Trump Tax Plan Creates Tax Problems for Schedule C Businesses

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The new Trump Tax Plan has created some tax issues that aren’t as well known. One of those is with Schedule C businesses. This is what’s happened, effective January 1, 2018.

A Schedule C business is a flow-through entity. As long as your taxable income is below the threshold, you’re fine. You will get a 20% reduction on the flow-through  income from your Schedule C.

However, if your income is above the threshold, the rules get a little more complicated. If your Schedule C is a service business, you also have a second threshold of $415K (married filing jointly) or $207.5K (single). Over that, and you can’t take any reduction at all for flow-through income from a service business. Between the two thresholds, the amount you can take will phase-out.

If your company is a product company, you still may qualify, but the service company business owner with taxable income between the two thresholds and the product company owner both have a limit on how much flow-through income is eligible for the pass-through reduction.

This is where the Schedule C problem occurs. The pass-through reduction when taxable income is above the threshold is limited to 50% of wages paid or 25% of wages paid plus 2.5% of depreciable assets. This is a critical point. If you have a service business with income between the two taxable income thresholds or a product business with income over the first threshold, you can ONLY take a deduction on the flow-through income up to the greater of 50% of W-2 wages paid or 25% of W-2 wages paid plus 2.5% depreciable assets.

Most Schedule C businesses don’t have employees. A Schedule C owner is precluded from taking a salary. The owner instead pays self-employment tax on his or her total net income. If that owner had an S Corporation, he or she would have salary for some of the income. The salary is not subject to the flow-through income reduction but all the salaries are added to determine the basis for the limitation.

The most flexible strategy would be to use a single member LLC for your business structure if you really want to stay as a Sole Proprietorship. That way if you find at a later date you’re about to lose the pass-through income reduction, you can elect S Corporation status. The S Corp election for an LLC can be made anytime for 3 years after formation under the late election rules. It’s a little more difficult, but possible. The easiest way to take a late election is to elect it within the same tax year.

That’s just one strategy that we talk about in “Taxmageddon 2018.” What strategies do you need to put in place right now?

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