Pass-Through Income: What is it and what’s changing?

You may have heard that there are some changes coming in 2018 and beyond for taxpayers with pass-through income. Unclear on what exactly this is? Put simply, it is net income after all expenses that is earned by a company and “passed through” to the company’s owners. This would encompass just about all business entity types out there except for C-Corporations. C-Corporations pay taxes at the entity level. Thus, they do not pass-through income to their shareholders until they pay dividends. C-Corporations got a huge tax break – from 35% to 21%, which is effectively a 40% reduction in taxes. As such, many clamored for tax breaks for pass-through businesses since C-Corporations tend to be larger companies and passthrough entities tend to be small businesses.

So, did the Ma and Pa shops get a 40% tax break like their C-Corp counterparts? Not quite. But, they did get something…They got a 20% reduction in pass-through income from their taxable income… I’ll admit, when I first read of this, I didn’t believe it. It sounds both too weird and too good to be true. Let’s run through a quick example:

• You get a K-1 from Ma and Pa LLC dba Dad Jokes that shows Income of $100K. In 2017 and prior, that would mean that you would be taxed on $100K. Go figure. In 2018 and beyond, however, you would reduce that $100K by 20% to arrive at your taxable amount of $80K. That is the same as getting a $20K deduction for free. Pretty sweet. What’s more is that tax rates have been reduced on that income as well. Very sweet. Continuing that example let’s say in 2017 you were in the 25% marginal tax bracket for all of that income. That would have meant you paid $25K in taxes on the $100K in income (ignoring self-employment taxes). In 2018, you would be in the 22% tax bracket AND you’d only be taxed on $80K, which means that your tax bill on that $100K in income would only be $17,600, a comparative savings of $7,400.

That represents approximately a 30% decrease in your tax bill. To that, I declare, “BOOMSHOCKALOCKA!”

To summarize:

2017: $100K x 25% = $25K tax

2018 (and beyond): $100K - $20K = $80K x 22%

Wondering how you too can benefit from these tax breaks? Give us a call (619-736-1404) or shoot us an email (info@darkhorsecpa.com) and let’s start a conversation.