The Case for Self-Employment Just Got a Whole Lot Better
The new tax law has brought with it exciting new tax strategies and predominately favorable tax rates for most individuals and businesses. One of the most intriguing changes deals with the new rules and rates on flow through business income and the handling of unreimbursed business expenses for W2 employees. Under the new tax law, individuals paid as W2 employees, will no longer be able to deduct their unreimbursed business expenses on schedule A (form 2106). With the 2% of AGI threshold and the additional standard deduction hurdle the majority of tax payers found it difficult to deduct these expenses in the past anyway. Now these deductions are eliminated for W2 employees entirely. The new tax law also affords a 20% deduction on pass-through profits (subject to certain taxable income thresholds and business types) which is a very welcome tax break for small businesses that operate as an S-Corp, Sole Proprietorship, Farm, Rental or Partnership.
These new tax rules make a very strong case for a tax strategy where an individual would start a business and work with their existing employer as a sub-contractor (sub-contractor rules apply). Even prior to the new tax law I contended that operating as a 1099 Sub-Contractor resulted in a superior tax outcome than being employed as a W2 employee. Generally speaking, when looking at the overall tax situation, a W2 employee pays all the taxes a 1099 Sub-Contractor pays except the employer FICA and Medicare match of 7.65%. However, the W2 employee is now unable to deduct unreimbursed business expenses and is not afforded the 20% tax deduction on profits. Therefore, the 7.65% additional tax on a 1099 Sub-Contractor can be easily offset with the proper handling of business expenses and other deductions. Additionally, the state of Ohio virtually eliminates State taxes on small businesses with profits of less than $250,000 (this state tax elimination is not available on most W2 income). Add those tax benefits to a solid S-Corp tax strategy to further reduce FICA and Medicare taxes and the small business owner will pay far less taxes than the W2 employee on the same amount of income/take home pay. As long as the taxpayer looks at the whole picture and makes quarterly tax estimates this strategy can greatly decrease the amount of money paid to Uncle Sam.
There are many more details that pertain to this particular tax strategy and this is just one of the revamped strategies made available through the new tax law. Our firm has helped hundreds of clients with these tax strategies and we have the knowledge and experience to assist many more going forward. With the proper tax strategies you can greatly mitigate your tax burden and significantly improve your after tax income.