With some very broad brushstrokes, the Trump administration laid out its tax plan. It is still very early in the process, and skepticism about how much of the plan will survive negotiations should be maintained. This article will discuss a substantial reduction in taxes for business owners.
Very Major Overview
During the campaign, Donald Trump proposed cutting the maximum business tax rate to 15%. There was uncertainty as to whether this 15% maximum tax rate would also apply to pass through entities such as LLCs and S corporations. The uncertainty has been resolved as it is now clear that the 15% maximum tax rate applies to pass through entities and to sole proprietorships.
Tremendous and Beautiful Tax Cut
Example: John owns an S corporation and it has profit of $200,000. Assume John has other income and he is in the 35% tax bracket. Under current law, his tax liability on the $200,000 S corporation profit would be $70,000 (35% times $200,000). Under the Trump proposal, John’s maximum tax rate on the S corporation profit would be 15%, so his tax under the Trump plan would be $30,000.
Example: Same facts as above except John is a member of an LLC and his share of the LLC profit is $200,000. Again, his maximum tax rate under the Trump plan is 15%, so his tax on the share of the LLC profit would be $30,000.
You May Even Get Tired of Paying Lower Taxes and You’ll Say “Please, Please, It’s Too Much. We Can’t Take It Anymore.”
There has been an incentive for S corporation owners to minimize officer compensation because S corporation owners only incur payroll taxes on their payroll, not on the remaining business profit. The Trump plan would further encourage S corporation owners to minimize officer compensation because officer compensation would remain subject to higher income tax rates, while S corporation profit would be subject to the 15% maximum rate.
Example: Jennifer has an S corporation with $100,000 profit before officer compensation. Assume she has other income and is in the 35% tax bracket. She has officer compensation of $60,000 and S corporation profit of $40,000 after officer compensation.
Under current law, her tax would be:
Tax on Officer Compensation: $21,000 (35% times $60,000)
Tax on S corporation profit: $14,000 (35% times $40,000)
Total Tax $35,000
Under the Trump plan, her tax would be:
Tax on Officer Compensation: $21,000 (35% times $60,000)
Tax on S corporation profit: $6,000 (15% times $40,000)
Total Tax $27,000
Joan prefers paying tax at the 15% tax rate so she reduces her payroll to $40,000 (leaving S corporation profit of $60,000).
Under Trump plan with officer compensation reduction, her tax would be:
Tax on Officer Compensation $14,000 (35% times $40,000)
Tax on S corporation profit: $9,000 (15% times $60,000)
Total Tax $23,000
Joan saves $4,000 by reducing her higher-taxed payroll and increasing her S corporation profit that is taxed at the 15% maximum rate.
There is already incentive for S corporation owners to minimize officer compensation because officer compensation is subject to payroll taxes (generally 15.3% FICA plus unemployment taxes) while S corporation profit is not subject to payroll taxes. The Trump plan increases the incentive to minimize officer compensation.
If you need help with small business taxes,
sign up for a FREE tax consultation.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.