As a small business owner or self-employed professional, you should be on the lookout for any tax savings possible. While you’ve given up some benefits associated with being a W-2 employee, you are now paying self-employment tax and probably have the additional expense of totally funding your company’s health insurance. All of these costs can add up very quickly!
Tax reform, or the Tax Cuts and Jobs Act signed into law in December 2017, offers something new and unique: a 20 percent deduction beginning in tax year 2018 (January through December 2018) on pass-through income from sole proprietors, limited liability companies, partnerships and S corporations.
In short, the 20 percent deduction applies to Qualified Business Income (QBI). This includes the net amount of income, gains, deductions and losses associated with a trade or business, but not investment-related items, such as capital gains or losses, dividends and interest income. In addition, the new deduction is taken below the line, which means it reduces taxable income not adjusted gross income.
Two Limitations on High-Income Earners
The Act does set limits on how much people with high incomes can deduct:- Professional service industries. If you work in health, law, consulting, athletics or financial fields, for example, the new rules deter high-income taxpayers from trying to convert wages or other compensation from personal services into income that qualifies for the deduction. The 20 percent deduction would begin to be phased out for those who earn more than $315,000 (for couples) and $157,500 (for singles). The deduction is fully phased out when income reaches $415,000 (for couples) and $207,500 (for singles).
- All industries. For high-earners in all other industries, the new act uses another calculation to limit the deduction. The limit would be set to whichever is higher: 50 percent of total wages paid or 25 percent of wages plus 2.5 percent of the cost of tangible depreciable property. This means pass-through entities that pay a large amount of employee wages or are in capital-intensive industries can take more of the deduction.
Tax Savings’ Opportunities
One benefit of working with a tax or accounting professional is the ability to explain this benefit in more detail as well as run various scenarios to optimize the 20 percent deduction.Here are three examples:
- Because of the phase-outs and threshold amounts, married taxpayers may want to compare married filing jointly versus married filing separately to see which status yields the higher benefit.
- Generally, it’s advantageous to reduce W-2 wages to minimize self-employment taxes. However, increasing W-2 salaries to a certain level may be necessary to optimize the 20 percent deduction. Thus, converting a 1099 contractor to a W-2 employee could be beneficial.
- Small businesses qualifying for the 20 percent tax deduction could see their effective marginal tax rate reduced to 29.6 percent. Under the new law, the top income tax rate for C corporations is reduced to 21 percent. C corporations are taxed twice (once on the income and then on the returns to investors), so it may not make sense to convert an S corporation to a C corporation.
Source: https://wordpress.intuit.com
Image Credit: Roberto Westbrook
Theresa Todman, Managing Partner/CEO of B&M Financial Management Services, LLC . Theresa works with small business owners and entrepreneurs to assist them with financial management and creating organized systems and procedures. She specializes in bookkeeping, accounting, QuickBooks solutions, small business tax issues and consulting.
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