Self-Employed or Small Biz Owner? How to Cut Your 2019 Tax Bill
Pass-through provisions of 2017 tax act can save you thousands
If you work as your own boss, a large tax break may await. The 2017 tax law gave small business owners and the self-employed a mammoth tax break officially worth an estimated $414 billion over a decade. Small entrepreneurs and those who work for themselves can cut their tax bills by up to one-fifth, potentially saving thousands of dollars a year.
As tax time approaches, know this: Claiming the benefit can be complicated. The basic aim is simple: Small entrepreneurs and those who work for themselves can shield 20% of their business profits from federal income tax.
The so-called pass-through deduction is available to all taxpayers whose total taxable income, from their business and other qualified sources (more on that below), falls at or below one of two core levels in 2019:
$321,400 (if you’re married and filing jointly)
$160,700 (if you’re single)
That’s welcome news for owners of mom-and-pop restaurants, local construction companies and millions of other small enterprises that form the backbone of the American economy. It’s also good news for many freelancers and some property owners, as well as for people who have both a salaried job and a side hustle.
It’s even positive for professional gamblers — yes, that’s correct — because prior tax rules consider “continuous and regular” wagering to be a business activity.
Here’s a simple example that shows how the deduction works, and how it can particularly benefit unmarried entrepreneurs.
Say your unicorn-themed cupcake business made $120,000 last year, and that was your only income (you baked 24/7). You’re either in the 22% tax bracket (married and filing jointly) or 24% bracket (single). Without the deduction, you would owe either $26,400 (married) or $28,800 (single) in federal income tax, before any other deductions are factored in.
Now say you deduct 20% of your business income, or $24,000, from your total taxable income. That leaves you with $96,000. If you’re married, your tax bill falls to $21,120, a savings of $5,280. Single, your tax bill falls to $23,040, a savings of $5,760. Accountant Jonathan Medows says that for both single and married filers, the 20% pass-through deduction is a boon to the self-employed.
To qualify, you have to run your business through a sole proprietorship, limited liability company, S corporation or partnership. Those “pass-through” entities don’t themselves pay tax; instead, their owners are taxed at ordinary rates on income that passes through them.
The deduction covers what the new law calls “qualified” business income — what you actually make from your business(es). That doesn’t include capital gains income or stock dividends, but it does include income from real estate investment trusts or mutual funds that own shares in one.
You must have enough total taxable income to use the 20% deduction. So if the newly doubled standard deduction zeros out your tax bill, no need for individual deductions.
The 20% deduction is generally aimed at helping ordinary working Americans, not highly paid professionals who decide to hang out a shingle as a solo practitioner. So the key to getting the deduction lies in what you and your business actually do.
If you are a doctor, veterinarian, lawyer, accountant or consultant, meaning that your line of work is what the new law calls “specified service trades or businesses,” you’re in a pickle.
If you earn at or below the core limits for 2019 ($321,400 for married joint filers, $160,700 for single filers), you get the deduction. But in those skilled professions, along with performing arts and athletics, you likely earn more. How much more dictates the extent to which — or if — you get the deduction.
For those highly skilled professions, if you’re over the core limits but under $421,400 if married filing jointly or $210,700 if single, you get the benefit, but it phases out on the excess part of your income. Once you’re over those higher thresholds, you can’t claim the deduction at all.
The new law is arbitrary in how it defines a business or profession that’s excluded from the tax break if it’s over those upper thresholds. For example, a lawyer or doctor or investment banker is excluded, but a courtroom stenographer or pharmacist or community banker who deals only in deposits and loans is not. Accountants say that an Instagram influencer or blogger is excluded, but it’s unclear if a professional chef or photographer can claim it. The issue is whether you are famous — whether your business is grounded in what the new law calls your “reputation or skill.”
What if you’re not in those skilled professions but are still above the core limits? For example, what if your trendy new hair salon or brick-oven pizza truck has gone gangbusters?
Then things get complicated, and you definitely need an accountant. Here, your deduction depends upon how much you pay in employee wages and how much you’ve invested in certain property, like real estate, for your business.
A Treasury Department clarification in 2019 indicates that certain owners of rental properties can also get the break if they perform at least 250 hours annually of “rental services,” like repairs, maintenance and marketing. Renting out your basement to your college friend doesn’t count. Neither does occasionally renting out your vacation home or your timeshare.
Either way, the deduction is expected to total $414 billion until it expires at the end of 2025. So claim it now.