Tax Planning for the New Tax Law: Part 5

Tax Planning for the New Tax Law: Part 5
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Tax Planning for the New Tax Law: Part 5

Incorporate your business if you would be deemed a “specified service business.”

According to Republican pundits, this new tax law is designed to not only help the economy and job creation but to simplify the law. I decided to examine what is meant by the word, “simplify”. So, I reached for my Merriam Webster Dictionary, which is next to both my computer and my thesaurus, I looked up the word “simplify”.

After reviewing the final version the Tax Cuts and Jobs Act, two thoughts came to mind: first, Congress must not have a dictionary and, second, the most influential lobbying organization in Washington must be comprised entirely of tax professionals.

In order to better appreciate – if not fully understand – the changes wrought by the Act regarding the Federal taxation of trade or business income that is recognized, “directly or indirectly,” by non-corporate taxpayers, the reader should be reminded of the existing rules, and should also be made aware of the policy underlying the changes.

Many businesses, who are pass through businesses such as sole proprietors, LLCs, S-corp, partnerships, can get a new deduction of 20% of their Qualified Business Income, which is essentially their net income from their business not counting any investment earnings of the business.

If you are in a specified service business, however, and If you are earning more than $415,000 and are married filing joint returns or earning more than $207,500 and are either a single or head of household taxpayers, you won’t get any benefit from the 20% pass-through deduction. Zilch!! If you earn under $315K married or $157,500 single, you get the full 20% deduction. If you earn somewhere in between these figures, you get a partial pass through deduction.

So what businesses are specified service businesses? They include law, medicine, consulting, financial service companies, companies that trade or deal in securities and commodities, dental firms, athletes, actuarial firms, and those in performing arts.

Sadly, Congress did add one other group to the definition of “specified service business.” This group is “any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”

Sandy’s elaboration: This last addition to “specified service business” could be occupations such as realtors and other “service oriented business.”

So, if you are making a high income and fall within the purview of being a specified service business, what should you do?

Tax Planning Tip #1: Consider forming a regular, C-corporation and get taxed at the 21% rate for any monies left in the corporation. In addition, you avoid Medicare taxes on monies left in the corporation and not paid out in salaries.

Tax Planning Tip #2: Consider dividing your company into several entities: entity one will be the specified service business entity. The second entity could be one that deals with product sales that don’t make it a specified service business.

Example: Matt is a financial planner who earns financial planning fees and earns commissions on financial products. Clearly his business would be deemed a specified service business since his business is a financial service firm. If, however, he forms a second entity, such as an LLC, to sell life insurance, this entity might avoid the “specified service business” designation.

Example: John is a Podiatrist who also sells orthotics. His business is considered a medical practice and would be a specified service business. If, however, he forms an LLC solely to sell products such as orthotics, his new LLC might qualify for the pass through deduction.

Thinking of ideas like this could make your life much less taxing.


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