IRS Definitions of Income You Need to Know

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One of the common questions that I’m receiving right now is regarding the pass-through 20% pass through income reduction. And, more specifically, how does that threshold limitation work?

Let’s start at the beginning.

Is your TAXABLE income below $315K (married, filing jointly) or $157.5 (single)?

If so, you’re going to get the 20% pass through taxable income reduction. This is applicable just on the pass-through income. So, let’s say you have an S Corporation with net income of $100,000, if you take a salary of $100,000, you will get NO tax reduction. If you take a salary of $40,000, there will be $60,000 of pass-through income from the company and so it will be reduced by 20%. You’ll only pay tax on $48,000 of the $60,000 ($60,000 * 80%)

If your taxable income is over that threshold ($315K married, filing jointly or $157.5K single), it gets much more complicated and you may not get any deduction at all. That’s why so many people are asking exactly what makes up this threshold.

It is TAXABLE income. That is the total income you report on your tax return: W-2 wages, interest, dividends, capital gains income, rental income and so forth. From that you subtract the adjustments to income such as SEP and SIMPLE pension contributions, IRA contributions, ½ self-employment tax and ½ self-employed medical insurance. Then subtract your standard deduction or itemized deductions. That is your taxable income.

If you are under the threshold and have multiple pass-through entities, then each one stands along for their 20% tax reduction. Say, your Schedule C has a loss of $10,000. There is no tax reduction. Now, let’s say your S Corp paid you a salary of $40,000 and then you have $50,000 in pass-through income. The $50,000 in pass-through income would have the 20% reduction. The salary is not eligible. If you have rental properties or are in a partnership, the same reduction is available on a case-by-case basis.

If your taxable income is above the threshold, the next step is to determine if you have a service business or a non-service business.

More on that definition tomorrow. Want more information about how to determine what your taxes will be and how you should put your tax plan in place? You may be ready for a one-on-one consultation with me.

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