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A significant change of the tax reform on small business is its permanency character which is different than individual tax changes that are temporary. From the changes in tax law made by the Congress, I will concentrate on the changes that affect small businesses and pass-through entities.
Business today can be structured as:
a) A sole property which is a simple form of business organization. In this case, the taxpayer needs to report using Schedule C of Federal form 1040.
b) Two or more persons as business partners. In this case, there are different forms to deal with tax reporting. It can be a general or limited partnership. Filing the return separately using form 1065 for Federal tax. Income and loss pass to the personal report os each partner that is responsible for his taxable duty.
c) A Limited Liability Company (LLC) Company can file for tax as a partnership or a corporation.
d) A Limited Liability Company (LLC) with one owner only is treated as “disregarded entity.” by the IRS. In this case, there is no separate tax form for the entity and its sole owner that has to report on a Schedule C.
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e) C corporation files a federal form 1120 and pays any tax due. Partners of a C corporation pay tax on dividends and other personal income, a case of double taxation.
f) A Professional or Personal Service Corporation are the corporations use by free professionals like Doctors, lawyers or other one person consulting or service givers.
g) S Corporation is very much similar to partnerships. S Corporation has to file using the IRS form 1120-S that takes all income or loss to the shareholder’s responsibility to report on their tax returns,
Tax rates are progressive for all taxpayers, Corporate or individual. Corporate rates for 2017 range goes from the lower of 15% up to the higher 39% There is an exception with personal service corporations that their tax rate is at 35%. Tax rates for individuals range between 10% to 39.6%. Rates for corporations and individuals are quite close but have different brackets.
The good news for 2018 is that new tax law reduced the tax rate for corporations to a flat 21%.
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The pass-through scheme would not be working if corporations were taxed less than individuals. Creating a new tax rate that would null the pass-through nature of this kind of entity was avoided by the Congress that gave up to 20% deduction of the income that comes from a pass-through corporation. This way the effective tax rate is much lower. It sounds simple; it maybe complicates to understand as there are some restrictions and limits. To make it clear, one needs to know some definitions like:
a) Qualified business income (QBI) or net income originates from his business without importance of any money gained by an S corporation that is considered as a reasonable gain, and payment for any services in business or money paid extra of his responsibility as a shareholder. When figuring QBI and using the standard rules, one needs to capitalize and amortize its expenditure accordingly. QBI is a per business not per taxpayer basis.
b) Qualified property is the tangible property that is used for the production of a “qualified business income” for your business and is subject to depreciation.
c) “Specified service trade or business.” are those who deal with health, law, consulting, athletics, financial services, brokerage services. When the principal asset of a business is a talent, skill or reputation of its stuff, it is defined as a “Specified service trade or business.”
d) The threshold amount is the total amount above witch both the limitation on specified service businesses the wage limit applies. The threshold amount is $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. Phase-ins apply: that means that the benefit decreases as income increases.
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With the below definitions we can figure the deductions:
b) When taxable income is lower than the threshold amount, your deduction percentage will be fixed on the 20% of QBI related to each one of your business entities.
c) For example, when a taxpayer is under the threshold amount when his income of $50,000 with QBI of $40,000 will get a 20% deduction of the QBI that is $8,000. If a taxpayer is above the threshold amount, he is subject to other exception and limitations that are defined by the occupation and salary limits.
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How to figure the QBI of a specific business:
Considering the balance between income or gain and deduction, loss plus allocable W-2 wages. When calculating the wage and capital limit, including salaries of the tax year without those that were allocable to QBI, this way is avoiding double counting. The 20% of QBI compared to bigger of 50% of W-2 wages related to the trade or business or the 25% of W-2 wages plus 2.5%of the unadjusted basis after the acquisition of qualified property. The amount that is over the threshold is pro-rated.
Paystubmakr.com team hope that you found this article interesting and wait for you to read the following articles.
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Part II of this article will continue in the next blog.