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Just Passing Through: New Deduction for Business Income Expires in 2026

pass through tax benefit dollarsUnder new IRC §199A, business entity owners may be able to deduct 20 percent of passthrough income. This tax boon, which is set to sunset after December 31, 2025, has many lawyers wondering whether they might personally benefit.

Almost any business can benefit from this new passthrough law: sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations. These passthrough entities include a law practice organized as a limited liability partnership (LLP) or professional corporation (PC).

The deduction for passthrough income is subject to three limitations:

  • Deductible income doesn’t include “reasonable compensation” for the business owner.
  • Deductible income doesn’t include income from personal services, including legal services.
  • The deduction is limited to 50 percent of wages paid to employees of the business.

But the second and third limitations are phased in over $100,000 of annual income above $315,000 for married taxpayers, and $50,000 of annual income above $157,500 for single taxpayers. So a married partner or shareholder with annual income of less than $315,000 may deduct passthrough income from the law practice without regard to these limitations.

Here’s an example of how it would work: Jody is the sole shareholder of a law practice with two associates, a paralegal, and an administrative assistant. Jody earns $200,000 per year from the practice. Her spouse earns $100,000 from an unrelated occupation. Because their combined income is less than $315,000 per year, the limitations don’t apply. As a result, it doesn’t matter how much she pays her employees. But if Jody and her spouse made more than $415,000 per year, they would be out of luck.

Assuming Jody’s reasonable compensation for her own services as an attorney is about $125,000 per year, she can deduct 20 percent of the remaining $75,000 of law practice income, or $15,000. This should save her about $5000 in state and federal income taxes.

For more on professional corporations, check out CEB’s Organizing Corporations in California, chap 6. On limited liability partnerships, see CEB’s Advising California Partnerships, chaps 9–10. Also check out CEB’s Selecting and Forming Business Entities, chaps 7–8 and 10.

Check out this other CEBblog™ post on the recent tax law changes: The Times They Are A-Changing (for Estate Planners). An overview of the new tax law changes is in the January issue of CEB’s California Business Law Reporter: Barrett, A Summary of HR 1 (aka the Tax Cuts and Jobs Act). And check out summaries, resources, and a free webinar and videos on the 2018 Tax Cuts and Jobs Act on

© The Regents of the University of California, 2018. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited.

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