The Tax Cuts and Jobs Act still has that new car smell, and it’s providing us with a unique opportunity to help self-employed clients and small business owners reduce their tax burdens.
For entrepreneurs, one of the most exciting aspects of the new law is a 20 percent deduction for qualified business income from “pass through” entities, which include S corporations and limited liability companies.
If you are self-employed, and are confused about whether you qualify for this new tax break or if you should restructure your business to reduce your tax burden, here is some helpful information.
Under previous tax laws, business income would “pass through” to owners and was subject to individual income tax rates as high as 39.6 percent.
But now, business owners whose taxable annual income falls below certain levels can claim a 20 percent deduction, according to a recent analysis piece by CNBC.com. The income thresholds are $157,500 for individuals or $315,000 for those who are married and file jointly.
Filers whose taxable income falls below those levels can take the deduction no matter what business they’re in. However, when an entrepreneur’s taxable income exceeds the threshold, some limitations are imposed. For example, entrepreneurs who own service businesses – including doctors, lawyers and financial advisors – might not be able to claim this deduction if their income is too high, CNBC.com reported.
In addition, partners inside a business might see a scenario in which one of them gets the 20 percent deduction but the other doesn’t. This can happen when a partner with a high-income spouse surpasses the taxable income threshold.
Between the lines
The new deduction is a “between the lines” deduction, meaning it does not lower your adjusted gross income and you don’t have to itemize it on your tax filing, CNBC.com reported.
If you do qualify, the 20 percent break applies to the lesser of your qualified business income or your taxable income, minus capital gains.
It’s important for those of you who are self-employed to understand how to tell the Internal Revenue Service to tax your businesses. Do you own a partnership or an LLC? If you are set up as an LLC, are you filing your taxes as an S-corp or a C-corp? What you choose matters for a variety of reasons.
Don’t qualify? Get creative
If your taxable income is too high to qualify for the 20 percent deduction, then there are some creative solutions that we can explore, CNBC.com reported.
Saving more money for retirement may recapture these savings. The overall contribution limit for defined contribution plans is $55,000 – that includes the $18,500 employees can put into a 401(k). A self-employed person could put the maximum into a retirement plan to help lower his/her taxable income and get yourself under the threshold.
Another option for S-corp owners is to reduce the salary you collect and classify more of the business’ money as “profit.” The IRS provides guidelines as to what is a “reasonable” salary, and you could justify a lower salary based on a wide range of factors.
If you are self-employed and have questions about structuring your business for tax purposes, how the new tax law affects you, or about making changes to your estate and business planning, we’d be happy to meet with you at our office.