Business owners have long sought the advantages of incorporation, including personal liability protection, while avoiding what is often a significant income tax drawback of incorporation, double taxation of income (once when the corporation is taxed for the income and once when shareholders are taxed for the distribution of this income as dividends).  Current federal law generally permits pass-through entities to avoid this double taxation of income.  Income earned by these entities is permitted to “pass-through” to its owners and is taxed a single time to the owners of the business.  Pass-through entities generally include corporations that make an S corporation election under federal law, as well as sole proprietorships, partnerships, and limited liability companies.

Under the federal Tax Cuts & Jobs Act, as introduced, the House of Representatives Ways and Means Committee majority tax staff indicates that active owners or shareholders of pass-through entities would generally be permitted to have a portion of their net income from the pass-through entity treated as “business income” subject to preferential income tax rates ranging from 9% to 25% when fully implemented, verses regular income tax rates ranging from 12% to 39.6%.  These active owners or shareholders of pass-through entities would generally be permitted to have 30% of their net business income subject to these more favorable rates as “business income.”

However, under the federal Tax Cuts & Jobs Act, as introduced, personal service businesses in such fields as engineering, law, financial services, accounting, performing arts or consulting would generally not qualify to have any net business income taxed at the more favorable rates as “business income,” except to the degree it was claimed under a formula based on the business’ actual capital investments.

In addition, unlike business owners actively participating in the business, all net income derived from a passive business activity would be eligible to be taxed as “business income” at the preferential income tax rates of 9% to 25% when fully implemented.

[Legal advice not only involves an understanding of the law, but the application of the law to a particular set of circumstances or facts.  Typically blog posts are imperfect tools to address the subtlety and exceptions of the law that may apply in particular situations.  As a result, the information in this blog post does not represent legal advice.  If you are in a situation where you need or desire legal advice, we would be happy to help.  Call 608-358-9413 to set-up a no-charge initial consultation.]