Congress has passed its big tax overhaul bill. The President has signed it into law. The reviews are… mixed. There’s a whirlwind of confusion surrounding these changes to the tax code – enough confusion to keep accountants and tax lawyers swimming in new clients for the foreseeable future. But despite the density of the new tax law, one provision stands out as a new way for many working Americans to significantly reduce taxes on the money they earn.
The part of the tax law I’m talking about relates to “pass-through” businesses like LLCs, sole proprietorships, unincorporated partnerships, and S-Corps. These businesses do not get taxed at the corporate level, like traditional corporations would; instead, revenues “pass through” to the owners, who are then taxed on that money at individual tax rates. Pass-through businesses are already popular (they make up the majority of businesses in the U.S.) because of their simplicity and the ability to avoid the “double taxation” that corporations are subject to. But pass-throughs may be about to get even more popular…
The new tax law includes a provision that should allow most pass-through entities to deduct 20% of their income before calculating taxes on it. In other words, if Jenny owns an LLC that brings in $100,000 in revenue, she will only have to pay taxes on $80,000 of that money. Let’s say, for the sake of simplicity, that Jenny will owe 25% in taxes. Before this provision was enacted, Jenny’s tax bill on her $100,000 revenue would be $25,000. Under the new law, however, Jenny’s taxes would be calculated on only $80,000 of that revenue, which reduces her tax bill to $20,000 – a savings of $5,000.
You may be asking, “Why should I care, if I don’t own a pass-through business?” Well, most types of pass-throughs, especially the popular LLC form, are easy and relatively inexpensive to create and maintain. Depending on your type of work and how you get paid, you may be able to form a simple pass-through entity to receive payment for your services – thereby shielding 20% of your income from taxation. That could make a big difference to a lot of Americans come April 15th.
There are exceptions and caveats, of course – this is the tax code, after all. Not all types of income can be claimed this way, and the people paying you may not agree to pay your pass-through entity instead of paying you directly; additionally, some professional service providers like doctors and lawyers face caps and restrictions on this deduction. So if the possibility of “You, LLC” interests you, your best bet is to discuss it with a qualified attorney or tax professional.