Tax law: How to get the pass-through deduction by reducing taxable income

Advisers are only eligible for the full 20% deduction if their income is less than $157,000 for singles and $315,000 for married couples

Mar 7, 2018 @ 5:24 pm

By Greg Iacurci

The pass-through provision in the new federal tax law has some financial advisers salivating over a potentially substantial tax break.

However, the 20% deduction on pass-through business income doesn't apply to all taxpayers equally. Because financial advisers work in "service" businesses, they're ineligible for the pass-through deduction if their overall taxable income exceeds a certain limit.

Single taxpayers get the full deduction if their income is below $157,500; for married couples, the limit is $315,000.

The question becomes: If advisers' taxable income exceeds these thresholds, how can they reduce it to claim the deduction on pass-through business income?

"It's profoundly expensive to be above $315,000 if you're married and the owner of a service business," said Leon LaBrecque, managing partner at LJPR Financial Advisors. "So I'm better off doing a whole bunch of other things [to reduce taxable income]."

Possible avenues include: making contributions to certain types of retirement plans, making large charitable gifts and buying new equipment for the business, for example. The tax savings for taking these steps could be substantial.

(More: Tax reform: 7 essential strategies for financial advisers)

Let's consider the hypothetical example of a married couple with pass-through business income of $300,000. The couple also has $15,000 in additional income, for a total taxable income of $315,000, making them eligible for the full pass-through tax break.

The couple would be able to exclude $60,000 (a 20% deduction on $300,000 in business income), and would pay taxes at a marginal tax rate of 24%.

The deduction is phased out for single filers with income between $157,000 and $207,500 and for couples with income between $315,000 and $415,000. At the higher limits, the deduction is totally phased out.

To stay below those income levels, certain strategies can be employed.


"The easiest, most obvious [strategy] is using a 401(k) plan," Mr. LaBrecque said.

Advisers could reduce their taxable income by a maximum $55,000 in 2018, which includes employer plus employee contributions, with a 401(k) plan. The maximum is $61,000 for those ages 50 and over.

So, an older, self-employed adviser with pass-through income of $370,000 can use a solo 401(k) plan to deduct $61,000 from income taxes and get the pass-through deduction, Mr. LaBrecque said.

"You're getting a double bang for your buck," he said.

Cash-balance plans can offer an even greater deduction, perhaps to the tune of a few hundred thousand dollars, advisers said.

"If the deduction you're trying to get is under $55,000 or $60,000, a 401(k) plan will typically work," said Jason Kolinsky, a financial planner at Kolinsky Wealth Management. "If you want to do more than that, that's when you're typically looking at a cash-balance plan."

These plans are a type of pension plan, but feel more similar to defined-contribution plans than to traditional pensions, he said.

The caveat, advisers said, is owners should expect to establish cash-balance plans for several years and be willing to make plan contributions for employees during that time period. They're also generally more costly to administer than 401(k) plans, Mr. Kolinsky said.

Another important distinction: Cash-balance plan contributions would reduce the net business income — the contribution is made at the business level, not the individual-owner level, said Timothy Steffen, director of advanced planning in the Private Wealth Management group at Robert W. Baird & Co.

For example, if a partnership with two 50% owners and $500,000 in profit makes a $50,000 pension contribution, it dips the partnership's taxable income to $450,000. In this case, each of the business owners' taxable income by $25,000.

(Again, the business owner's taxable income is what determines if he/she gets the 20% pass-through deduction.)


Making large charitable gifts is also a way to reduce taxable income. Advisers can only offset a certain percentage of their income through charitable donations, Mr. Steffen said.

They can offset up to 60% of their income in a given year by gifting cash to a public charity (like a donor-advised fund); a gift of stock only offsets up to 30%. So, advisers with taxable income of $1 million, for example, wouldn't be able to solely gift their way to the pass-through deduction.


The tax law changed rules around bonus depreciation — through 2022, business owners will be able to write off 100% of the cost of a new piece of equipment in the year it was purchased, Mr. Steffen said. (It was 50% for 2017.) That percentage will then ratchet down in 20% increments, eventually hitting 0% in 2027.

The effect is a reduction in taxable income, via a reduction in business income. For example, let's say the sole owner of an advisory business with $500,000 in profit buys a $200,000 piece of equipment. The adviser can take a $200,000 write-off in 2018 and ink a $300,000 total profit.

"Advisers sitting marginally over the income threshold can look at what they want to do in their office, like new furniture or computers," said Mr. LaBrecque.


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 30


Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video


The #MeToo movement and the financial advice industry

Attendees at the Women to Watch luncheon commend the #MeToo movement for raising awareness about the issue of sexual harassment and bringing women together.

Latest news & opinion

What to watch for next with the DOL fiduciary rule

Much hinges on whether the Labor Department appeals the 5th Circuit decision by April 30.

Social Security benefits losing buying power

Low inflation combined with rising Medicare costs threaten the adequacy of seniors' income.

Finra looks to streamline broker-dealer exams

CEO Robert Cook says three examination teams may be consolidated.

The 401(k) robo-revolution is here

Could human advisers be displaced as digital-advice firms use technology to deliver services to plan sponsors and participants?

SEC forging ahead on fiduciary rule despite DOL rule decision in 5th Circuit

Chairman Jay Clayton says 'the sooner the better' when asked when an SEC fiduciary rule will be ready.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting It'll help us continue to serve you.

Yes, show me how to whitelist

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print