For every action in this universe, there’s an equal and opposite reaction. Isaac Newton said that, and while he applied this principle to the world of physics it can be applied equally well to just about anything. In the world of business, where there is spending there tends to be growth, where there is under investment there tends to be stagnation, where there us scandal, stock prices tend to plummet. Throughout the course of an entrepreneur’s career they’ll have to master the art of reacting prudently and productively to changes in the political and economic landscape.
A business is (if you’ll forgive the mixed metaphors) like an organism, trying as best it can to traverse the landscape of an economy, doing what it can to sustain itself while trying to insulate itself from the caprice of its environment. Every change in the social, political and economic landscape could be a downpour that will allow the surroundings to become richer and more verdant, or it could become a blizzard that becomes the precursor for lean and precarious times. This is (aside from political tribalism) why entrepreneurs either jump for joy or wring their hands with the election of a new political party, president or prime minister.
Throughout the world, whether in capitalist or socialist societies, the relationship between legislation and business is important. The state has the capacity to benefit or cripple businesses through their legislature. Thus, whatever your political bias you probably have an opinion on current POTUS Donald Trump. With such a storied business background behind him, opinions were divided on how well Trump would be able to benefit the small businesses that would help to make America great again. Thus, entrepreneurs and business persons are divided on the Republican Tax Reform bill that came into force late last year. If you run a small business you will likely wonder how this piece of legislation is likely to affect you. The bill is complex so it’s always worth getting the opinion of a team of CPAs to be sure. Nonetheless, we know enough to determine how it will affect some business owners…
The main take-home of the bill is the notion of Qualified Business Income deduction. This is (in most cases) a flat rate saving of 20% for businesses that meet the qualifying criteria. This means that 20% of your annual income will be tax deductible and you will not have to pay a penny in tax on it. This is deducted directly on your 1040 Form. This includes S corporations, partnerships, sole proprietors like grocery store or hair salon owners, Limited Liability Companies, landlords with rental properties reported on Schedule E and farms reported on Schedule F. This is slightly different, however, for partners and owners of S corporations as their deduction will be claimed on their individual tax return. Their return will be based on the amounts shown on their Schedule K-1 for business income. While this deduction can be just the boon that a young business needs to help navigate its early years, it does have some inherent limitations.
The deduction is accessible to single taxpayers with an income of $157,000 or less or married couples who file jointly with a combined income of $315,000 or less. But there are more complex limitations outside of taxable income. The QBI deduction is wither 20% of the business owner’s QBI or 20% of taxable income calculated without the QBI deduction. There are also limitations on specified service businesses. These are trades wherein the principal asset is the reputation or skill of one or more of its employees. Just to clarify, these are;
- Health professionals
- Actuarial scientists
- Actors, dancers, musicians and other performers
- Professional athletes
For all of the above there is no QBI deduction if the taxable income for the business exceeds $207,500 for single taxpayers and $415,000 for married taxpayers. For married taxpayers earning over this amount (who are not involved in specified service businesses) the QBI deduction is limited to 50% of the business’ w-2 wages or 25% of W-2 Wages plus 2.5% of the original cost of qualified businesses property.
That sounds confusing!
Yes, it is and that’s why it’s always best to use a tax accountant to ensure that your paperwork is filled in correctly and so that your business applies for every leniency that’s coming to it. While you could do this yourself, it’s a lengthy, laborious and intensive process. It will eat up your free time and likely cause you some stress, anxiety and frustration. You should also consider having a tax attorney on speed dial, in the event of an audit especially while the new tax allowances are being phased in and there’s such a huge capacity for error. While the bill is still in its infancy there’s much to be celebrated, especially for “Pass-through” businesses which make up 95% of businesses in the United States. These are businesses for which the income from the business passes directly through to the owners. It’s worth noting that this deduction does not affect your self employment tax.
So, how much could my business save?
This will depend on many factors such as the nature of your business, and whether you operate it as a sole proprietor or with a customer, but let’s say for the sake of argument that you’re a self employed nail salon owner. You run a pass-through business and you operate it as a sole proprietor.Let’s a pick a nice round number for your annual income. $100,000 has a nice ring to it, doesn’t it? After deducting 50% of your self-employment tax and assuming you claim the standard deduction of $12,000 your taxable income is $88,000.
Your QBI deduction is $17,600 (That’s 20% of taxable income of $88,000) as this is less than $20,000 (20 percent of your QBI). Thus, your income tax savings from claiming this deduction will be approximately $4,000. Again, the QBI deduction does not reduce your self-employment tax. Nonetheless a $4,000 saving is nothing to be sneezed at.
You may indeed be liable for a far greater saving which is why it’s so important to enlist the aid of professionals who will more than pay for themselves in ensuring that you keep every penny you’re eligible to save.
By investing that money back into your business you can help to ensure a future of prosperity and growth.