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Taxing Pass-Through Income After Tax Reform in 2018

By : Mark Battersby

 

Confusion is the name of the game as a result of lawmakers’ attempts to level the playing field between the new 21-percent tax rate for incorporated feedlots and the tax bills of owners of pass-through businesses, creating a new 20-percent income deduction for pass-through income as part of the Tax Cut and Jobs Act (TCJA).

Despite that 20-percent deduction, the owners of feedlots and other businesses operating as pass-through entities such as partnerships, limited liability companies (LLCs), S corporations and sole proprietorships, might find themselves facing personal tax rates as high as 29.6-percent—far above the new 21-percent corporate tax rate.

Pass-through business entities, those that don’t pay taxes but, instead, pass income (and losses) onto the personal income tax returns of their owners, have long been extremely popular. Now, thanks to the TCJA, owners of pass-through entities, even those that pay no wages, can deduct 20-percent of their income below $315,000 (half that amount for single taxpayers). For income above that level, the 20-percent deduction remains—but only for “business profits.” In other words, that 20-percent deduction from pass-through income applies only to business income that has been reduced by the amount of “reasonable compensation” paid the owner.

An unintended consequence of the lowered tax rate for regular corporations is that a majority of businesses currently operating as pass-through business entities find themselves paying more in taxes by remaining as a pass-through than they would by revoking the S corporation election or switching from pass-through to regular corporate form.

The TCJA contains a more complicated and convoluted way to calculate the tax on pass-through income, placing limits on who can qualify for the pass-through deduction, with strong safeguards to ensure that so-called “wage income”  oes not receive the lower marginal tax rates for business income. For pass-through income above the threshold, the new law also provides a deduction for up to 20-percent— but only for “business profits.”

In the eyes of many experts, there is no longer a reason to operate a cattle operation as an S corporation or other pass-through entity. With the taxes on regular, ‘C’ corporations reduced to 21-percent, many operators have begun taking a closer look at pass-through entities and questioning whether they remain a good entity for operating a business.

However, converting from a pass-through entity to a regular‘C’ corporation can be a complicated process requiring quite a few adjustments.

With a regular ‘C’ Corporation, writing off a medical reimbursement plan, educational expenses that do not exceed $5,150, having a company car and many other fringe benefits are feasible and often aren’t classified as dividends and can avoid the dreaded double tax.

Because S corporations and other pass-through entities attempting to convert to regular, ‘C’ corporation face new rules under the TCJA, professional guidance is obviously needed, especially when attempting to decide which type of business entity is right for the feedlot operation—and which will produce the lowest possible tax bill under the Tax Cuts and Jobs Act.

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