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Tax benefits of being self-employed

Paul Pahoresky

July 6, 2018

As the tax laws continue to change and evolve the need to evaluate the best method to be compensated arises.

Although most people are compensated as W-2 wage employees of an organization and may not have an ability to change this, the recent tax law changes at the federal level as well as some previously enacted legislation at the State of Ohio level make it such that it may be much more tax advantageous to be taxed as self-employed if that option exists.

First off, the new tax law eliminates the deduction for unreimbursed employee expenses.

So, for those employees such as truck drivers, sales people and others who previously deducted significant expenses that they incurred related to their job that were not reimbursed by their employer this deduction is no longer available.

Previously this deduction was taken on Form 2106 as part of Schedule A.

With these deductions no longer being allowable the taxable income of those taxpayers that previously took these could be higher. Necessary and proper employment related expenses such as mileage, cell phone, home office, and others can no longer be deducted by an employee as a result.

In addition to the fact that a self-employed taxpayer would be allowed to deduct these items going forward, another significant tax benefit of being self-employed is the newly enacted Section 199A deduction also known as the Qualified Business income Deduction.

Essentially this deduction allows pass through entities including sole proprietorships, LLCs, and S corporations to deduct 20% of their taxable income below the phase out income limits. The phase out income limits begin at $157,500 for single taxpayers and $315,000 for married filing jointly. Above these phase out limits there is a complex formula to determine the actual tax deduction.

Specific service trade or businesses are also impacted differently over the limits as well.

Essentially this new law allows a self-employed taxpayer or small business owner to deduct 20 percent of their income if they are below the phase out limits.

In other words, a married taxpayer who had $250,000 of taxable income from self-employment sources could deduct 20 percent or $50,000 from their income and ultimately pay tax as if their income were $200,000.

So, not only can the self-employed taxpayer deduct the necessary and proper business expenses that an employee could not, they would also deduct 20 percent of their income in computing their taxable income.

This tax savings for those that are self-employed or own small businesses is not limited to the federal level either.

Previously enacted legislation in the State of Ohio essentially allows these qualified taxpayers to exempt the first $250,000 of business income from Ohio taxes. Business income above that level is also taxed at 3 percent versus ordinary Ohio income tax rates.

The savings from this law alone can amount to $10,000 per year or more for a small business owner.

These laws were enacted to encourage small business growth in our country and in our state.

However, a small business can be as small as a self-employed individual. As such, the tax savings can be significant if an individual has the ability to be taxed as self-employed versus as an employee.

Many large companies and employees alike are going to have to address the new tax law changes that were recently enacted. For some taxpayers, the new tax laws may encourage them to go out on their own and become self-employed. Our tax code and economy favors those who own their own businesses, and this recent tax legislation only further strengthens that notion.

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