Of special interest to entrepreneurs, self-employed individuals, and investors, the new tax law also includes a potentially significant tax benefit by allowing them to deduct 20 percent of their qualified business income (QBI). Here are the basics of how it works. The new rule provides many individuals with a deduction for QBI from a qualified trade or business operated directly or through a pass-through entity. The deduction has two parts. First, there is a deduction of up to 20 percent of QBI from a business operated as a sole proprietorship or through a partnership, S corporation, trust or estate (the deduction is limited by several factors, including total taxable income). Second, there is a deduction of up to 20 percent of combined qualified real estate investment trust dividends and qualified publicly traded partnership income. The sum of these two amounts is referred to as the combined QBI amount. The deduction is available, regardless of whether an individual itemizes their deductions or takes the standard deduction.
Qualified Small Business Stock (QSBS)
Although not technically part of the new tax law passed in 2017, it is worth mentioning the tax reform passed in 2015 allows investors a full tax break on capital gains associated with the sale of Qualified Small Business Stock (QSBS). While certain tax benefits of QSBS have been around for some time, the 2015 tax reform significantly expanded the tax benefits. Of course, not all stock is considered QSBS. Certain requirements must be met, such as the stock must be originally issued from a U.S. corporation, the tax basis in the gross assets of the corporation needs to be less than $50 million, the stock is required to be held for more than five years, and certain businesses don’t qualify, such as professional organizations, banking and financial businesses, farming businesses, and certain hospitality businesses. Nevertheless, the tax breaks offered by the sale of QSBS can provide a very attractive opportunity for investors who directly invest in small companies.
Tony McEahern is senior managing director of wealth planning for Cresset. Dan Terlep is senior managing director of financial and tax strategy for Cresset.