Did you know that 2018 was the biggest year for marketing practices looking to generate 4-or-5 figure tax savings with a shiny new super deduction?
A major tax reform like this hasn’t occurred in over 30 years! The Tax Cuts and Jobs Act was a huge boon for marketing agencies in the US, especially when a massive super deduction under Section 199A was introduced.
Super Deduction – Section 199A
One of the major changes to the Tax Code was a 20% super deduction for qualified business income. I call this a super deduction because it’s a tax benefit that’s generated out of thin air and not tied to any of your business expenses.
It was introduced to level the playing field between the reduced tax rates for corporations and the higher tax rate for individual business owners. The super deduction haircuts your net business income you report on your tax return to 80%.
Super Deduction Example – Six-Figure Agency
Let’s assume you run your marketing agency in a wholly-owned Limited Liability Company (“LLC”):
- You gross $10,000 in revenue per month from running paid advertising campaigns for your clients.
- You incur $1,000 in expenses per month to manage your back office platforms and software.
- Your total business profit in 2019 is $108,000.
Assuming that the various limitations don’t apply, your super deduction is $21,600. Your after-tax savings could be anywhere between $3,000 to $6,000!
What are the Super Deduction limitations?
You can never assume that you’re going to get the full benefit of a tax break because of all the exceptions. This is why it’s important to consult your Tax Strategist to see if there is an opportunity to build the savings into your Strategic Tax Plan.
There are two primary limitations that impact marketing agencies trying to take advantage of the super deduction. Both limitations kick in once you’ve exceeded the lower Income Threshold – $157,500 for single filers and $315,000 for joint filers. The higher Income Threshold ends at $207,500 for single filers and $415,000 for joint filers in 2018. These thresholds are adjusted for inflation every year.
The two primary limitations that apply to marketing practices are:
- Specified Service Trade or Business (“SSTB”)
- Wages Paid to Employees (“W-2 Wages”)
Let’s explore both limitations below.
Specified Service Trade or Business (“SSTB”)
How you run your marketing practice or agency will dictate whether the SSTB limitations apply. The general rule of thumb is: if the income of the business depends on the reputation and/or skill of one employee, then your business income would be categorized as an SSTB… which is bad.
If your business is an SSTB, every additional dollar your business makes over your Income Threshold will reduce your super deduction by 1%. So if you’re single and making over $207,500 then you’re SOL. This limitation applies on top of the W-2 Wages limitation found below.
How do you avoid classifying your practice as an SSTB if you’re over the income threshold? It depends on your business model.
If your business model is:
- 1-on-1 or group sales and marketing coaching, or
- Contracted labor for digital, content, or social media marketing
Then the business model depends on the reputation and skill of one employee (you!) and your super deduction will fall under the SSTB limitations.
However, if your business model is:
- Selling courses or information products through a web platform, or
- Your agency has contractors performing most of the marketing work
Then it’s quite possible that your super deduction will not be classified as an SSTB.
The W-2 Wage limitation becomes a factor after you’ve exceeded the lower Income Threshold.
If you pay employees (1099 contractors don’t count) in your business then it’s possible that the 50% W-2 wage limitation won’t apply. You might still be able to claim the full super deduction even after you’ve exceeded the lower Income Threshold (assuming your business isn’t an SSTB.)
If you don’t have employees, then you would look to the 2.5% of unadjusted tax basis limitation which, if you’re running a digital marketing agency, won’t be very much if anything at all.
Note that if your tax classification is an S-corporation or corporation, your business should be paying at least one employee – yourself. If not, you might need to get in touch with a Tax Strategist to fix that for you.
Not sure if the Super Deduction applies? Ask a pro!
As with all things in the tax world, the tax benefits you’re entitled to are going to depend on too many factors for you to research on your own. If you’re not sure on how these rules apply to your practice, touch base with your Tax Strategist. They should be able to work through your fact pattern to see if you’re eligible for immediate tax savings.
Don’t have a Tax Strategist to save you the big bucks? Get to know one on a 15-minute chat!