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Pass Thru Deduction Explained

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  • Avatar docnews 
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    One more question, we are a C -corp. Income around 450-480K. If we give ourselves a W2 of 315K and the rest in dividends, will those dividends be charged at 20%, my marginal rate or (21% + 3.8% + 20% = 44.8%) ? Is dividends in C corp a pass through income?

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    My limited understanding is that you would be paying 23.8% (20% + 3.8%) on your dividends.

    480k – 100.8k (21%) – 315k (W2) = $64200 in dividends

    I was also under the impression that dividends in a c Corp are NOT pass thru income

    Perhaps someone with a better understanding could clarify for us?

    Click to expand…

    Correct C corps are not pass thrus and C corps’ dividends still face “double taxation”.

    #93419 Reply
    Avatar Caligas 
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    For those with a Corp, how can you have all of your income as K-1? I thought you had to keep the “business income” portion relatively limited to avoid audit.

    We do $100k as distributions/k-1 and the rest (250k) as w-2.

    #93430 Reply
    Avatar docnews 
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    I’m glad we can now file our taxes on a postcard.  ?

    Click to expand…

    More will be able to if they are employed and don’t have any pass thru / side gig income. Then the scrutiny will really be on those with schedules (especially C since A has no misc section now) whose taxes seem to be more confusing (at least until IRS clarification). I believe if you own a pass thru your audit risk will be higher in general.

     

    Employed docs who don’t give much to charity are likely to just need the 1040, especially if they are failing to do bdRoth which the average WCI disciple does but not your average doc.

    #93433 Reply
    Avatar docnews 
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    For those with a Corp, how can you have all of your income as K-1? I thought you had to keep the “business income” portion relatively limited to avoid audit.

    We do $100k as distributions/k-1 and the rest (250k) as w-2.

    Click to expand…

    I’m not well versed in this since it isn’t advantageous for me but from my recent research the K1 has lots of types of income listed on it. Some people might be saying dividends when they really mean guarenteed payments which this deduction is treating like wages which I think is fair since it is given despite how the partnership does.

    K1 lists your share of and its breakdown for a partnership. See attached IRS form.

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    #93435 Reply
    Avatar TheGipper 
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    Haven’t read most of this thread so apologies if redundant, but interesting article on Evergreen Small Business blog yesterday on who qualifies as as a service professional for the purposes of the 20% deduction.

    Depends on your interpretation of the following definition:

    “trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”

    Author implies that this may disqualify many professionals who previously assumed they were in the clear (ie bloggers). One would need to be able to point to a discrete asset that is more valuable to the company then the reputation or skill of the primary owner/employee (ie writing skill or financial knowledge of WCI).

    Its going to be a mess to figure out who qualifies and who the IRS goes after, unless you are one of the blessed few such as engineers or architects, who have been given the green light.

    #93466 Reply
    Avatar docnews 
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    Haven’t read most of this thread so apologies if redundant, but interesting article on Evergreen Small Business blog yesterday on who qualifies as as a service professional for the purposes of the 20% deduction.

    Depends on your interpretation of the following definition:

    “trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”

    Author implies that this may disqualify many professionals who previously assumed they were in the clear (ie bloggers). One would need to be able to point to a discrete asset that is more valuable to the company then the reputation or skill of the primary owner/employee (ie writing skill or financial knowledge of WCI).

    Its going to be a mess to figure out who qualifies and who the IRS goes after, unless you are one of the blessed few such as engineers or architects, who have been given the green light.

    Click to expand…

    True, could be trouble for WCI but I think blogging is passive enough. WCI is not actively advising but fostering community beyond his skills. The first thing people think of when it comes to passive income is a web-based businesses and real estate, but we all know it takes a lot of active participation to setup and manage.

     

    For your average IC doc that can make it below $415k taxable income this stringent definition will not apply.

    #93499 Reply
    Kkhanmd Kkhanmd 
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    Another questions, if I have a S corporation and make around 480K, If I pay myself 315K on W2 and the rest 165K as S corporation distributions or dividends, does that distribution qualifies for (20 + 3.8)% tax rate?

    #93514 Reply
    Avatar Sergio Estavillo 
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    Another questions, if I have a S corporation and make around 480K, If I pay myself 315K on W2 and the rest 165K as S corporation distributions or dividends, does that distribution qualifies for (20 + 3.8)% tax rate?

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    It’s my understanding the 1st threshold you must clear (for professional service organizations) is taxable income.  If your married taxable income is >$415k, you are not eligible for the Qualified Business Income deduction.  Your taxable income would be, at a minimum, your W2 wages plus K-1 item #1 Ordinary Business Income.

    #93542 Reply
    Liked by docnews
    Avatar docnews 
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    Sent changes to POF for my article after a deeper read of the bill:

    How is the deduction calculated?

    It’s the least of the following 3 calculations:

    1) 20% of your taxable income. If the majority of your income is from your business, this will be applicable to you.

    2) 20% of your business income. If your service business is a side gig and your main job does not generate too much income to hit the limitation described above, this will be applicable to you. For those with service S Corps this includes dividends and wages.

    3) 50% of your nonservice S Corp W2. This does not apply to those with only doctor income. Those below the taxable income limit are exempted from this wages calculation and those above the taxable income are excluded from this deduction. If you pay yourself less than 40% of your nonservice business profits (ie >60% dividends), this will be applicable to you. This is because 50% of W2 on 40% of all = 20% on all income (Calculation 1). As someone who lives in a state that adds an extra S Corp tax, it was not advantageous to use this to circumvent Medicare taxes. For those doctors in a service S Corp no changes will change their ability to get this Pass Thru Deduction since this is based completely on the taxable income limit. I see this as guidance written into the code for those who use nonservice S Corps to be more reasonable. For those who are reading this and are not business owners, this W2 is not the same as the one you get from your employer and this article is not for you. For those pass thru businesses with sizeable depreciable assets such as real estate or machinery there is an alternate calculation of 25% of the W2 plus 2.5% of unadjusted basis that can be used if larger than 50% of the W2. Ironically those nonservice businesses without W2s or depreciable assets above the taxable income limit such as a married sole proprietorship with a taxable income >$415k would get no deduction and will likely be advised to setup an S Corp if the setup costs were less than the tax savings but I doubt few of these exist since the FICA exemption on the dividends should already make an S Corp useful.

    #93554 Reply
    Avatar docnews 
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    Another questions, if I have a S corporation and make around 480K, If I pay myself 315K on W2 and the rest 165K as S corporation distributions or dividends, does that distribution qualifies for (20 + 3.8)% tax rate?

    Click to expand…

    It’s my understanding the 1st threshold you must clear (for professional service organizations) is taxable income.  If your married taxable income is >$415k, you are not eligible for the Qualified Business Income deduction.  Your taxable income would be, at a minimum, your W2 wages plus K-1 item #1 Ordinary Business Income.

    Click to expand…

    True if you change “minimum” to “maximum” unless you have another source of income because you have to include all the deductions/adjustments.

    Tax Reform! How Physicians and the Self-Employed are Affected

    #93555 Reply
    Avatar Bartl007 
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    Found this great article over in the bogleheads forum and thought it was worth sharing. Some good examples to help get your head around the variables.

    https://www.forbes.com/sites/anthonynitti/2017/12/26/tax-geek-tuesday-making-sense-of-the-new-20-qualified-business-income-deduction/#f0bd4df44fda

    #93558 Reply
    Avatar docnews 
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    Docnews seems right on s-Corp deduction if w2 wages and dividend. From bill conference section which is a little easier to read than actual bill:

    “The taxpayer’s deduction for qualified business income for the taxable year is equal to the sum of (a) the lesser of the combined qualified business income amount for the taxable year or an amount equal to 20 percent of the excess of taxpayer’s taxable income over any net capital gain69 and qualified cooperative dividends, plus (b) the lesser of 20 percent of qualified cooperative dividends and taxable income (reduced by net capital gain). This sum may not exceed the taxpayer’s taxable income for the taxable year “

    Qualified business income is the dividend minus reasonable salary. Taxable income should be wages or wages plus dividend? Weird wording but it adds up to all s-Corp income (provided you meet the phase in and the other wage limits.) For those of us near but under 315k total taxable income we get the $15000 tax cut, not bad! I’ll still wait for the spelled out IRS interpretation or consensus interpetation though.

    Click to expand…

    I think I’m wrong again. Article from Forbes:

    http://flip.it/oviq5h

    Basically w2 for s-Corp owner probably not deductible? I’ll wait for IRS to clarify.

     

     

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    Very interesting LONG article. I am starting to see consensus on other articles that the 50% w2 limit is limited by the taxable income limit. So therefore if your income is >$415k you use the lesser of 20% of taxable income or 20% of qualified business income.

    Then the topic at hand is the QBI definition: does it exclude s corp w2 wages / reasonable compensation even for those below the taxable income limit? If so what does this mean for a sole proprietorship’s QBI? Do they also need to make up a reasonable compensation? If not, couldn’t all single person s corps dissolve to get this deduction? Please let us know IRS!

     

    Click to expand…

    I reread the bill and answered my own question. For those who need to read it for themselves note page 34 (ii) which specifically includes W2 wages for those is this service business exception. Basically service S Corps under the taxable income limit just like sole proprietorships can include all business income (dividends+W2).

     

    For those who think the 50% w2 calculations applies to businesses under the taxable income limit see pages 25-26 exemption from the limit that excludes 2B which is w2 calculations.

    #93559 Reply
    Kkhanmd Kkhanmd 
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    Status: Physician
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    This is what I found about C corporations that they will be taxed at 21% and (? maybe) dividends are not taxed? Is this true? There is so much confusion.

    I am posting this white paper revised Dec 22 here

     Using corporations as tax shelters. C-corporations will be used to shelter income from
    the top ordinary income rate, with no further protections added to the bill to avoid this
    outcome. As we described in our prior report, the use of corporations as tax shelters can
    result in labor income only being taxed at the preferential 21% rate, and entirely
    eliminate the “second layer” of tax when an individual receives a dividend or sells the
    corporate stock (for example, through the through step-up in basis at death).

    https://poseidon01.ssrn.com/delivery.php?ID=601116105008116122097029066076074105042086062072079074028086127029087074031104113120107060033115123035020099119029109013075021043086006050076114019083071078106089119064015034122066027012073122031030110065114021006028111074003093077091120077104118127095&EXT=pdf

     

     

    #93601 Reply
    cgossage cgossage 
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    The taxation of dividends has not changed. So if you are in the upper tax bracket, you would be paying 23.8% tax rate on the dividends you receive.

    If there is a way around that I would sure like to know what it is.

    Clint Gossage CFA, CFP, CPA
    cmgfin.com

    #93605 Reply
    Liked by docnews
    Avatar docnews 
    Participant
    Status: Physician
    Posts: 412
    Joined: 01/09/2016

    This is what I found about C corporations that they will be taxed at 21% and (? maybe) dividends are not taxed? Is this true? There is so much confusion.

    I am posting this white paper revised Dec 22 here

     Using corporations as tax shelters. C-corporations will be used to shelter income from
    the top ordinary income rate, with no further protections added to the bill to avoid this
    outcome. As we described in our prior report, the use of corporations as tax shelters can
    result in labor income only being taxed at the preferential 21% rate, and entirely
    eliminate the “second layer” of tax when an individual receives a dividend or sells the
    corporate stock (for example, through the through step-up in basis at death).

    https://poseidon01.ssrn.com/delivery.php?ID=601116105008116122097029066076074105042086062072079074028086127029087074031104113120107060033115123035020099119029109013075021043086006050076114019083071078106089119064015034122066027012073122031030110065114021006028111074003093077091120077104118127095&EXT=pdf

     

     

    Click to expand…

    What I believe this is saying is your company could hold onto to the dividends until death so your family gets it with a step up in basis or you give yourself the dividends when your tax rate is lower like possibly in retirement. I’m not well versed in this since my income will be below 21% overall tax after my personal deductions. If you make near a million maybe the extra administrative burden would be worth it but from what I gathered you would not have access to all of your money at this 21% rate. I am not sure how much profit can be held in the business before it raises red flags with the IRS. Either way if you are making that much from a personal business surely you have an accountant who could run this scenario for you. You would need one anyways if you were trying to be a c corp.

    #93623 Reply

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