Will the 2018 Tax Act Change Your Schedule C?

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One of the questions that I’m getting a lot now has to do with Schedule C (Sole Proprietorship) businesses and the pass-through tax reduction. Just to recap the possible challenge.

The Tax Cuts and Job Act provides a 20% reduction of taxable income from flow-through entities, in certain circumstances. If you are under the Taxable Income threshold ($315K for married, filing jointly and $157.5K for single), you will be able to reduce your taxable federal income by 20% for the net flow-through income. You still have 15.3% self-employment tax to pay, though.

If you’re over the threshold, it gets more complicated. If you have a service business, there is a second threshold ($415K for married, filing jointly) and $207,500 for single). If you’re over that amount, you don’t get any reduction.

If you have a non-service business, you can take the pass-through reduction. If your taxable income is over the $315K/$157.5K reduction, you have one more limitation.

In both cases, though, there is one more limitation if over the threshold. The amount that you can take the reduction on is subject to the greater of 50% of W-2 wages paid or 25% of W-2 wages + 2.5% of depreciable assets. The Act is very specific with the language “W-2 wages”. Until we get the final Tax Code written by the IRS, all we can assume is that ONLY W-2 wages will work in calculating the reduction.

That brings us to a problem. Sole Proprietorship owners can’t take a salary. So there will be no W-2 wages that count, at least for the owner. If you have a lot of other employees, that might still work.

Our advice right now is to form an LLC for your business if there is a chance you will go over the threshold. If you’re close or you’re under the threshold, it won’t matter. Over that and you may need to elect to be taxed with S Corporation status so that you can pay yourself a salary. The LLC can do a late election, but if you don’t have the LLC in place first, you’re just going to be out of luck!

Want more strategies to turn the new 2018 tax law into personal gold? Look for my new book, “Taxmaggedon 2018”, to be released March 2018.

One Comment

  1. Cynthia Smith says:

    For a sole proprietorship that owns one multifamily building with depreciable value of $1,000,000 and taxable income of $100,000 per year. Owner has no employees. The calculation would be

    20% of earned income= $20,000
    .025 x $1,000,000.= $25,000.

    The smaller of the two is $20,0000

    Sole proprietor can take a $20,000 deduction. In this case, there is no need to change the ownership structure.

    Please correct me if I am wrong.

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