Preface: Shining some sunlight on the business landscape, the Tax Cuts and Jobs Act of 2017, one favorite from the Trump law revisions, has brought surprising and welcome lower tax costs for all business owners, and nearly all selections of tax entities. This blog provide a perspective on what entity maybe right for your business.
Flagstone Crossings To Lower Taxes: What Entity is Right?
Credit: Donald J. Sauder, CPA | CVA
Say, taxes have never been plain or simple. Yet, maybe one day in the future; right? No risks in business owners envisioning that day? Let’s add the Canadian English expression “eh” to that question as a reader’s (and writer’s) agreement.
Choosing the right entity for your business startup is a tax decision with what could include unknown long-term ramifications for any business owner. Getting it right is not as easy as it seems. Making the best decision for your specific tax attributes, that will support a lower tax burden usually requires collaboration with your tax advisor. Often, optimized preplanning can easily pay big dividends with lower future year tax costs. Then again, time has always brought change, and with that change tax law revisions. Flipping a coin is not advised.
Shining some sunlight on the business landscape, the Tax Cuts and Jobs Act of 2017, one favorite from the Trump law revisions, has brought surprising and welcome lower tax costs for all business owners, and nearly all selections of tax entities. With those regulation revisions, in this blog we’d like to discuss some of the current applicable tax planning features for entrepreneurs 2019.
Sole Proprietorship or Single Member LLC’s
Independent contractors, entrepreneurial startups, and business ventures with only one owner can organize as a Schedule C tax entity. The taxes are filed with the owners 1040 tax filing. While this is the simplest approach to entity taxation, because it doesn’t require an independent and additional business tax filing, FICA taxes are always assessed on all earnings for both the employer and employer in a higher tax costs, exemplified in a coffee and tea type tax filing for higher income earners. Rates begin above 15% for FICA and income tax costs are added on top as an additional 15% to 30% for most tax payers.
Taxpayers who are FICA tax exempt, with an approved Form 4029 exemption, have a solid and favorable tax structure with the Schedule C in single owner businesses. A Single Member LLC (SMLLC) is taxed the same as a Sole Proprietorship, but has the LLC legal umbrella with the State Department. Talking with an attorney with regards to this optimal legal decision is advised.
A SMLLC also is eligible for the 199A deduction, that is a 20% deduction on qualified taxable earnings up to $207,500 for singles, and $415,000 for married filers. Certain service professions are excluded from the 20% deduction from 199A, but for the majority of cornerstone small businesses in the United States, the deduction substantially lowers tax costs with the current tax laws.
Quoting excerpts from WatsonCPAGroup.com here’s an example of the applicable 199A for a SMLLC.
The basic Section 199A Qualified Business Income pass-through deduction is 20% of net qualified business income which is huge. If you make $200,000, the deduction is $40,000 times your marginal tax rate of 24% which equals $9,600 in your pocket.
(2) DETERMINATION OF DEDUCTIBLE AMOUNT FOR EACH TRADE OR BUSINESS. The amount determined under this paragraph with respect to any qualified trade or business is the lesser of-
(A) 20 percent of the taxpayer’s qualified business income with respect to the qualified trade or business, or
(B) the greater of-
(i) 50 percent of the W-2 wages with respect to the qualified trade or business, or
(ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property (in other words, prior to any depreciation).
Wilma makes $100,000 in net business income from her sole proprietorship but also deducts $5,000 for self-employed health insurance, $7,065 for self-employment taxes and $10,000 for a SEP IRA. These are not business deductions- they are adjustments on Form 1040 to calculate adjusted gross income. Her deduction is the lessor of 20% of $100,000 (net business income) or 20% of her taxable income, which could be less. This might change as the IRS clarifies.
Barney owns three rentals with net incomes of $20,000 and $5,000, with one losing $8,000 annually. These are aggregated to be $17,000. He would deduct 20% of $17,000.
Yes, 199A regulations are very complex, and as new chapter to the tax laws, there are many regulation nuances that require tax advisor guidance for assurance of accurate tax compliance, including services, rentals, and other applicable tax planning attributes. Yet for SMLLC’s or sole proprietorships this tax deduction now saves and lowers single owner business taxes. It is also applicable to partnerships and S-Corporations as we will examine next.