Pass-Thru Income Deduction
evergreensmallbusiness.com
evergreensmallbusiness.com
Over the last 10 years I have had experience with small business taxes, small business retirement plans, and various estate-tax avoidance schemes. The tax code is a joke. It rewards people who have the resources to game it, and it employs an entire class of people who specialize in doing just that. Its demoralizing, but while it exists, everyone has to play the game.
Edit: Also, that same site has an even more detailed summary of the deduction here:
https://evergreensmallbusiness.com/sec-199a-qualified-busine...
But if I have to shut down while my competitors stay open just because they hired a better CPA? Especially as a small business? That's a problem for me. A much bigger problem than the tax rate being 22% instead of 21%.
That's what was so nice about a pass-through entity: It was both politically and revenue neutral. All of the profits flowed through to the taxpayer and the politics and revenue occurred there. Terms like "fairness" had no relevance to them.
It could not have been simpler and it was completely outside the sphere of the political discussion on taxes.
But now, by answering a question that nobody asked, the new tax code politicizes the passthrough entity and, in my opinion, will eventually lead to its discontinuance - or at the very least, layers of complication added every time we revisit this topic.
I benefit maximally from this change to passthrough entities but it is a benefit I never asked for and that will hurt me (and all of us) in the long term.
This article is a clear example of that, laying out 10 different things you need to know with complicated formulas for deduction and professions that do and do not get benefits. What a mess.
Right now, I spend a few thousand/year and an annoying amount of time to make sure I'm doing it right.
I am amazed at how far from the stated goal of "We want you to do your taxes on an index card" this bill is going to come out as... and saddened that the majority of voters supporting the GOP won't feel fleeced by it.
*(with the exception of those preparers that very much want to keep the complexity and rich people/large businesses that can exploit loopholes effectively)
Perhaps the people who look at a tax return as free money from the government won't feel fleeced, but anyone who understands the concept of saving for retirement should be able to put together that we're having our tax burden lessened by $1k-$2k per year and, in exchange, needing to almost entirely fend for ourselves in retirement.
It's not a tax return, it's a tax cut. That means the government is taking less money from me (not giving me more money). I don't know anyone under 35 that's actually counting on SS on being there for them (not saying they're happy about, but most realized 10+ years ago that it's not gonna happen). That was a reality before this happened.
Those kinds of people are the ones that don't think far enough ahead to realize that what's being taken from them, retirement, is much more valuable than what's being given to them, a small tax cut. But anyone with an actual retirement plan should be furious because those programs--that we've paid into for our entire working careers--will be supplying us with significantly less than they would otherwise.
Yes, we've known that Social Security isn't going to be enough on its own ever since Bush II replaced all the money with IOUs, but until this tax cut, there was a reasonable expectation that those programs would survive in some form and augment our 401(k) and IRA accounts. Now, we're basically on our own. And with the Republican unwillingness to deal with health care, we'll likely be left to fend for ourselves in that area...convenient since that's the most expensive part of life when it comes to medical expenses.
But hey, the 0.01% got it rough and need some tax relief, right?
The same happens in a lot of companies. IT develops rules for IT people and the regular user is screwed.
Generally these changes have some sort of champion requesting them and don't just arise from the ether. I'm not sure we can explain it all away as Congress not realizing that their decisions will advantage large business interests at the expense of smaller ones, particularly when the beneficiaries are also sponsors.
I've often wished a test city/state would be allowed to just do a flat tax and completely remove all tax code and see what happens.
Obviously the convolutedness is a barrier to entry to small startups and a unfair advantage for established market entities.
Also I'd love to see an experiment on a zero tax law that basically amounted to no taxes unless the business/person earned a net profit of something deemed reasonable (say 30-50k in a modern society).
Why our societies constantly try to suffocate individuals trying to innovate and create value for his fellow members of society is beyond me.
That's the kind of armchair philosophizing that leads to all kinds of problems, we need more scientific method and less philosophy if we want to get anywhere in a productive manner.
There's plenty of counter points to be made about the sales tax. Here's two.
1. Its the most efficient tax.
2. It has the lowest economic damage.
For point #2, the idea is that if you can increase the wealth everyone benefits, since economics is not a zero sum game. Also you can get around whatever you deem vital needs/rights i.e. food, shelter, in your society through subsidizing. Here's some other information from an economic perspective as well (https://www.taxanalysts.org/content/economic-analysis-can-st...).
Anyway, to say its even more regressive and we don't need to experiment is not progressive. We have ostensibly the same goals (more wealth for everyone, fewer people in poverty/elimination of poverty,etc) and the only way to get at social systems that optimally give us our goals is to apply a more rigorous scientific method and get out of the political philosophy camp - IMHO :)
How would we ever make any progress in medicine if we never conducted any experiments and relied instead purely on observational studies? How much slower would our progress be?
see: https://www.thoughtco.com/the-economics-of-sales-taxes-11475...
No I absolutely would be, so long as it is formed in a traditional experimental design. I wouldn't want anything I was proposing above or you are here to just be globally implemented, since we don't actually know how it would work out. So, I freely admit my bias. But the only way to counter bias and make progress is with data and a process for checking yourself. For me, that is the scientific process, anything else is really just us following our emotions which doesn't lead anywhere fruitful, that's my point.
This has been shown wrong since the trickle down economists trickled down on us all.
I don't want a flat tax (as in "all income taxed at 15%," let's say) because a flat tax has an unfair impact on people at lower income levels. But, otherwise, I agree with your entire post. Here's my ideal law, with the caveat that I have zero legal training beyond six seasons of Law and Order and four seasons of Suits:
(1) The following marginal rates are established:
(Emphasis here: these numbers are made up for demonstration purposes only.)
- $0 through $13,000: 0%
- $13,001 through $25,000: 5%
- $25,001 through $46,000: 8%
- and so on
(2) All money earned, by whatever means and from whatever source, by a person or legal entity resident in the United States shall be subject to the tax specified above.
(3) The Internal Revenue Service shall, no later than the 15th of April of each calendar year (or the next day following the business day after the 15th of April if the 15th of April falls on a Saturday, Sunday, or federal holiday), prepare and mail to each holder of an EIN, each person for whom any tax or income declaration form (such as W2, 1098, 1099, and similar) has been submitted to the IRS, a statement of what the IRS believes the taxpayer owes or is due as a refund.
(4) If the IRS has notified the taxpayer that the IRS believes the taxpayer is due a refund, the taxpayer may notify the IRS of a financial account located inside the United States into which such refund shall be deposited or may request a paper check for such refund or, under such rules as the Secretary shall provide, make a request for United States Savings Bonds. Any request must be made within five years of the date the taxpayer knew or reasonably should have known that the refund was due, otherwise the refund is the property of the Treasury absent a showing of exigence.
(5) If the IRS has notified the taxpayer that the IRS believes the taxpayer owes additional taxes, the taxpayer shall make payment to the IRS no later than the 15th of July following receipt of said notice (or the next day following the business day after the 15th of July if the 15th of July falls on a Saturday, Sunday, or federal holiday) by providing the IRS with debit instructions for a financial account located inside the United States or via a paper check or other form of transfer of dollars.
(6) In the case that the taxpayer disagrees with a notice provided by the IRS under paragraphs 5 or 6, the taxpayer shall, no later than the 15th of July following receipt of said notice (or the next day following the business day after the 15th of July if the 15th of July falls on a Saturday, Sunday, or federal holiday), file the tax forms designated by the IRS under such rules as the Secretary shall provide, to indicate what the taxpayer believes is the proper tax due or refund owed. If the taxpayer still owes additional tax, the tax payment shall be due at the time of filing. The IRS shall have 120 days to respond, otherwise the taxpayer's submission is deemed valid and binding upon the IRS.
(7) There is no paragraph seven.
You remove this important policy tool, offering no other tool to replace it.
The tax code should, in my current view which I'm willing to entertain rebuttals against, be used to raise revenue for the operation of the government. If you want to use the government to encourage other behaviors, do it in another way, like direct payments or some other incentives I can't think of right now, but keep the tax code simple lest we wind up with, frankly, the mess we have now.
Every non trivial system gets more complex with time, as you discover more and more edge cases, similar to software, and as we all finding out now, a rewrite would replace a known set of issues with an unknown set of issues.
What about barter? If I trade my property or time for someone else's property or time without it ever being denominated in "money, cash or equivalent," is that taxable? From the recent controversy, does a graduate school education have a taxable value when it's offset by work the graduate student does for the University?
What about inherited wealth? Does an inheritance count as income? From one perspective, at T-1, you didn't have it and at T you did. But from the family unit perspective, nothing changed. If someone's spouse dies, since their 50% ownership of communal property just increased to 100%, is that taxable? If not, how is that really different than leaving wealth to children or extended family?
What about expatriates? If someone lives in France, earns money in France and pays French taxes, do they pay US taxes too? What if they work part time in France and part time in the US...does that earn them the lower marginal rate in both countries despite earning a much more comfortable living?
These kinds of overly-simplistic tax plans always seem to breakdown in accounting for situations that happen in the real world. And once all the necessary questions have been asked and the answers incorporated into the tax code, it's not that much simpler than what we currently have. Yes...the tax code is an overly-complex maze of crap that tends to benefit those with the best team of CPAs. But we're better off fixing that without throwing out the entire thing and starting from scratch.
If you're a software developer operating either as a sole proprietorship or as an S corporation, I don't think you'll get the deduction. (If you have an LLC, that doesn't mean anything to the IRS; it's treated either as a "disregarded entity", i.e. a sole proprietorship, or as an S or C corp if you've taken that election.)
See Steve's comment on the article from 12/19 at 2:48 PM, replying to someone asking whether developers and other IT professionals would get this break:
> The Sec. 199A statute references another older chunk of tax law, Sec 1202(e)(3)(A). It says this:
> “…any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees…”
> So computer/IT consulting pretty clearly fits within the “consulting” category.
> Also, if you’re a one person business, it seems pretty tricky to argue against the position that the principal asset of the business is the reputation or skill of the 1 employee doing the work.
I would appreciate correction if I'm misunderstanding this, as I certainly like tax deductions!
From the bill text: https://www.congress.gov/bill/115th-congress/house-bill/1/te...?
“(3) EXCEPTION FOR SPECIFIED SERVICE BUSINESSES BASED ON TAXPAYER'S INCOME.—
“(A) IN GENERAL.—If, for any taxable year, the taxable income of any taxpayer is less than the sum of the threshold amount plus $50,000 ($100,000 in the case of a joint return), then—
“(i) any specified service trade or business of the taxpayer shall not fail to be treated as a qualified trade or business due to paragraph (1)(A)
But I've always read about games you could play, like buying the office building you operate in and then charging your software business an exorbitant amount of rent. It seems like that's a lot more overt than just a "gray area" though.
What if you're a one-person business but you're a reseller or a consignment shop like most mom-and-pop stores? That takes very little skill or reputation.
Not trying to argue, that's an actual legitimate question I have.
I don't see how that vague wording couldn't be expanded to cover everyone, it'd certain cover Trump with his self-professed "Brand Name Value" pretty much all he ever sells is his name.
Is it just me or is it a bit disheartening that they have defined this using the term `thru` which google defines as `informal spelling of through`?
Isn't a legal document about as formal as one can get? I'm just worried it opens opportunity for confusion from the ambiguousness of language.
Slippery slope: Next thing we'll see is a law defining how much of a deduction you get with the money with wings emoji.
Since it's a pass-through, it seems like taxable income might be roughly the same either way, so maybe it doesn't impact the size of the deduction all that much. Has anyone thought through this?
I don't think that makes a whole lot of sense. Do people actually do that?
How the hell is this being touted as making the tax code simpler?
For example:
$0 - $20,000 - 0% (yes, poor people wouldn't pay sales tax. You could even make it so poor people get a discount, even.)
$20,001 - $40,000 - 5%
etc.
The above tiers would be defined by income plus assets times some interest rate, to represent potential gain on assets, if it were liquidated and invested. So if you had 1M in assets, and made $100,000 a year, your income would be $100,000 + 1M * federally defined interest rate.
The main difficulty with this would be that debit/credit cards would have to be issues by the government or there would have to be some collaboration between the government and banks in order to accurately determine purchases.
I think the deduction is 20%. If I understand it correctly then what it means is that if you have earned $100k then you are taxed only on $80k and 20% (20K in this case) is your deduction.
Can someone confirm/deny it.
If your company earned $100k, and paid you $50k, you can deduct 20% of the 100k capped at 20% of your ordinary income ($50k), for a total deduction of $10k.
BTW - There is no 20% tax. There is a 20% deduction for some pass-thru income.
If other people or real estate work to generate the income, go for it!
I literally jumped for joy... then I read #5, and had a sad. I still come out better than I originally thought, but not as good as #4 led me to believe.
It underscored just how whacked things are. The next twenty years will change society. What now seems like a personal responsibility (for everyone to save for retirement) will fail so thoroughly that it will become a massive societal problem. I know so many people who pat themselves on the back for "being responsible" by putting a few hundred bucks into their Roth during tax season. It's dumbfounding how insufficient that is.
Students and people with service income think that tech people have it made. In reality we're probably more like the middle managers of the early 80's, earning one notch above the blue collar union folks. We don't really know if we'll make it to retirement before ageism or a crashing market will make our savings irrelevant.
If you're making a big salary working for tech, your not as well off as you think. You may be earning x10 more than a the average "poor" person, but after income taxes, sales tax, property tax, etc, it's barely x5 to x6. And if google forces you to live on the penninsula, then your living costs are x5 to x10. I'm sure there are plenty of high tech working families in 150k to 250k range who are barely making ends meat. Those with kids will be especially hit hard: the exemption for those kids is now gone. Millenials in CA are being hit really hard with this housing crisis: the birth rate is at it's lowest it's ever been since the great depression in 1933.
lol, you made me laugh.
"Look, I know it looks like I make more than you Mr Grocery Bagger, but I have a lot of property taxes on my mansion and Ferrari. So you see, I barely make 5 times more than you!"
Most of the spending goes to housing and groceries. When you spend 3 million+ on a extra crappy house with a leaky rough and 1500 sq ft in palo alto, do you see what i mean?
Penninsula house prices are roughly 1-2.5 million now, and the lower range ones are pretty crappy, often in a bad neighborhood.
Also, are you getting value out of living on the penninsula? If so, is it worth the cost you're paying? If not... move. There are plenty of companies outside of SV and now quite a few of the companies there have very flexible remote working options.
As for your 10x income being reduced to 6x, do you honestly feel justified making more than 2x as someone else? Why are you as a person worth twice any other person?
It seems weird to take the fruits of someone's labor. I mean, if you can make your bed twice as fast as I can, I don't demand that you come over and make 1/3 of my bed.
And if you grow your crops, but do it much better, yielding more fruit, it would be wrong of me to take a 1/3 of your crops.
For someone in a 25% tax bracket, the additional $1,000 credit is basically the same as a $4,000 exemption.