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Pass Thru Deduction Explained

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  • Avatar docnews 
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    So super impatient nerd who couldn’t wait for someone in the media to actually explain these details. Preface: this my amatuer read. Looking for Kitces to chime in. If you scroll through the bill this is part 2 with key stuff on this exception to exception on page 35.

    So the service industries are excluded except if your TAXABLE income is less than $315k (half if single) and phases out over next $100k ($50k if single).

    TAXABLE is the key word. This is not your net profit from schedule c. It specifies that this deduction does not help you reach this deduction income limit which doublely confirms to me that all other deductions do! Charitable giving, 401k, HSA, mortgage interest, self employment tax deduction definitely drop me personally below this limit. I suspect most IC physicians could/do drop their taxable income at least $100k from their gross income.

    I also see no language that makes sole proprietorships are excluded from this exception.

    The 20% deduction is also applied to taxable income, not net profits (as long as that is less than your net profits which should be the case unless you have other bigger sources of income other than your business). In a sense any of my deductions (especially optional ones like charity) effect is reduced by 20% once I reach the $315k number.

    #86032 Reply
    Avatar docnews 
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    Also the max amount of tax saved is calculated as: $315k*20% at 24% rate = $15,120

    These limits will be indexed to inflation.

    #86038 Reply
    PhysicianOnFIRE PhysicianOnFIRE 
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    If you’d like to develop this further, I’d love a guest post on the topic!

    40-something anesthesiologist and personal finance blogger @ https://physicianonfire.com [Part of the WCI Network] Find me on Twitter: @physicianonfire

    FIRE. Financial Independence. Retire Early.

    #86041 Reply
    Avatar Mantis Toboggan 
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    Status: Physician
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    Thank you for this. I’ve been searching for a good explanation all weekend. This makes sense. Will be curious to see how the AMT numbers work out.

    #86047 Reply
    Zaphod Zaphod 
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    Status: Physician, Small Business Owner
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    Thanks for the work on this.

    So are you saying that the pass through tax that was first floated as a rate is now a deduction instead? Is that correct?

    #86094 Reply
    Liked by Dr. Mom
    Dr. Mom Dr. Mom 
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    So are you saying that the pass through tax that was first floated as a rate is now a deduction instead? Is that correct?

    Click to expand…

    Yes

    #86099 Reply
    Liked by docnews, Zaphod
    The White Coat Investor The White Coat Investor 
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    Status: Physician
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    Joined: 05/13/2011

    This is the hardest part of the tax bill to understand. I’m still trying to wrap my head around what this means for me. I have a service business which will make less than $315K next year, but I have a taxable income well above that thanks to another non-service business, of which I am an owner and an employee.

    Here’s the link to the bill by the way:

    http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT-466.pdf

    I’m still totally lost on what this is actually saying on pages 23-26 and how it applies to my situation.

    As near as I can tell, I get a deduction of 20% of 50% of what I pay myself as salary. If that’s the case, I have an incentive to pay myself a much larger salary than I otherwise would. Previously, I paid myself just enough to max out my retirement accounts in order to minimize payroll tax. But that deduction is way bigger than what I’m saving in Medicare tax. I think the incentive is now to make sure that my salary is precisely 50% of my business income. Whereas this year I think we’re only paying ourselves about 25% of the business income as salary.

    But I think this could potentially be a $150K deduction, or about a $55K tax cut for WCI, LLC. But it would cost me another $10-15K in Medicare tax to get it. I don’t think I would get to take the deduction at all from my practice partnership though.

    Site/Forum Owner, Emergency Physician, Blogger, and author of The White Coat Investor: A Doctor's Guide to Personal Finance and Investing
    Helping Those Who Wear The White Coat Get A "Fair Shake" on Wall Street since 2011

    #86101 Reply
    Liked by Zaphod
    Dr. Mom Dr. Mom 
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    I am having a hard time wrapping my head around it also.  I read that if you are an owner and draw a salary from the business that the deduction will not apply.  So, it favors passive over active owners. IDK if that is true.  Like docnews, I am hoping for some clarification from Kitces and others once it is passed.  We have both active and passive options available to us and can play with the amounts that go into either.  Years ago this setup was very beneficial.

    #86111 Reply
    Avatar spiritrider 
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    Status: Small Business Owner
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    WCI: As pointed out by docnews the deduction is limited by your (MFJ in your case) taxable income on Form 1040 Line 43 not counting the deduction. It is not based on any individual businesses that you own.

    Also, it is a 20% deduction not a credit (as I also first thought) on a maximum of $315K for maximum deduction of $63K. At the maximum MFJ taxable income ($315K) this deduction falls entirely within the new 24% tax bracket. The maximum tax savings is as docnews stated is $15,120.

    #86116 Reply
    Vagabond MD Vagabond MD 
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    I am also confused by the wording, and I expect that there will be some clarification moving forward.

    I understand that my professional income from my professional corporation is not eligible for this “deduction”.

    I am wondering if our imaging center business, in which we are investors with other parties in a separate corporation, which passes through income through an LLC, to the tune of about $50k/investor per year, would be eligible for this deduction. Currently, we pay ordinary income tax on these distributions. (Our salaries are otherwise above the $315k number, but I do not know if I am mixing apples and oranges).

    "Wealth is the slave of the wise man and the master of the fool.” -Seneca the Younger

    #86117 Reply
    Avatar Complete_newbie 
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    Status: Physician, Small Business Owner
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    Very interesting thread

    So dumb questions:
    1. 20% deduction applies to which entities? LLC is oass through so if business is generating 300k I can just slap 20% deduction ?
    2. What are the restrictions/phase outs ?

    #86118 Reply
    Zaphod Zaphod 
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    Im glad its not just me.

    #86119 Reply
    hatton1 hatton1 
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    Confused!

    #86121 Reply
    Avatar Complete_newbie 
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    Status: Physician, Small Business Owner
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    Yea hoping for dumbed down tl;dr version. Either way if I’m interpreting this right that 20% deduction is pretty huge for serial business owners

    #86123 Reply
    Avatar NJDoc 
    Participant
    Status: Physician
    Posts: 196
    Joined: 02/07/2016
    I am wondering if our imaging center business, in which we are investors with other parties in a separate corporation, which passes through income through an LLC, to the tune of about $50k/investor per year, would be eligible for this deduction. Currently, we pay ordinary income tax on these distributions. (Our salaries are otherwise above the $315k number, but I do not know if I am mixing apples and oranges)

    Click to expand…

    I have the same question as it applies to my Surgery Center income.

    #86124 Reply

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