Self-Employed Workers Who Do This Could Get a Huge Break Under Trump’s Tax Plan

Woman drinking coffee in front of white board.
Photo by Peshkova / Shutterstock.com

If you are self-employed or work as a freelancer, the tax changes proposed by the Trump administration this week may have a big impact on how you opt to pay yourself — and whether or not you want to take the step of incorporating your business.

If legislation is passed in accordance with this sweeping tax reform proposal — forged by the White House and Republican leadership — the top rate for federal corporate taxes would drop dramatically, as CNBC reports:

The framework … calls for lowering the corporate rate from 35 to 20 percent. It would also bring down the rate for so-called pass-through businesses to 25 percent; currently, they are taxed under the individual code.

For freelancers and most people who are self-employed, what is important is the pass-through rate.

A huge potential tax benefit

The key to the proposed tax changes for freelancers and other self-employed people lies in how “pass-through” income is dealt with as it moves from a partnership, S-corp (the simplest kind of corporation you can form) or a limited liability company (LLC) to the individual or individuals who own the partnership or company.

President Donald Trump’s tax plan would set a top rate of 35 percent on personal income. However, owners of partnerships, S-corps and LLCs could benefit from the much lower 25 percent rate on pass-through business income.

That rate would only apply to money paid as profits from the business, not as a salary. Strictly speaking, companies are supposed to pay the people who work for them before distributing “profits” to owners. So if you are the owner of the company and work for it, there is an expectation that you’ll pay yourself a “reasonable” wage — which will be taxed at the normal, and potentially higher, personal income tax rate.

But once you’ve paid yourself that “reasonable” salary, remaining income could qualify for the lower pass-through rate.

Example under the proposed rules: Say you’re the sole owner of an LLC, which in turn owns a website with profits of $500,000 per year. You could choose to pay yourself an annual salary of $100,000, which would be taxed at your normal rate. You’d also be subject to Social Security taxes, Medicare and unemployment taxes on that income. However, the remaining $400,000 of profit would be taxed at 25 percent, with no additional employment taxes.

If you’re in the 35 percent tax bracket, paying 25 percent on your $400,000 profit rather than 35 percent would save you $40,000.

The tax reform devil is in the details

Incorporating or forming a pass-through business to lower your tax burden sounds great, but the reality is a little more complex. According to an analysis by the Tax Policy Center — a joint venture of the Urban Institute and Brookings Institution — the big challenge will lie in how the government determines what is allowed as pass-through income.

The report further suggested that so many self-employed people might set up these pass-through entities that it could force the government to consider a much stricter way of vetting them. In a report that came out early this year, the Tax Policy Center warned:

Current-law rules are difficult to enforce, leading to significant avoidance of payroll taxes; with the much larger rate differential under the revised Trump plan, avoidance would be much more prevalent.

In April, U.S. Treasury Secretary Steve Mnuchin said that the administration would deal with this issue by putting rules in place so wealthy people can’t create pass-throughs “and use that as a mechanism to avoid paying the tax rate that they should be on the personal side.”

At that time, Mnuchin also responded to a direct question about how new provisions would apply to freelance or contract workers as follows:

As it relates to the definition of contractors and things along those lines, those will be the details we will be working with Congress on as we turn this into a bill that will get signed by the president.

Trump’s tax reform plan might change

One other important caveat is that this remains a proposal from the president — it is not yet law. The plan will have to jump over significant legislative hurdles before it gets back to him to be signed into law. In the meantime, it might be worth reviewing other reasons to incorporate. If some form of the president’s plan makes it into law, you might have an extra reason to incorporate soon.

What do you think of Trump’s plan? Let us know in the comments below or on our Facebook page.

Stacy Johnson contributed to this post.

How to earn $30 in less than 30 seconds

Earn extra money by using Rakuten (formerly known as Ebates) — a site that gets you cash back at more than 2,500 stores. As a bonus for joining Rakuten between now and Aug. 6, 2020, you'll earn $30 when you spend at least $30 shopping online through Rakuten within the first 90 days. Start earning cash back and claim a free $30 bonus today.

Read Next
12 Ways Retirees Can Earn Passive Income
12 Ways Retirees Can Earn Passive Income

These simple ways of earning income without a lot of active, ongoing effort can stretch your retirement dollars.

Should You Hire a Service to Negotiate Your Cable and Other Bills?
Should You Hire a Service to Negotiate Your Cable and Other Bills?

Services like BillCutterz and BillFixers will negotiate your cable, internet, phone and other monthly bills in exchange for a share of the savings. I tried it: Here’s what happened.

60% of People With This Disease Don’t Know They Have It
60% of People With This Disease Don’t Know They Have It

Millions of people overlook this potentially potent condition that tends to strike women and older adults.

The 3 Biggest Regrets of Retirees — and How to Avoid Them
The 3 Biggest Regrets of Retirees — and How to Avoid Them

Rescuing a retirement from regret starts with these steps well before it’s time to quit working.

5 Memberships That Offer Car Insurance Discounts
5 Memberships That Offer Car Insurance Discounts

These discounts may save you hundreds — even thousands — of dollars a year.

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Most Popular
Will I Get My Ex-Husband’s Social Security When He Dies?
Will I Get My Ex-Husband’s Social Security When He Dies?

Two factors determine how much money is coming to you.

10 States Where COVID-19 Threatens Seniors the Most
10 States Where COVID-19 Threatens Seniors the Most

No state is immune from the coronavirus. But statistics show that some places are especially dangerous for older residents.

7 Ways to Boost Your Credit Score Fast
7 Ways to Boost Your Credit Score Fast

Your financial security might soon depend upon the strength of your credit score.

20 Things That Are Actually Worth Stockpiling
20 Things That Are Actually Worth Stockpiling

You probably don’t need a year’s supply of toilet paper to survive an outbreak, but consider stocking up on these items.

5 Household Disinfectants That Can Destroy the Coronavirus
5 Household Disinfectants That Can Destroy the Coronavirus

You likely already have some of these products at home.

6 Reasons I Will Never Trust Suze Orman
6 Reasons I Will Never Trust Suze Orman

Beware: The self-proclaimed personal finance expert has a track record that suggests more sizzle than steak.

22 Things You Should Always Buy at a Dollar Store
22 Things You Should Always Buy at a Dollar Store

The dollar store has great bargains on these purchases.

America’s Most Reliable Appliance Brand Is a Surprise
America’s Most Reliable Appliance Brand Is a Surprise

Have you heard of this appliance manufacturer?

12 Amazon Purchases That We Are Loving Right Now
12 Amazon Purchases That We Are Loving Right Now

These practical products make everyday life a little easier.

The Top 11 Jobs That Employers Want Retirees to Do
The Top 11 Jobs That Employers Want Retirees to Do

Tired of age discrimination? Businesses are clamoring for older workers to fill certain roles.

This Type of Social Security Benefit Is Often Overlooked
This Type of Social Security Benefit Is Often Overlooked

The Social Security Administration is not helping certain people get money to which they are entitled, a report says.

9 Things That Are Cheaper Due to the Coronavirus
9 Things That Are Cheaper Due to the Coronavirus

The pandemic has a silver lining.

9 Everyday Problems You Can Solve With Vaseline
9 Everyday Problems You Can Solve With Vaseline

Forget expensive specialty products. Good ol’ petroleum jelly can address many common annoyances.

19 Purchases That Buyers Almost Always Regret
19 Purchases That Buyers Almost Always Regret

Think twice before buying these things.

7 Tips for Building an Emergency Stockpile
7 Tips for Building an Emergency Stockpile

A pandemic or natural disaster could leave you reliant on your existing food supply. Is your pantry prepared?

19 High-Paying Jobs You Can Get With a 2-Year Degree
19 High-Paying Jobs You Can Get With a 2-Year Degree

These jobs pay more than the typical job in the U.S. — and no bachelor’s degree is required.

8 of the Worst Things to Buy at a Dollar Store
8 of the Worst Things to Buy at a Dollar Store

Not everything sold at dollar stores is a great bargain or a safe purchase. Here’s our list of products to avoid.

41 Things You Should Never Buy
41 Things You Should Never Buy

Some purchases are just plain dumb. Give yourself — and your budget — a break. Don’t spend money on this stuff.

5 Ways to Get Amazon Prime for Free
5 Ways to Get Amazon Prime for Free

Hesitant to drop $119 a year on an Amazon Prime membership? Here’s how to get it for free.

View More Articles

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Add a Comment

Our Policy: We welcome relevant and respectful comments in order to foster healthy and informative discussions. All other comments may be removed. Comments with links are automatically held for moderation.