A little while ago (October 3rd to be exact), I wrote about the hypothetical Tax Reform plan the House GOP Leadership, in conjunction with the Trump White House, was working on. At the time very little other than the super basic framework was put forth. I had some fun crunching a few numbers and looking at what good could come out of whatever the Republicans were cooking in the kitchen. It was an optimistic blog to be frank, but I always try to look on the bright side of things.
Today, we have a tax plan sitting in front of us. Two of them really, one from the House of Representatives and one from the Senate. Both plans have a few similarities, both have a ton of differences, and both plans have garnered strong reactions from all sides.
I am both unqualified and uninterested (for the purposes of this blog) in going over the entirety of both tax plans. That’s FAR too much for me to read. I previously took the perspective I am quite familiar with; that of the Sole Proprietor. I will be doing the same for this post as well. I will be examining the broad strokes that affect a Sole Proprietor and at the end, draw a conclusion that I think works best for this incredibly narrow segment of the tax paying population.
More than likely, I’ll have a few notes about the overall plans at the end as well. I have other feelings too!
What’s in this thing for a Sole Proprietor (House)
There’s quite a lot to digest, but in general there are a few big issues that a Sole Proprietor will want to focus in on:
- Any Pass-Through Corporation has its maximum tax liability capped at 25%, unless you are a service company or a lawyer. In addition, the final bill has a 9% rate on the first $75,000 in income if your total income is below $150,000. So, in essence, a Sole Proprietor like myself would be taxed at a rate of 9% instead of my current rate of 25%. Needless to say, assuming this is accurate, it’s HUGE for many freelancers.
- Taxes are set to go up in 2023 for many Americans. This is tied into the expectation of the Family Flexibility Credit expiring as well as the measure of inflation shifting around that time.
- Tax Brackets are reduced from 7 (10%, 15%, 25%, 28%, 33%, 35%, and 39%) to 4 (12%, 25%, 35%, and 39.6%). The top rate really only applies to those who make a million dollars a year for married couples or $500K for single filers.
- The Standard Deduction is doubled to $12000 for individuals and $24000 for married couples. This comes with a few caveats. First, most individual deductions are going away. Mortgage Interest can still be deducted but it’s capped at $500k. Also, State and Local Taxes, or SALT, will be removed.
- Regarding college, you would no longer be able to deduct student loan interest. In addition, grad students with tuition waivers would have to pay income tax on the waiver, which is a huge deal when you consider that it’s not “real income”. There’s a story/meme going around where a current grad student would have to basically give up her income from teaching to pay for the waiver. This isn’t necessarily a Sole Proprietor issue, but it’s a big issue non the less.
- My understanding is that the majority of business deductions that Sole Proprietors can utilize remain.
What’s in this thing for a Sole Proprietor (Senate)
While the House and Senate bills have some similarities, they are really two significantly different bills.
- Pass-through companies continue to get good benefits out of the Senate Bill, but in a different way. Instead of capping it at 25%, most pass-through income earners can deduct 17.4% of their income. This lowers the top rate paid. In essence, this plus the ability to write off half of your self employment tax means that you’re going to be paying roughly no self employment tax when it’s all said and done.
- The Vox article I’m sourcing this from mentions that the rich could ‘incorporate’ as sole proprietorship and ‘contract’ with their employers so income is pass-through. While technically true, this will likely only affects someone who runs the business they work with. Plus, there are a lot of legal laws in place that define who is and isn’t an employee and what benefits employees can receive. Some of this is easy to work aound and ignore, but bigger things (insurance and having taxes withheld, direct control over the worker at work) can’t be ignored. That brings in a bunch of questions that would span a brand new article. So in short, this Vox article gives me good bill details but absolutely editorializes a bit more than I would prefer.
- The tax rates are tweaked, but the overall number of brackets remains at 7. The breakdown is as follows: 10%, 12%, 22.5%, 25%, 32.5%, 35%, 38.5%. You can look at the source article for more, but the basic breakdown follows somewhat closely with the current tax bracket breakdown.
- It’s worth noting that the brackets are adjusted by a Chained Consumer Price Index. This more or less factors in that if apple prices rise too high, people will switch to bananas. Most economists consider this a somewhat more realistic approach to calculating CPI-but it does show less inflation. This is important when you consider the increase in rents across the country, but again that’s a different article.
- The Standard Deduction doubles just like the House Bill.
- Mortgage interest remains unchanged unless you own a second home. Can’t deduct that second home anymore.
- SALT deductions, much like in the house bill, are gone.
- Student Loan Interest, Medical Expense Deduction, and the Adoption Tax Credit all remain. This is different than the House bill, where all of these deductions are gone.
Which do I like Better?
Like I said, there is WAY MORE to both bills. Looking at it strictly from the perspective of a Sole Proprietor and nothing else, I prefer the House Bill. While there are a few more deductions that are removed on the individual side, I like the idea of only having 4 total tax brackets. I also really like what they have opted to do with Pass Through Taxation. By having the secondary small rate on income earned under $150,000, small outfits and individuals (like yours truly) will have their tax burden significantly reduced-even more so than the Senate Bill.
You can argue that Pass-Through companies already receive generous tax treatment, and in some cases I would agree with you. Unfortunately, the general public doesn’t understand how a lot of contract and other 1099 workers are classified by the federal government. These changes will help tons of people.
Other quick thoughts on these bills in general
In short, I want to see more work done to the House Bill. There’s a few things that are getting glossed over because the honorable King Lord Donald J. Trump is the President. By focusing so much on what he personally stands to gain, the focus on the good AND the bad is getting washed out.
Lets start with the fact that both bills will explode the budget deficit by roughly $1.5 trillion. I can’t stand for that. A bit of deficit is fine. That is not. The thing is, the money can be found without having to phase out certain cuts on the middle class. For starters, close corporate loopholes and end most corporate deductions. Large companies are getting a 15% cut across the board and are getting to keep most of their deductions. Normal people are not. Imagine how much just doing that would help fix some of the budget issues these bills will cause. Along those same lines, throw an extra 2.5% on the corporate rate. 22.5% won’t kill anyone. It’s not like they are going to invest this money in people and production anyway. It’s all going right into stock buybacks. It’s all about the stock market.
If you make those changes, I think you can add back in some of the smaller deductions that were removed for middle class Americans. I also think you can remove the stupid change to grad school waivers. Frankly that needs to be removed immidately.
I know a lot of people will want to have the SALT deductions added back to the bill, and considering I live in Philadelphia, it’d be good for me too (Philly taxes you hard). However, I think that outside of New York, New Jersey, California, and Chicago, removing SALT isn’t the worst idea. Only around 30% of individuals itemize and the huge increase in the standard deduction is going to make the removal of SALT a wash in the majority of cases.
Conclusion
That pretty much sums up what’s in these tax bills and what I think from the perspective of a Sole Proprietor. Keep an eye on the federal government for the next few weeks. If either bill makes it to the President’s desk, I’d be prepared to dump in a TON of cash into the market. The gains won’t last forever, but large corporations will be ready to buy back so much stock you can earn a few bucks quickly.
As for me? I’ll be investing in myself.
-Dan
Sources:
https://www.vox.com/2017/11/9/16620290/senate-republican-tax-plan-orrin-hatch-mitch-mcconnell
https://www.vox.com/cards/entitlement-reform/whats-chained-cpi
https://www.legalzoom.com/knowledge/limited-liability-company/glossary/llc-pass-through-entity