On Dec. 22, 2017, President Trump signed the Tax Cuts and Jobs Act into law. This new tax code is meant to benefit small business owners by offering a large deduction for qualified business income from pass-through entities, as well as providing several tax benefits to the self-employed. Learn more about what exactly that means for you (and your taxes) below.
Besides small businesses and self-employed people, pass-through businesses — businesses that define the profits of the company as income for the owner — also receive a 20 percent tax deduction on profit thanks to the new code. As a result, this allows people who are self-employed or who work as contractors to pay less money than those receiving a paycheck directly from their employer.
“For example, a contractor doing the same work as a plumber but booking that income to a limited liability corporation would get a significant tax break compared to an employee working as a plumber for a company,” writes policy reporter Bob Bryan in a December 2017 article for Business Insider.
What’s more, before the new tax code, if you were self-employed and your income was less than $127,200, you were required to pay Social Security and Medicare taxes at a rate of 15.3 percent. In comparison, employees of a business only needed to pay 7.65 percent while their employer paid the rest.
In most cases, with the new legislation, the aforementioned 15.3 percent tax no longer applies to income that also qualifies for the lower small business rate. In a November 2017 article for CBS News, financial advisor Ray Martin says the combination of these two benefits “could save almost 30 percent in tax on a portion of income for many self-employed people.”
Increased deduction cap on equipment
The new tax code also expands an existing tax break already used by many self-employed individuals. In 2017, self-employed business owners could deduct the full cost of qualifying equipment purchased or financed up to $510,000 — equipment such as office furniture, tools, computers and even vehicles used for business. Starting in 2023, the deduction cap will be significantly increased, as will the list of qualifying equipment.
“The expensing limit would remain as it is now until 2023 and then gradually rise to $20 million,” Martin writes. “The current and new limits would be indexed to inflation, and the eligible property would be expanded to include qualified energy-efficient heating and air conditioning equipment placed in service after Nov. 2, 2017.”
The new tax code attempts to simplify the process by removing or reducing a number of above-the-line deductions. Fortunately, health insurance costs and retirement plan contributions, which are among the two most commonly claimed above-the-line deductions by the self-employed, aren’t affected.
Furthermore, Martin says “if you’re self-employed, you’ll still be able to take a tax deduction for the premiums you pay for medical, dental and even qualifying long-term care insurance for you and your family. This is done via an adjustment to income and is claimed under the adjustment gross income section on form 1040. So it’s available to you even if you don’t itemize deductions.”
Fund your own retirement plan
Under the new tax plan, self-employed business owners may also create and contribute to their own retirement plan, and the deduction for contributions made into the plan can still be claimed as an adjustment to income. “My favorite type of retirement plan is the self-employed 401(k) profit-sharing plan, which allows you to make contributions both as an employer and as an employee,” says Martin. “Using this type of plan . . . you can make an additional contribution that’s a percentage of net profit and a fixed-dollar amount up to the 401(k) contribution limits.”
For the self-employed and small business owners, the new tax code comes with a number of potential benefits. Consult with an expert at your financial institution to learn how to maximize these benefits to your advantage.