While the newly operational tax law lowers the corporate tax rate and changes the tax bracket thresholds for some taxpayers, it also eliminates other deductions that offered additional tax savings for individuals and families. As a result, some business owners might count themselves among the 12% of Americans who are considering incorporation to reap tax benefits.
If you’re a solopreneur—a sole proprietor, freelancer or independent contractor—and you want to know if a new business structure would help you benefit from the new tax law, you should speak with a lawyer before changing your existing business reality.
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Business form determines tax benefits
According to a 2015 report by the U.S. Census Bureau, there are over 24 million “non-employer” businesses in America. These are the sole proprietorships and single member limited liability companies (LLC’s) in which the owner is also the sole operator, employee, chief cook, and bottle washer.
The tax laws treat these tiny entities differently from other business forms that have employees. In most cases, the tax system disregards the “business structure” of the company (even if it’s not formally registered as a business) and instead, taxes the income that “passes through” it to the individual worker. However, there are new tax standards that apply to these pass-through filers that will impact the amount of taxes they are now required to pay. How the new tax law affects each person’s business situation will determine whether it would be beneficial for them to assume a more formal corporate status. To understand how the new law might impact your business, it is important to talk to a tax lawyer or other tax professional.
Significant changes that might inform corporate status decision
Both businesses and individuals have new tax rules to follow:
The Qualified Business Income Deduction
The most notable tax change for solopreneurs is the introduction of the “Qualified Business Income” (QBI) deduction, which permits most individual business owners to deduct 20 percent off the top of their gross income to determine the value of their taxable income.
However, the QBI deduction is automatically allowable only to those companies/individuals that earn less than $157,000 as a single filer, or $315,000 as joint filers. Once the taxpayer(s) reaches those thresholds, the value of the deduction is based on the actual total of their income. For service providers such as lawyers, doctors, and certain other professionals, the value of the QBI decreases as their incomes rise.
Elimination of exemptions and expense deductions
Another factor that might inform the decision is the elimination of several business deductions and other exemptions that in previous years further reduced the value of taxable income. For example, the new law eliminates personal and child exemptions, which reduced taxable income by over $4,000 per person. (These exemptions will return in 2025.)
Additionally, several previously itemized deductions have been eliminated, including employee business expenses, tax preparation costs, and investment interest expenses. And state and local taxes — previously deducted from the calculation of gross income — are now limited to a combined total of $10,000 (but there are exceptions here, too). This change affects taxpayers who live in high state-tax states more than those whose home states don’t tax as highly. An accountant or other tax professional can help you understand how these changes will affect your tax bill.
The tax law changes are complex
Changing business status depends on many factors, each of which are specific to the taxpayer. If you are a solopreneur or freelancer and want to understand how the new tax law affects you and your family, talk to a lawyer today.