The year is almost halfway over and a swath of business owners still remain uncertain as to how they should plan their taxes for the remainder of 2018.
The Tax Cuts and Jobs Act provides a 20 percent deduction for qualified business income from pass-through entities, which include S corporations and limited liability companies.
"Pass-throughs" are known as such because income from these small business "pass through" to the owner on his or her own taxes, where they are subject to individual income tax rates.
Though the 20 percent tax break is attractive to entrepreneurs, many are still uncertain as to whether they qualify for it. They are anxious because the middle of 2018 is rapidly approaching and their tax planning for the year is still in question.
"Business owners don't want to overpay their taxes during the year, but if they assume they qualify for the deduction and then later find out they didn't, they may find themselves underpaid and subject to a penalty," said Tim Steffen, director of advanced planning at Baird.
Here are where some of the key gray areas remain for business owners when it comes to the Internal Revenue Service and taxes, and how they're dealing with them.
Doctors, lawyers, consultants
To qualify for the full 20 percent qualified business income deduction, single filers must have no more than $157,500 in taxable income ($315,000 if married and filing jointly).
Below those thresholds, you can claim the break.
Once taxable income exceeds those amounts, limitations begin to kick in. For instance, "specified service trades or businesses," including doctors, lawyers and consultants, can't take the break if their taxable income exceeds $207,000 if single ($415,000 if married and filing jointly)
Business owners who are in the middle of the income ranges or those who aren't sure if they're considered service corporations are really left twisting right now.Tim Steffendirector of advanced planning, Baird
Just defining "trade or business" in the context of qualifying for the break is an exercise in prognostication.
For instance, it's uncertain whether real estate owners who collect rent passively will be eligible for the 20 percent deduction, said Jeffrey Levine, CEO and director of financial planning at BluePrint Wealth Alliance.
"If you have a passive business and you collect income, depending on the definition the IRS chooses to use, they could take the stance that you're not really in a 'trade or business,'" he said.
Spinning off a business
Businesses that don't qualify for the 20 percent break because they are in a "specified service" and exceed the taxable income limit can split themselves into two companies.
For instance, a radiologist who wouldn't otherwise qualify for the deduction splits his business into two separate entities, said Levine.
One entity holds the radiology practice itself, which won't be able to take the break. The other entity is a company that leases back radiology equipment — and which could qualify for the 20 percent deduction.
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Undergoing this strategy at this point of the year could be complicated.
"If you were to split up your business now, it would be eligible for the deduction half of the year and ineligible for the other half of the year," said Kathy Keylor, CPA and director at MAI Capital Management.
Even nailing whether 2018 income would qualify for the break can be complicated if the entrepreneur is paid by the project and has sharp variations in compensation.
"Income can vary so much and we won't know if we're over or under the threshold until later in the year," Keylor said.
Wait and prepare
Until the IRS shares regulations on these specific aspects of the tax law, accountants are recommending that business owners take a conservative tack.
"If you're considering a strategy that is hard to unwind, wait for some guidance," said Levine of BluePrint. "When you do these things, what happens in seven or eight years if these breaks aren't extended — how do you unwind this? You can't."
If possible, meet with your accountant now to get a projection of what your income and estimated tax load will look like for the remainder of the year, said Keylor.
Don't risk underpaying your taxes if you're unsure about whether you'll qualify for the 20 percent deduction.
"Business owners who are in the middle of the income ranges or those who aren't sure if they're considered service corporations are really left twisting right now," said Steffen at Baird.
"Until we get more clarification on how this new exclusion will be applied, they have to be careful how they plan for this," he said.
