The “Pass-Through” Deduction – Part I

The Tax Cuts and Jobs Act is one of the most active topics for businesses and individuals right now. The new legislation contains a significant tax deduction that applies to qualified business income “(QBI”) of pass-through entities and sole proprietors – including partners in partnerships, members of LLCs taxed as partnerships, shareholders of S corporations, owners of single-member LLCs and sole proprietors not operating through any legal entity.

We will cover this issue in two parts – Part I will address the QBI issues related to “specified service businesses.”  Part II will address all other types of QBI.

Summary of the new pass-through rules:

  1. A new deduction of 20% of the QBI will effectively reduce the tax rate on such income by 20%. So, qualified income otherwise taxed at 24% will be taxed at 19.2%.
  2. Qualified business income will generally include the ordinary, operating income of a trade or business.
  3. The new rules are the same for ‘active’ and ‘passive’ investors and don’t change the rules governing net investment income taxes or self-employment taxes.
  4. For joint filers with taxable income below $315,000 (and lower amounts for single filers), there will be no limitations other than the requirement that the income be bona fide ‘trade or business’ income and not disguised ‘wages.’ However, those benefits will be phased-out as joint taxable income increases from $315,000 to $415,000, or as single filer taxable income increases from $157,500 to $207,500.
  5. For S corporations, it is safe to say there is no change to the requirement that ‘reasonable compensation’ be paid as wages to shareholders providing substantial services. As a result, a personal service business operating through an S corporation may effectively be ineligible for benefits.
  6. A specified service business service is defined as follows:
  • A specified service business includes firms involved in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services.
  • Engineering and architecture were specifically excluded.
  • Specified service businesses would also include any business, “which involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.”
  • The bill also includes “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees [or owners]” in the definition of a specified service business.


As with any major tax law change, there are ambiguities in need of clarification.  As the last bullet point above suggests, this particular prong of the specified service business definition will almost certainly have numerous interpretations.

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