The changes to the pass-through entity taxation are, without a doubt, some of the most confusing and convoluted parts of the 2018 Tax Act.
I have gotten a lot of questions about this, so I thought I would break it down in a couple of blogs so that we can walk through the steps, one by one.
Let’s start with what happens if your taxable income is under $315,000 (married filing jointly) or $157,500 (single).
If your income is more, you’ll find a later blog this week for you based on your circumstances.
Let’s start with the threshold definition. It is “taxable income.” This a line item on your Form 1040. For your 2016 return, it’s near the top third of page 2 of your Form 1040, line 42.
It is the total of ALL taxable income, your W-2, your spouse’s income (if applicable), capital gains, interest, dividends and flow-through entity taxable income. There are some adjustments such as IRA and half your self-employment tax which take you to Adjusted Gross Income. That’s the total that is shown at the bottom of page 1 of Form 1040.
Most tax thresholds use Adjusted Gross Income (AGI) or a variation of that number. The new 2018 threshold however, does not use the AGI, it uses Taxable Income instead.
For your 2017 taxes, subtract your itemized deductions or standard deduction from AGI, For 2017, you also get to deduct exemptions, one more time. That goes away in 2018.
That all gives you Taxable Income.
If your Taxable Income is under the threshold, then 20% of your net income from the flow-through entities can be reduced. Your salary from the businesses is not reduced, just the income on the K-1.
This adjustment happens at the individual tax return level.
Let’s say you and your partner are 50/50 in a flow through entity. Your taxable income is $300,000 and your partner’s is $500,000. You get the reduction on your return. Your partner does not.