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Pass Thru Deduction Explained

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  • Avatar AustinDoc 
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    So as you understand, you get the first 315k 20% deduction no matter what then just get less up to $415k?  That seemed fair (and logical) to me but when I read the actual information and the bill, it doesn’t have a phase out, only a delineation.  I hope you are correct.  That would partially offset my lost property tax deduction.  Where are our organizations on advice?  You would think the AMA and ADA would be putting out some guidelines since almost all of us in private practice are S-Corps.

    #90557 Reply
    Avatar Caligas 
    Participant
    Status: Physician
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    Joined: 12/19/2017

    I thought that when physicians formed an S Corp that they only pay a portion of income through distributions and the rest is regular w2 income.

    Our group does 100k as distributions, so I assume that only that portion gets the deduction.

    #90559 Reply
    The White Coat Investor The White Coat Investor 
    Keymaster
    Status: Physician
    Posts: 4601
    Joined: 05/13/2011

    Let’s publish a Pro / Con piece on this. We’ve almost got enough material here already; it just needs to be better organized.

     

    Tax drag is minimal if you never realize any gains. In fact, it could be negative thanks to tax loss harvesting. But it’s basically the 2% yield x 23.6%, so 0.47%. 

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    Don’t forget 5% UT state income tax. Now you’re up to 0.57%. If dividend yield increases even 5 or 10 percent, your tax drag will exceed the DAF fee.

     

    Why do you think that letting money sit in your DAF for a decade before giving it is better than just giving it? Who do you think is benefitting from it sitting there? 

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    I’ll admit it makes the most sense for someone like me who has cut back on earned income with plans to drop even further into the lower tax brackets by retiring early. Unless online income fouls up those plans (woe is me  ? ), I could potentially be in the 12% federal income tax bracket in two short years.

    I also think there’s a psychological benefit, particularly for the naturally frugal person who doesn’t love to part with money. You’ve read that vacation can be more enjoyable if it’s pre-paid, and you may be more likely to do things you otherwise would not have chosen to pay for a la carte. I think it’s like that with the DAF for me. I’ve got a pre-paid endowment that will allow me to donate $10K or more per year for decades based on a 4% SWR. If I had no income, I might be less inclined to give away a five-figure sum each year. But the DAF money is already out of my hands. It will be given away, and I can’t change my mind and decide to be stingy later on.

     

    If I had another $100K that I felt like I could give to charity right now, I would have already given it to charity. What’s the point of making the pit stop in the DAF? I don’t think the charity cares if it gets the money on 12/31 or 1/1. Only the IRS cares. 

    Click to expand…

    That’s mostly true, but if you normally give $10,000 per year, but last year you gave $20,000, they might expect at least that much next year. They might even budget based on prior year’s donations. When they get nothing from you, that might not sit well or be unexpected. I have a feeling a lot of charities will see a dropoff from 2017 to 2018, unfortunately. Using the DAF allows you to practice “donation smoothing.”

     

    Without any charitable contributions, we wouldn’t even itemize in 2018. So we’d pick up another $14K in standard deduction. So donating $100K right now would knock $46K off this year’s tax bill at the expense of paying another $36K next year in taxes. ($4K saved by the tax arbitrage, and $6K from doing the new standard deduction next year.) If we decide to give more next December (which we probably will), we just hold it until January 2019. 

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    Bunching itemized deductions is a smart strategy, especially with the $24,000 standard deduction. A DAF makes that really easy. Load it up every few years, itemize that year, and give consistently to charities large and small every year.

    Without the DAF, if you want to donate $50 here and a few hundred there, you won’t see any tax benefit from those gifts in 2018 if you’re not itemizing. “That’s fine,” you might say. To which I say, if you’re willing to part with $100 to the soup kitchen, would you rather give them exactly $100 and have it cost you $100 or give $180 via the DAF at a cost to you of $100?

    The DAF will be a better giving strategy than before if we have the higher standard deduction and SALT limitations.

    We give from ours quite often. When the school sends home catalogs for our boys to sell overpriced crap to our friends and neighbors, we toss the catalogs in the recycling and donate directly to the school’s PTO instead. I don’t feel right pressuring people we know and like to buy things they don’t need and probably don’t even want. Isn’t that what MLM is for? ?

    Cheers!

    -PoF

     

     

    Click to expand…

    Okay, you’ve got a little bit of an valid argument in there about the little tiny donations. I still think it’s pretty weak. Let’s do the Pro/Con.

     

    I woke up this morning at 5 am in disbelief that I’d be taking the standard deduction in 2018 and realized that I should be trying to prepay my property taxes (actually, I should do that whether or not I take the standard deduction next year.) I think the changes to the bill just prevent you from prepaying income taxes and deduction them, not property taxes, right?

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    Our county will not allow prepayment of personal property tax. YMMV

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    I called this morning. Mine will. The state will take income tax early too, but that won’t do me any good.

    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

    #90563 Reply
    Liked by Vagabond MD
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 412
    Joined: 01/09/2016

    So as you understand, you get the first 315k 20% deduction no matter what then just get less up to $415k?  That seemed fair (and logical) to me but when I read the actual information and the bill, it doesn’t have a phase out, only a delineation.  I hope you are correct.  That would partially offset my lost property tax deduction.  Where are our organizations on advice?  You would think the AMA and ADA would be putting out some guidelines since almost all of us in private practice are S-Corps.

    Click to expand…

    The bill includes the phaseout on page 27 in the following thick legalese:

     

    ii) AMOUNT OF REDUCTION.—The amount determined under this subparagraph is the amount which bears the same ratio to the excess amount as— ‘‘(I) the amount by which the taxpayer’s taxable income for the taxable year exceeds the threshold amount, bears to ‘‘(II) $50,000 ($100,000 in the case of a joint return).

     

    Basically the ratio is at a 100% when you have (415k-315k)/100k. So at $415k of taxable income your excluded.

    #90623 Reply
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 412
    Joined: 01/09/2016

    I thought that when physicians formed an S Corp that they only pay a portion of income through distributions and the rest is regular w2 income.

    Our group does 100k as distributions, so I assume that only that portion gets the deduction.

    Click to expand…

    No, the lesser of 50% of the s corp w2 or 20% business income (which includes the salary and dividends) or 20% your taxable income.

    #90624 Reply
    Avatar Caligas 
    Participant
    Status: Physician
    Posts: 68
    Joined: 12/19/2017

    Ok, and the highest possible tax savings for a physician from this deduction is about $15,000?

    #90625 Reply
    Liked by docnews
    Avatar Caligas 
    Participant
    Status: Physician
    Posts: 68
    Joined: 12/19/2017

    I think I get it now, the $100k you earn over the 315k limit costs you that deduction of $15k, so it’s like an additional tax of 15% for this income, or a federal marginal rate of 15 + 35=50%.

    #90626 Reply
    Liked by docnews, Dr. Mom
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 412
    Joined: 01/09/2016

    Ok, and the highest possible tax savings for a physician from this deduction is about $15,000?

    Click to expand…

    Yup you got it now. $15,120 to be exact.

    I’m surprised the media including on the internet is slow to cover this. Rumor has it POF is on the case to rectify it 😉

    #90629 Reply
    Avatar tex 
    Participant
    Status: Physician
    Posts: 140
    Joined: 01/11/2016

    Ok, and the highest possible tax savings for a physician from this deduction is about $15,000?

    Click to expand…

    Yup you got it now. $15,120 to be exact.

    I’m surprised the media including on the internet is slow to cover this. Rumor has it POF is on the case to rectify it

    Click to expand…

     

    Sorry for the newbie tax question coming from somebody who’s never worked as an independent contractor: let’s say as married IC you could hit exactly 315k taxable income and set yourself up as a pass-through entity. How does the increase in self-employment taxes vs W2 compare with the new 15k deduction? I know you can deduct 1/2 of SE taxes… just confused

    I imagine lots of W2 docs are wondering if all else being equal (for simplicity’s sake) what the pass through deduction means if you switch from W2 to 1099

    #90657 Reply
    Avatar beagler 
    Participant
    Status: Physician
    Posts: 273
    Joined: 07/08/2017

    To show the math:
    315000 x 20% x .24= 15120

    Assumes business income w2 plus s Corp shareholder draw/ distribution of 315000. Then 20% deduction on marginal 24% tax rate.

    Are you sure business income is w2 wage plus draw and not just the draw? If so great for s-corps under 315k

    Solo Internist, Midwest

    #90707 Reply
    Avatar Caligas 
    Participant
    Status: Physician
    Posts: 68
    Joined: 12/19/2017

    Anyone figured out how the AMT will play into this pass through deduction issue?

    #90708 Reply
    Avatar beagler 
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    Status: Physician
    Posts: 273
    Joined: 07/08/2017

    Kitces says:

    “In addition, Qualified Business Income (eligible for the deduction) does not include “reasonable compensation” to an S corporation owner-employee (which, similar to the rules for FICA taxes on S corp owner-employees, prevents them from under-paying themselves on salary “

    Sounds like w2 salary for s-Corp owner employee not deductible?

    If the AMT kicks in for large pass through deduction how much would it negate the benefit? Someone do the crazy math! Ugh.

    Solo Internist, Midwest

    #90726 Reply
    Liked by Dr. Mom
    Avatar beagler 
    Participant
    Status: Physician
    Posts: 273
    Joined: 07/08/2017

    Page 32 of the bill says qualified business income does not inculde reasonable payment for services rendered.

    I read that as owner w2 salary not deductible. ;(

    Solo Internist, Midwest

    #90730 Reply
    Liked by Dr. Mom
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 412
    Joined: 01/09/2016

    Kitces says:

    “In addition, Qualified Business Income (eligible for the deduction) does not include “reasonable compensation” to an S corporation owner-employee (which, similar to the rules for FICA taxes on S corp owner-employees, prevents them from under-paying themselves on salary “

    Sounds like w2 salary for s-Corp owner employee not deductible?

    If the AMT kicks in for large pass through deduction how much would it negate the benefit? Someone do the crazy math! Ugh.

    Click to expand…

    Kitces: “Notably, though, these wage limits to the QBI deduction apply only if the taxpayer’s own taxable income (not AGI, but taxable income after deductions) exceeds a threshold of $157,500 for individuals or $315,000 for married couples … Similar to the W-2 wage limits, the specified service business limit will only apply to those whose taxable income exceeds the thresholds ($157,500 for individuals, and $315,000 for married couples).”

    #90742 Reply
    Avatar beagler 
    Participant
    Status: Physician
    Posts: 273
    Joined: 07/08/2017

    How sure are you? Here’s another interpretation:

    Section 199A Qualified Business Income Deduction: Big Savings for Small Businesses

    I read Kitces as saying limitation for over 315k applies to 50% w2 but not to definition of qualified business income.

    The bill say lesser of combined qualified business income (draw?) or 20% of taxable income ( profit or total income?) But who knows it is dense legalese. I hope you’re right and s Corp w2 is deductible, but seems unclear.

    Solo Internist, Midwest

    #90769 Reply
    Liked by Dr. Mom

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