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The New Tax Law: Pass-Through Income -- WSJ

14 Feb 2018 7:32 am

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (February 14, 2018).

The tax overhaul created a new deduction of 20% of net income for many pass-through business owners, effectively lowering their top rate to 29.6% from 37%. Lawmakers made the change as a boon to firms that won't benefit from the cut in the top corporate rate to 21% from 35%.

So-called pass-through businesses include millions of partnerships, limited-liability companies, S corporations and sole proprietorships that don't pay corporate taxes or dividends. Instead, their net income flows directly to the owner's personal return and is only taxed once, at the owner's individual rate.

Businesses organized as pass-throughs include large private companies, as well as fast-food franchises, manufacturers, investment funds, law firms and mom-and-pop businesses.

Pass-through owners can claim the 20% deduction if their taxable income is under $315,000 for joint filers or $157,500 for single filers. Above that, the new law has important limits that are designed to reduce the measure's cost and prevent higher-earning pass-through owners from claiming a business tax break for what is really their own labor income.

High-earning doctors, lawyers, accountants, consultants, investment advisers and other owners of service businesses generally can't claim the 20% deduction. Separate restrictions are tied to the level of wages paid and capital investment.

Phase-outs, exceptions and gray areas in these limits make this new tax break highly complex, and tax advisers are struggling to figure it out.

For example, tax specialists say the owner of a chain of tanning salons should qualify for the new tax break, while someone who earns the same amount from a group of dermatology clinics won't.

A high-earning chef who owns her restaurant can expect to get the new deduction -- unless she is a celebrity chef. In that case, she may not be able to qualify because the write-off isn't available to owners earning above the limit if the business's principal asset is the "reputation or skill" of its employees or owners.

Tax specialists are looking to the IRS for guidance on these and other issues raised by the new pass-through deduction.

--Michael Rapoport and Ruth Simon

Write to michael.rapoport@wsj.com and ruth.simon@wsj.com

(END) Dow Jones Newswires

February 14, 2018 02:32 ET (07:32 GMT)

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