As part of the Tax Cuts and Jobs Act, the way income from pass-through entities is taxed is changing. Starting in 2018, income earned through entities such as sole proprietorships, LLCs, and partnerships may be entitled to a 20% deduction before income tax rates are applied. The deduction is available beginning with the 2018 tax year but is currently set to end after the 2025 tax year, unless it is made permanent.

However, there are still some vague points and unanswered questions when it comes to the new law. The IRS recently provided some new guidance -- 184 pages worth -- on the pass-through deduction. Here's what we know so far.

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What types of income are considered "pass-through?"

Section 199A of the newly updated U.S. tax code allows owners of certain types of pass-through businesses to deduct as much as 20% of their business income. Generally speaking, this includes most business income not derived from ownership in a corporation.

For a little more color, pass-through income includes (but isn't necessarily limited to):

• Income from a sole proprietorship
• Income from an LLC or S-corporation
• Partnership income
• Income from rental properties (Including income passed through from REITs)
• Any S-corporation, partnership, or trust that owns an interest in another pass-through business.

To claim the deduction, the taxpayer may not be performing services as an employee. In other words, if any of the income from the pass-through business is wage income, that portion cannot be deducted. For example, if you own an S-corporation and receive a salary of $50,000 as W-2 wage income and separately receive $100,000 as business profits, you can't deduct the wage income portion.

Finally, owners of "specified service businesses" cannot use the pass-through deduction if their income exceeds certain thresholds. This list provided by the IRS includes businesses that perform services the following fields:

• Health -- including doctors, pharmacists, nurses, dentist, and more.
• Law -- specifically lawyers, paralegals, legal arbitrators, and mediators.
• Accounting
• Actuarial science
• Performing arts -- However, broadcasters are generally excluded.
• Consulting
• Athletics
• Financial services -- such as financial advisors, investment managers, and investment bankers.
• Brokerage services -- This only has to do with securities. Real estate brokers, for example, are excluded.
• Investing and investment management
• Trading
• Dealing in securities, partnership interests, or commodities
• Any trade or business where the "principal asset ... is the reputation or skill of one or more of its employees or owners."

Taxpayers with pass-through business income related to one of these types of service businesses must have taxable income (before the pass-through deduction) of less than $315,000 (married filing jointly) or $157,500 (other filing statuses). In other words, a married taxpayer who operates a financial services business with $250,000 in total taxable income could still use the deduction. Above these thresholds, the deduction begins to phase out until a maximum taxable income of $415,000 (married) or $207,500 (everyone else). So, if a married individual with one of these types of businesses has taxable income of say $375,000, they could still get a partial deduction.

What income qualifies?

In a nutshell, qualified business income means the amount a business generated after taking its income and gains and subtracting any deductions or losses. In other words, if your business earned a gross profit of $100,000 and is entitled to $40,000 in deductions, your qualified business income would be $60,000.

However, qualified business income does not include capital gains and/or losses, dividend income, interest income (unless it's part of the business' usual operations), gains from currency transactions, or any other type of investment income.

Income limitations

According the IRS guidance, taxpayers are entitled to a deduction equal to 20% of their non-corporation business income. However, there are some important limitations you need to know.

Specifically, the deduction is limited for high-income taxpayers to whichever of these two options produces the greater number:

• 50% of the W-2 wages with respect to the qualified trade or business.
• The sum of 25% of the W-2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

These don't apply when the taxpayer's total taxable income -- before any pass-through deduction -- is less than $315,000 (married filing jointly) or $157,500 (all other filing statuses).

Separately, there's another limitation. The pass-through deduction is also limited to the lesser of 20% of the qualified business income or 20% of the excess of taxable income over the taxpayer's net capital gain for the tax year.

This may sound a bit confusing, so here's an example. Let's say that a single taxpayer has $50,000 of qualified business income, $60,000 of long-term capital gains, and uses the $12,000 standard deduction for a total taxable income of $98,000. The deduction will be limited to the lesser of 20% of the $50,000 business income ($10,000) or 20% of the amount of the taxable income minus the capital gains (20% of $38,000, or $7,600).

It's complicated

The general takeaway is that this is a far more complicated deduction than it seems. You may think that you simply multiply your pass-through income by 20%, but unfortunately that's not always the case.

Furthermore, it's important to point out that these are just the key points. There's obviously a lot more in the IRS's 184-page guidance document than I can thoroughly cover in a roughly 1,000-word article. So, if you have a pass-through situation that isn't obviously qualified or not qualified, it's a good idea to consult a tax professional (which I am not) when the time comes to do your 2018 tax return.