Who Benefits from Trump's Tax Cut Law

The Tax Cut and Jobs Act of 2017 was meant to simplify the process of doing one’s taxes—at least that was the promise of President Trump. While the tax cuts that Trump pledged to sign into law did finally arrive late last year, simplicity is not a term that neatly summarizes the piece of legislation, according to Nitti (2017), Forbes contributor. This paper will discuss how Nitti (2017) explains the new 20% qualified business income deduction, showing there is more to it than meets the eye.
The first thing needed to know about the new deduction is that defining one’s business from the outset is important. One has four basic choices to choose from: C corporation, sole proprietorship, S corporation, and partnership. C corporation owners are doubly taxed—first, when income is earned at the business level, and under previous law, the tax rate stood at 35%. Dividends to shareholders, once paid, when then taxed—the second tax—and that rate stood at 23.8%. The other three types of business—sole proprietorship, S corporation and partnership—are different in that they are taxed once, not twice. A sole proprietor, for example, reports income on a schedule C of one’s individual return. For an S corp or a partnership, the income of the business is distributed to the businesses owners, who then report it on their individual tax returns. In all three cases, the business owner pays taxes on the income at rates that can rise as high as 40.8% under the old law.
Trump’s Tax Cut and Jobs Act reduced the C corporation tax rate from 35% down to 21% (Nitti, 2017). Under the new law, “the advantage of a single level of taxation would shrink from 10% to just 2.8%” (Nitti, 2017). This is crucial to understanding the 20% qualified business income deduction. Since some of the country’s largest businesses operate as sole proprietorships, S corps or partnerships, there was pressure on Congress to get them a cut as well. This is where Section 199A of the new tax code comes into play.
Section 199A lets owners of the other three types of businesses “to take a deduction of 20% against their income from the business” (Nitti, 2017). This in turns lets business owners who do not classify as a C corporation still maintain “their competitive rate advantage”—just as it was a 10% rate advantage under the old tax code, so too will it be a 10% rate advantage under the new code (Nitti, 2017).
However, the Section 199A gets complicated the more one looks into it—which means that the supposed 20% deduction is by no means a guarantee for everyone. In order to get the deduction, one has to negotiate “a tangle of limitations, terms of art, thresholds, and phase-ins and phase-outs, with one critical definition thrown in the mix that could potentially jeopardize” the entire qualification (Nitti, 2017). What constitutes a qualified business income under the new code?
Qualification depends on how the formula is applied. The new deduction is meant to be equal to the sum of two parts. The first part is: the lesser of either the combined qualified business income or 20% of the excess of taxable income that is over the sum of any net capital gain. The second part is: the lesser of either 20% of qualified cooperative dividends or taxable income less net capital gain. In other words, an owner of an S corp, sole proprietorship or partnership in 2018 will be able to deduct the LESSER OF:
· 20% of of the taxpayer’s “qualified business income” or
· THE GREATER OF:
· 50% of the W-2 wages with respect to the business, or
· 25% of the W-2 wages with respect to the business plus 2.5% of the unadjusted basis of all qualified property (Nitti, 2017).
The qualified business income is simply the ordinary income, minus ordinary deductions earned through the business. It does not include wages one pays oneself as an employee. A self-employed contractor worker would qualify for the 20% deduction. A wage employee would not. It does not include the following: income from interest or dividends, or short- and long-term capital gains/losses.
Still, there are limitations that apply. For example, the 20% deduction can only be used to a point, defined by another either/or—this time, the greater of either 50% of one’s allocable share of W-2 wages paid or 25% of one’s allocable share of W-2 wages paid plus 2.5% of one’s allocable share of unadjusted basis of qualified property that is acquired. The limitations are designed to prevent business owners from changing their business types in order to take advantage of the deduction, which is why the first “lesser than” stipulation applies.
In conclusion, the 20% deduction looks good on paper, but in practice there are few things that have to be considered before a business owner can use it. The type of business is important, and limitations that are set on the deduction are also crucial. Not every business owner will be able to obtain the 20% deduction. The variables that will act as factors in the outcome are: the corporation type, what constitutes qualified business income, wages paid, and unadjusted basis of acquired property—if any. Once those variables are factored in, the business owner will be able to see the extent to which the 20% qualified business income deduction serves him.