Post Tax Reform Business Planning: Pass-Through Business Entities
One of the most significant and confusing provisions of the 2017 tax legislation is the qualified business income (QBI) deduction for pass-through business entities. Pass-through businesses account for about 95% of U.S. businesses and include sole proprietorships, partnerships, LLCs and S corporations. So, the impact of the legislation is significant and likely impacts most financial advisors’ business clients as well as the financial advisor.
Under the prior tax law, the taxable income from pass-through entities was taxed at the individual taxpayer’s rate. While this is still true for taxpayer’s W-2 wages, business owners’ pass-through income may receive a deduction to help lower the rate. With the first tax season since the legislation now behind us business owners are beginning to understand the impact of the legislation.
So, now is the perfect time for financial advisors to help educate clients about how the changes impact business life insurance.
So, now is the perfect time for financial advisors to help educate clients about how the changes impact business life insurance.
High Level Change in Pass-Through Business Taxation
At its simplest level the tax legislation provides up to a 20% deduction for qualified business income (QBI) for tax years 2018 to 2026. In general, QBI is ordinary income earned by a business within the United States, but does not include investment income such as interest, dividend, capital gains and it does not include W-2 wages earned as an employee. Implementing strategies to optimize this deduction will be a critical aspect of planning going forward.
At its simplest level the tax legislation provides up to a 20% deduction for qualified business income (QBI) for tax years 2018 to 2026. In general, QBI is ordinary income earned by a business within the United States, but does not include investment income such as interest, dividend, capital gains and it does not include W-2 wages earned as an employee. Implementing strategies to optimize this deduction will be a critical aspect of planning going forward.
Threshold Questions – What is the Taxpayer’s Taxable Income? Is the Taxpayer’s Business Activity Considered a Specified Service Business?
Two initial considerations for any discussion will be the income level of the taxpayer and the type of business generating the income. How much a taxpayer makes determines whether they can take a deduction. For taxpayers with taxable income below the “threshold amount” the deduction is the lesser of 20% of QBI from pass-throughs or20% of taxable income less net capital
gains. The threshold amount for tax year 2018 was $315,000 of taxable income for married joint filing and $157,500 for all other filers.
Two initial considerations for any discussion will be the income level of the taxpayer and the type of business generating the income. How much a taxpayer makes determines whether they can take a deduction. For taxpayers with taxable income below the “threshold amount” the deduction is the lesser of 20% of QBI from pass-throughs or20% of taxable income less net capital
gains. The threshold amount for tax year 2018 was $315,000 of taxable income for married joint filing and $157,500 for all other filers.
If taxable income is over the $315,000/$157,500 then it’s necessary to determine if the taxpayer’s business is a specified service business. There are 13 types of specified service businesses which generally include high income professions such as medical/health care, law, accounting, consulting, financial services, athletics, and performing arts. If the business is a specified service business the QBI deduction is eliminated for taxable income over $415,000 joint filers/$207,500 for all other taxpayers. Taxable income between $315,000/$157,500 and $415,000/$207,500 receive a proportionate deduction. In contrast, if the business is not a specified service business once it exceeds the $315,000/$157,500 threshold the business must pay wages or own property because the
amount of the deduction is based on the lesser of the following two calculations:
amount of the deduction is based on the lesser of the following two calculations:
- 20% of QBI; or
- the greater of (1) 50% of w-2 wages or (2) 25% of w-2 wages plus 2.5% of your qualified property cost
Unlike specified service businesses, there is no income cap for non-specified service business owners.
Impact on Life Insurance Fringe Benefit Arrangements
One area where the new QBI deduction may impact life insurance planning is in the fringe benefit area. From the discussion above it’s clear that for successful pass-through businesses that are not specified service businesses, the availability of the deduction can be dependent on wages paid to employees. This might increase the opportunity for bonus and restricted bonus arrangements for your business clients seeking to establish fringe benefit arrangements that attract and retain key employees. Highly compensated owners of specified services businesses will be looking for ways to reduce their taxable income. Since bonus and restricted bonus arrangements for non-owner employees are deductible expenses, financial advisors might see more interest in these arrangements for these business owners as well.
How DBS Can help
This year, your business clients will be trying to sort out the details of the tax reform legislation and how it impacts their business. This will give you the opportunity to make them aware of how they can utilize the changes to help achieve their planning needs. Questions about the recent legislation can be directed to DBS advanced case design resource, Terri Getman, JD, CLU, ChFC, RICP, AEP (Distinguished) at extension 230.
