We discussed the Tax Cuts and Jobs Act in a previous blog post, but six months after the bill took effect, there are still parts of the new tax law that need clarification as small businesses, home owners and tax professionals await guidance from the IRS.
1) Pass through Deductions
The general consensus is that the tax changes have been well received by U.S. corporations as the top corporate tax rate was reduced to 21% from 35%. But for non-corporate businesses known as “pass-throughs”—S-corporations, partnerships, LLC’s or sole proprietorships—the effect is less clear. The new tax law establishes a deduction of up to 20% of qualified business income generally defined as the net amount of qualified items of income, gain, deduction, and loss from any qualified business. Business income does not include investment income, guaranteed payments and reasonable compensation income from the business. Business owners that provide personal services (except engineers and architects) are not eligible for the deduction unless their income is below certain thresholds. A single taxpayer with taxable income of $157,500 or less ($315,000 or less for married couples filing jointly) will be entitled to the full 20% deduction, subject to the taxable income limit.
The pass-through deduction, which expires in 2026, is quite complicated, leaving business owners unclear exactly how to calculate it and wondering how the IRS will police it. There is a growing urgency for the guidance to be issued as soon as possible, so that businesses can plan to take advantage of the deduction.
2) Real estate deductions
The new tax prohibits interest deductions for home equity loans, unless the funds are used for home improvements. In the past, homeowners could borrow up to $100,000 of home equity debt for any purpose, including paying for college, paying down debt, or buying a new car and then deduct the interest on the loan. Those transactions no longer qualify for an interest deduction. As of 2018, the law states that interest on home equity loans is deductible only if the money is used to “buy, build, or substantially improve” one’s home. There is no guidance yet from the IRS about what counts as a substantial improvement.
Businesses are still sorting through the impact of the tax law, which is the first major tax reform in the U.S. since 1986. The IRS and U.S. Treasury have issued some guidance already, but more is needed. It is estimated that it could take months or years to understand the full effect of the changes. The outcomes will play a large role in determining just how much business and homeowners can reduce their tax bills.
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