Wouldn’t it be nice if all taxpayers could operate their own LLCs?
Like baseball, young love and hay fever, we’ve entered the high season for taxes.
New this year, however, we begin to react to changes in the tax reform law of December 2017.
The changes were designed mostly to help businesses and their owners. If you don’t own a business, I’m sorry to say the tax reform bill wasn’t really about you.
It could be, though, if you want to hurry up and create a limited liability company, LLC or S corporation.
I’m sure you already know that traditional corporate owners — people with C corporations — won big in December by getting tax rates on profits dropped from 35 percent to 21 percent. High five! That was awesome.
A huge range of businesses, especially small businesses, choose to incorporate as a LLC or S corp because they offer greater flexibility, low costs and are easier to administer.
Turns out these socalled pass-through entities — which also include limited liability partnerships, LLPs, and sole proprietorships — allow income for taxation purposes to “pass through” to the owners as if they were salaried employees.
Before the tax overhaul, high-earning LLC owners could get end up taking a big hit come every April 15 because they were taxed at the highest personal rate, which is 37 percent starting this year.
Congress “fixed” that discrepancy in last year’s tax overhaul, allowing the owners of pass-through entities to take a 20 percent itemized deduction from income. Again, high five everybody. Given that deduction, remaining a salaried employee is really for chumps.
So here was my logical thought after the law passed: I need to set up a pass-through company for my freelance work so the Express-News can pay “Mike’s Smart Money Stuff LLC” for my columns instead of Michael Taylor, the individual.
That should get me the 20 percent deduction off total income, saving a lot in taxes.
In fact, why doesn’t everyone do the same thing? I can just see the IT guys at USAA and Rackspace trying to convince HR to change their direct deposits to wire paychecks to their newly incorporated tax dodge vehicles.
I recently ran this amazing scheme past my accountant. But my accountant Noah Rifkin, a principle at MBAF in New York City, quickly burst my bubble.
The 20 percent deduction on income from pass-through entities, my accountant explained, can’t be claimed by huge swathes of LLCs engaged in everything from law, health, accounting, performing arts, consulting, athletics, brokerages, actuarial science and financial services.
Rifkin describes the 20 percent deduction as claimable mostly for businesses that produce “widgets,” that catch-all accounting word used to denote anything manufactured and sold as a product. Not, in other words, a personal service like I was hoping. The 20 percent deduction isn’t supposed to be claimed for a business that depends on, to quote the explanatory paper my accountant sent me, “the skill and reputation of one or more employees or owners.”
Well, I intended to claim that writing a column does not involve any skill! Surely you agree? If all readers would continue to vouch for that statement in writing, to both the IRS and my editors, I think this plan could still work.
Slightly more seriously, the law has created some interesting gray areas. The Wall Street Journal gives the example of two restaurants organized as LLCs. One highly profitable restaurant succeeds based on the reputation of a celebrity chef and therefore can’t take the 20 percent deduction. The other profitable restaurant, succeeding without the celebrity chef ’s reputation, might be able to take the deduction. That’s kind of an odd result.
Despite what my accountant says, and all jokes aside, my plan still might work for many people. If you make less than $315,000 as a married couple, or $157,500 as a single filer, you can still claim that 20 percent LLC income deduction, despite being in one of these disqualifying businesses like law or health or accounting or column-writing that supposedly involve skill and a reputation.
Since 97 percent of people earn less than $157,500, I still say a great number of currently salaried workers could form an LLC, sell their labor though the entity, and potentially save on taxes.
My accountant doesn’t agree with me at all. But, you know, check with yours.
Michael Taylor is a columnist for the San Antonio Express-News and author of the upcoming book “The Financial Rules For New College Graduates.” michael@michael thesmartmoney.com | @michael_taylor