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Pass-Throughs and the New Tax Law: Should You Form One?

pass through and tax law - the authors guild

pass through and tax law - the authors guild

It seems like everyone has been trying to figure out how the new tax law will affect them—and authors are no different. Neither, for that matter, is the IRS, which has provided relatively little guidance on how to interpret many of the unclear elements of the new law. We previously reported on the principal changes in the law that will affect authors and all individuals, with a note that our tax advisors were still trying to determine whether the new deduction for pass-through entities would apply to authors. Well, guess what: There is still no definitive answer.

Authors and other creators have been eager to find out whether they should use a pass-through entity such as an S corporation, partnership, or sole proprietorship to take advantage of the new 20% deduction (from qualified business income) for pass-throughs. The deduction was included in the law as a way to provide a tax break to pass-through entities with some parity to the radically lowered tax rate for corporations (from 35% to 21%).

Since these types of entities are not subject to income tax (because the entity’s income “passes through” to the employee-owners, who are then taxed as individuals), 20% of the income that such an entity passes through could be deducted, substantially reducing the income on which the owners would ultimately be taxed. This could be of real benefit to sole proprietorships.

The hitch is that the law limits the types of pass-through entities that are eligible to take this 20% deduction, and expressly carves out “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more employees [i.e., owners]” (Section 1202(e)(3)(A) of the Internal Revenue Code). This restriction is meant to prevent employees from becoming contractors and using pass-throughs to take advantage of the tax break. While we have not yet heard from the IRS as to whether this provision excludes authors’ and other creators’ pass-throughs from the deduction, its broad language does seem to sweep them in. That would be unfortunate since authors and other creators who own their copyrights are not ever considered employees and so the rationale for the carve-out does not apply to them.

According to Robert M. Pesce, CPA, of Marcum LLP: “We are concerned that authors will be caught in the catch-all service description where the principal assets of such trade or business is the reputation or skill of one or more of its employees or owners. We’ll see what comes out of Treasury, but in general, IRS and the Code perceives writers’ book royalties as essentially being a service.”

Stay tuned… Mr. Pesce will provide an update in a Guild webinar he is presenting on March 20, 2018 entitled Tax Tips for Authors. In the meantime, the Guild is continuing to monitor the IRS’s and accountants’ interpretations of the new law and will let you know if we learn any additional information.

We continue to recommend that our members consult with financial professionals in order to determine the best approach for your individual circumstances.