Rejoice if you operate your business as a sole proprietorship, partnership, or S corporation. The simplified synopsis:
You can reduce your business profit by 20% if your overall annual income (not counting capital gains) is less than $315K (married-filing-jointly) or $157.5K (single).
If you make more than $315K/$157.5K, then the discussion starts to become complicated – the law was written to try to keep high-earners from converting from a W-2 employee to a self-employed business; so you may not be entitled to the deduction if you make over these amounts.
It appears that the average middle class W-2 wage earner is going to be tempted to convince his employer to treat him as an independent contractor in order to:
- Receive the 20% deduction
- Be able to deduct 100% of his un-reimbursed business expenses (which are non-deductible under the new tax law)
- Create and fund a retirement plan (401k/SIMPLE/SEP) that works for him
- Reduce FICA tax by converting to an S Corporation and paying himself a wage less than his profit
Imagine a married salesman who makes $120K/year. The salesman has $20K of un-reimbursed work-related expenses.
Under the current law, the salesman pays tax on $120K at the following rates:
- Social Security and Medicare tax: 7.65% times $120K = $9,180
- Federal Income Tax: 15% times $120K = $18,000
Total Federal Taxes are $27,180.
If the salesman forms an S Corporation and convinces his employer to give him a 1099 instead of a W-2, then:
- He can deduct the $20K of un-reimbursed expenses
- He then gets a deduction of 20% of his profit (profit is: $120K minus $20K of now-deductible expenses) – this yields another $20K deduction
- His Social Security and Medicare tax would remain unchanged (long story – just trust me) = $9,180
- His Federal Income Tax would now be 15% times $80K = $12,000
Total Federal Taxes are $21,180…a savings of $6,000.
There are, of course, potential downsides/risks to this decision (foregoing the retirement plan matches from employer, foregoing subsidized health insurance from employer, increased audit risk) that have to be weighed.
As with most tax-related issues, the devil is in the details – contact us to make sure you know all of the angles.