New tax law gives pass-through businesses a valuable deduction

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Although the drop of the corporate tax rate from a top rate of 35% to a flat rate of 21% may be one of the most talked about provisions of the Tax Cuts and Jobs Act (TCJA), C corporations aren’t the only type of entity significantly benefiting from the new law. Owners of noncorporate “pass-through” entities may see some major — albeit temporary — relief in the form of a new deduction for a portion of qualified business income (QBI).

A 20% deduction

For tax years beginning after December 31, 2017, and before January 1, 2026, the new deduction is available to individuals, estates and trusts that own interests in pass-through business entities. Such entities include sole proprietorships, partnerships, S corporations and, typically, limited liability companies (LLCs). The deduction generally equals 20% of QBI, subject to restrictions that can apply if taxable income exceeds the applicable threshold — $157,500 or, if married filing jointly, $315,000.

QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss from any qualified business of the noncorporate owner. For this purpose, qualified items are income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.

The QBI deduction isn’t allowed in calculating the owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.

The limitations

For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the owner’s share of:

  • 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
  • The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.

Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year end and used by the business at any point during the tax year for the production of qualified business income.

Another restriction is that the QBI deduction generally isn’t available for income from specified service businesses. Examples include businesses that involve investment-type services and most professional practices (other than engineering and architecture).

The W-2 wage limitation and the service business limitation don’t apply as long as your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.

Careful planning required

Additional rules and limits apply to the QBI deduction, and careful planning will be necessary to gain maximum benefit. Please contact us for more details.

 

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Build a solid frame for your performance management system

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Most organizations reach a point where they could substantially benefit from formalizing their performance management system. Doing so typically isn’t easy, of course. Many employers prop up an old system involving an employee manual, perhaps various memos and an annual job review only to see it falter ineffectiveness or even collapse. To succeed at executing an effective performance management system, you need to build a solid frame by recognizing the foundational details.

Common tasks

Information overload is inherent to the development of any performance management system. So don’t be surprised if you and your team initially feel overwhelmed. To help you set realistic expectations, here are some of the most common tasks associated with designing a system:

Choose the number and types of performance categories to assess.
Design performance-review forms that are fair and appropriate for all employees.
Establish a sensible time frame for establishing and reviewing job duties and objectives.
Set up a schedule of formal job reviews, check-ins, and other interactions.
Secure approvals from managers and ownership.
By completing these tasks, and others like them, you’ll form the frame of your performance management system. And it’s here that careful; patient construction is paramount. Undertaken hastily, you could inadvertently create a cumbersome, bureaucratic and ultimately ineffective system.

Establish time estimates for implementing and administering each step in the new performance-management process. Specifically, ascertain the time each supervisor and a staff member will spend during each phase. Try to come up with ways to help both manage their time appropriately, such as implementing mandatory check-in sheets or setting up email reminders.

Sensible structure

It can be a painful irony when a performance management system ends up inhibiting supervisors and employees from doing their jobs and being productive. Done right, however, this method can provide a reliable structure for maximizing performance and helping employees envision their future with your organization. Contact us for more ideas on enhancing employee performance.

6 valid reasons to reject a domestic relations order

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With the U.S. divorce rate in the 40% to 50% range, your retirement plan is likely to receive a domestic relations order. These orders entitle an “alternate payee” to a portion of a participant’s retirement benefits.

But it’s up to you, the plan sponsor or administrator, to determine whether the order is qualified • making it a qualified domestic relations order. Although domestic relations orders are typically issued by a state authority, you can still reject one if it doesn’t comply with your plan’s terms. Here are six valid reasons to do so:

1. Inaccurate details. Sloppily drafted domestic relations orders may identify your retirement plan incorrectly, such as by naming the custodian instead of the plan by its legal name.

2. Inappropriate form of requested payment. This could occur, for example, if you have a defined benefit plan that doesn’t allow for lump-sum distributions, but the order calls for one.

3. Distribution timing issue. The order might request an immediate distribution, but your plan might allow distributions to occur only when the participant reaches retirement age.

4. Valuation timing issue. Suppose your defined contribution plan allows for the valuation of a participant’s vested benefits only on a quarterly basis. If the order calls for an immediate valuation of benefits so that a stipulated proportion (for example, 50%) of assets ultimately can be distributed to the alternate payee, you can reject the order.

5. Fluctuations in asset values. If the order doesn’t address an increase or decrease in the amount of plan assets between the order’s date and the date of distribution, this could lead to subsequent confusion and disputes.

6. Addressing the prospect of the premature death of an alternate payee. Your plan document might require that the order specify the implications of the death of an alternate payee before paying the retirement benefit. Thus, to be qualified, an order might, for example, stipulate that the interest be payable to the deceased alternate payee’s estate.

Should you need to reject a domestic relations order, work closely with your professional advisors to follow the applicable rules to issue the required formal notice. Remember, rejection isn’t likely the end of the matter; whoever drafted the domestic relations order will probably resubmit it. We can advise you on cost-efficient ways to manage your plan.

How long should you retain payroll records?

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Employers must exert a certain amount of time and resources to accurately retaining their income tax records. But these aren’t the only documents you need to maintain. Retention of your organization’s payroll records is also essential.

Rule of thumb

Most employers must withhold federal income, Social Security and Medicare taxes from their employees’ paychecks. As such, you must keep records relating to these taxes for at least four years after the due date of an employee’s income tax return (generally, April 15) for the year in which the payment was made. This is often referred to as the “records-in-general rule.”

These records include your Employer Identification Number, as well as your employees’ names, addresses, occupations and Social Security numbers. You should also keep for four years the total amounts and dates of payments of compensation and amounts withheld for taxes or otherwise —including reported tips and the fair market value of noncash payments.

It’s also important to track and retain the compensation amounts subject to withholding for federal income, Social Security, and Medicare taxes, and the corresponding quantities withheld for each tax (and the date withheld if withholding occurred on a day different from the payment date). Where applicable, note the reason(s) why total compensation and taxable amount for each tax rate are different.

Other data and documents

A variety of other data and documents fall under the records-in-general rule. Examples include:

The pay period covered by each payment of compensation,
The employee’s Form W-4, “Employee’s Withholding Allowance Certificate,”
Each employee’s beginning and ending dates of employment,
Statements provided by employees reporting tips received,
Fringe benefits provided to employees and any required substantiation,
Adjustments or settlements of taxes, and
Amounts and dates of tax deposits.
Follow the rule, too, for records relating to wage continuation payments made to employees by the employer or third party under an accident or health plan. Such records should include the beginning and ending dates of the period of absence, and the amount and weekly rate of each payment (including payments made by third parties). Also keep copies of each employee’s Form W-4S, “Request for Federal Income Tax Withholding From Sick Pay,” and, where applicable, copies of Form 8922, “Third-Party Sick Pay Recap.”

Simple rule, complex info

As you can see, the records-in-general rule is fairly simple, but the various forms and types of information involved are complex. Please contact our firm for assistance in managing the financial aspects of your role as an employer. Additional information can be found in our record retention guide.