call for mandatory cash distributions to cover maximum tax. Do you assume that everyone gets the 20% income reduction so the cash distributions are less? Do you assume that no one gets the 20% income reduction and so cash distributions are more?
You may want to take a look at your partnership agreements in light of all of the changes with the 2018 Tax Act.
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