On December 22, 2017, President Trump signed into law H.R. 1, commonly known as the Tax Cuts and Jobs Act. This Act is the most significant reform to U.S. tax law since 1986. The majority of the Act takes effect on January 1, 2018; you may want to discuss with your legal and tax professionals.
Though the intent of tax reform was initially simplification, this has, for the most part, gone by the wayside. In place of “simple” is the promise of pro-growth tax reform; just not on a post-card. The most notable change for small business owners is the Section 199A Qualified Business Income Deduction. Section 199A provides for a 20% deduction of net qualified business income (NQBI). Income limits apply at $157,500 phased-out at $207,500 for single, and $315,000 phased-out at $415,000 for married filing jointly. (Note: the deduction is limited to the lesser of 20% of the pass-through income or taxable income – the below are “rough numbers” not accounting for various adjustments.)
For purposes of simplicity, say your NQBI is $100,000. Your deduction would be $20,000, multiplied by your marginal tax rate of say 24% (if single), which is $4,800 in savings – a win!
However, not all pass-through’s are created equal. For instance, a sole-proprietor, partnership, or disregarded entity would still have to take into account self-employment tax of 15.3% (12.4% Social Security plus 2.9% Medicare). In looking to reduce self-employment tax, you may wish to establish a Limited Liability Company and make an S-Corp election. The deadline for such an election is March 15, 2018.
Say your S-Corp business income is $100,000. If you pay yourself a salary of $40,000, you pay $6,120 in FICA. The other $60,000 is net income not subject to FICA, saving $9,180. The Section 199A deduction is available for the $60,000. So under this scenario, you would save $9,180 in FICA and $2,880 in income tax – a double win!
To throw in another planning opportunity – if your business owns the real estate on which it operates – establish two Limited Liability Companies. Why? First and foremost for asset protection purposes; separate the business from the real estate. Second, passive income; renting the real estate (from yourself) is not subject to FICA.
As you can see, the Tax Cuts and Jobs Act is anything but simple. With a little help from your legal and tax professionals, it may be worth taking a closer look.
If you are a small business owner – or are looking to be, schedule a no-cost educational meeting. I would be happy to discuss how Jones Law PLC can help you plan for 2018.
Attorney Joseph C. Jones advises clients on estate planning, asset protection, business law, and real estate law matters. Joe can be reached at (906) 914-4181 or firstname.lastname@example.org. Jones Law PLC is a Michigan & Wisconsin based provider of legal services.