Self-Employed & Small Business Tax Reform – All About The Net Business Deductions
Editor’s Note: Read on to learn more about small business tax reform and how the Tax Cuts and Jobs Act affects many business entities. Plus, we’ll unveil new business deduction changes for pass-through entities.
Under the recently passed Tax Cuts and Jobs Act, people who are self-employed, partners, and S corporation shareholders will experience tax changes, including the new adjustment to business deductions.
People who run these types of businesses make “pass-through” income. This means that income they generate through their business is reported directly on their return and is taxed at their individual rate.
Starting in 2018, small business owners and independent contractors can deduct 20% of their net business income before computing federal income tax.
What is Net Business Income?
Under the new law, business income generally means income from your business that you don’t report on a Form W-2. So, that includes income from Schedules C, E, and F. But take note: S Corporation shareholders’ wages and partners’ guaranteed payments don’t qualify for the 20% deduction.
Business owners with income of more than $157,500 ($315,000 if married filing jointly) have a complicated limitation on the deduction, but small businesses with taxable income below the thresholds aren’t affected.
Certain self employed people who primarily provide professional services and earn more than $157,500 ($315,000 if married filing jointly) will be phased out of the 20% deduction.
How Does the 20% Deduction Work?
- Calculate your net business income by deducting all ordinary and necessary business expenses from your gross business income.
- Multiply your net business income by 20% to get the deduction amount.
- Deduct that amount from your net business income to determine your taxable business income.
An independent contractor who earns $60,000 a year and has $15,000 in business expenses has $45,000 of net business income. The new deduction equals 20% of $45,000 for a total of $9,000. The net taxable income from the business would be $45,000 minus the $9,000 deduction, or $36,000. The deduction would result in a tax cut of approximately $1,000 for this taxpayer.
If the taxpayer earned $157,500 a year and had $28,000 in business expenses, the same 20% deduction would result in a tax cut of approximately $25,000. So, the value of the deduction increases as net business income increases.
How Does the Deduction Impact other Tax Benefits?
The 20% deduction is a “below the line” deduction. That means it doesn’t affect your adjusted gross income (AGI), so it won’t increase AGI-related benefits.
Want Help With Navigating Around the New Small Business Tax Reform Challenges?
Small business taxes can be complicated. To find out exactly how the new tax laws affect your business, make an appointment to see your Block Advisors tax professional, who can walk you through the changes and help you plan for 2018. Make an appointment now.