I’ll be honest: this isn’t for the faint of heart or spirit.
This is about taxes, something SUPER HOT to discuss right now, and a topic I am not an accredited professional on. I’m sharing my best understanding as a longtime small business owner here, and I hope you verify as needed with your tax professional for your situation. 🙂
First: Regarding the tax bill
There’s a new tax bill coming through, and I want to clarify a few things:
First, it’s not finalized, so we all just need to see what comes out in the wash these rich, privileged congresspeople, who have no idea what life is like for most americans, come up with for the majority of us to deal with.
Next, I noticed a fair amount of small biz people are freaking out and, while no one – not even the senators who voted for the bill – has had a chance to read the 479-page document before it was voted on, in my searches I can’t find a change to biz deductions – only personal ones. Other writers have done more research and come up with the same conclusion.
Let me clarify for you: The “standard deduction” a/k/a “individual deductions” a/k/a “itemized deductions” are DIFFERENT than your business deductions, or write-offs. If you spend money on your biz, there’s no indication you can’t still write things off. How else are the ultra-wealthy going to expense all that golf and luxury suits? They’re not giving that up. In one bill, money you spend on capital investment (like buying a plant or apartment building) has a cap, but that’s not what I’m hearing people worry about. If you’re buying a plant, call me! I have some equity needs.
Next, there’s a change to both corporate tax rate AND taxes for pass-thrus, the kind of business I am and most freelancers are. But most of us — people making under $91k/yr — will see no change or a slight reduction in biz taxes. Now firstly, this is adjusted income, the money left AFTER business expense deductions. Next, here it gets complicated but I’m a break it down, and read this if you want more on how pass thrus work:
- If the income passes thru, it just goes on your income tax
- Except now, up to 30% of it will be eligible to only be taxed at a total of 20 or 25% depending on which bill
- Who’s taxed at 25%? Everyone making under $90k – SO, if you make OVER 90K, then (according to the House) 30% of your income will be taxed less up to $250k. The rest of us are already “saving” by not being taxed in the first place.
- And, according to the Senate, you’d be eligible for a tax deduction (e.g., not taxed on) 17.4 percent of your income or half the wages you paid, for earners with income up to $500k
- Will we all become corporations because of the lowered 20% tax rate thing? Maybe. There seems to be an urge to keep individual high-earners from not being employees and just getting dividend payouts, but rich people find ways to “optimize” for taxes.
Speaking of ways to optimize for taxes…
Second: Small business hacks are about being willing to interact with your money, understand taxes, and think like a strategic businessperson.
I love all these, so I’m ready to hack the heck out of being a small-business owner.
One thing I love is understanding how super-wealthy people leverage tax loopholes, and then understand how I can do the same thing here in my little microcosm.
When you have a small business – whether you’re a sole proprietor, a single-member LLC, or a S-Corp – a few things are happening:
- the income is “passing through” directly from the business to you, and onto your taxes. That’s why it’s called a “pass through” – the business itself is not a tax-paying entity.
- you have access to write-offs, and to additional pre-tax retirement accounts to lower your taxable income. These are the expenses you deduct from your income, to get your adjusted, taxable income.
- you pay self-employment tax on your adjusted income.
The income goes on your taxes
So, be smart about how much goes onto your taxes.
Sometimes you want a lot of income so you can, for example, get a mortgage more easily.
Sometimes you want less income so you can stay in a certain tax bracket. Acting on any of this info is a hack in my definition.
Writeoffs allow you to buy things you legitimately need for your business with business income, and then not pay taxes on the income you used to buy these things. For most pass-throughs, you claim those on the schedule C.
Another great thing, and hack, about working for yourself is that you can put up to 20% of your biz income away for retirement, in pre-tax accounts. That means you pay the taxes later, when you go get the money at 59 1/2 or older. This can reduce your taxes and overall income a LOT.
Plus, anyone who earns income – from a small biz or not – is also eligible to put aside up to $5,500 each year in a Personal IRA or a ROTH IRA. A Personal IRA is also pre-tax.
The taxable income you bring in has a 15% self-employment tax applied (because there’s no employer to pay it for you), along with other income taxes. Yes, you read that right. It goes pretty directly to SSI and Medicaid so take it with a grain of salt, but this is another reason to be super smart about taxes and/or charge more for your work.
An example with some rough estimates
Pat makes $1,000/month as a freelance consultant. That’s $12,000 annually.
Writeoffs: Pat needs to pay $50/month for software to do their work, and $50/mo for a portion of their cellphone bill so they can communicate with clients.
Pat pays out and writes off $1,200 a year from the $12,000, leaving $10,800 taxable.
Pre-tax retirement 1: Pat sets up a SEP IRA (Self Employed Plan), and puts aside 20% of their biz income pre-tax.
Pat puts aside another $2,400 year, leaving $8,400 taxable.
Pre-tax retirement 2: Pat also puts money towards a Personal IRA, choosing to max it out.
Pat puts aside another $5,500 each year, leaving $2,900 taxable.
Self-employment tax: Pat estimates they’ll owe about 40% in taxes (because they also have a day job), when they add up federal, state, local, and self-employment taxes on what’s left. Pat or their accountant might have to do some extra math here, but let’s estimate:
Pat puts aside a final $1,160 for taxes, and has $1,740 in cash left to party on with.
Hacks: saving $3,640 in taxes
If Pat had done no hacks and expected to owe 40%, they might have paid $4,800 in taxes – but they were able to cut that amount down by over 75% AND have $7,900 invested for the future.
That’s small business hacking. It’s legitimate, legal, and I like it when I see people in the 99% do it.
Or, if you want to spin up your own business, get started today with my course on Fearless Freelancers.