Pass-through deduction: Good news for the PEO industry

By Jim Mack
Managing Director

In good news for professional employer organizations (PEOs) and their clients, the Treasury Department and IRS last month clarified that being a client of a PEO does not affect pass-through tax deduction eligibility.

The Tax Cuts and Jobs Act of 2017, passed by Congress in December, created a new deduction for households with income from pass-through businesses – partnerships, S corporations and sole proprietorships that are not subject to the corporate income tax.

The deduction was designed to give a tax break to entities that otherwise wouldn’t have benefited from the corporate tax relief that was the cornerstone of the Trump administration’s tax reform agenda.

Called Section 199A, the pass-through deduction allows owners of these entities to deduct taxes generally equal to the lesser of 20% of the taxable profit of a business, or 20% of the excess of the individual’s taxable income over his or her net capital gains.

There was confusion after the tax bill passed as to whether businesses that used PEOs to pay their W-2 wages would qualify for this new pass-through deduction.

The clarifications issued in August by the IRS and the Treasury Department affirm that an owner of a pass-through business entity is entitled to the pass-through tax deduction.

“Some accountants had erroneously advised their clients that are pass-through entities that a PEO relationship might jeopardize their eligibility for this new 20% tax deduction,” according to a news release issued last month by the National Association of Professional Employer Organizations (NAPEO), a trade group for the PEO industry.

The IRS guidance clarifies that being a PEO client does not affect the eligibility of a pass-through entity to claim the Section 199A deduction.

As always, we advise PEO clients who believe they may qualify for the pass-through deduction to seek professional tax advice on the issue. Despite the IRS clarification, the regulations surrounding the pass-through are complex, and the IRS guidance didn’t clarify all issues. Still, this latest update is certainly good news for the PEO industry.

Capital Alliance Corporation is a Dallas-based investment banking firm with an extensive international reach and a 40+ year history of providing trustworthy advice to private company shareholders who want to sell their businesses. Our team has deep operational and M&A experience across many sectors, including human resource management.


Business Services