Small Business Deductions and 2018 Tax Law

Reducing taxable income is an important part of running a small business, and there are two key ways to do it.

1. Open a Retirement Plan

First, you can open a retirement plan, such as a SEP-IRA, SEP 401(k), SIMPLE IRA, or SIMPLE 401(k). Qualified retirement plans such as these benefit employees and employers alike.

Although each plan works differently, any contributions you make as an employee are excluded from your taxable income. The money you put into a plan grows tax-deferred until you retire. Then, distributions and earnings will be included in your taxable income.

If you’re an employer, your contributions to qualified retirement plans are generally deducted from your business’s income.

2. Use the New Tax Law

Additionally, thanks to the Tax Cuts and Jobs Act of 2017, which went into effect in January 2018, there’s another way to reduce your business’s taxable income.

The new law allows pass-through entities (business entities that are not taxed at the entity level) to take a deduction of 20% against their business income. This essentially reduces the effective top rate on pass-through entities’ income by roughly 10 percentage points over pre-2018 tax law.

Of course, nothing that involves taxes is ever easy. Claiming the new 20% deduction requires navigating a tangle of barely comprehensible requirements and limitations that make it far from accessible to small-business owners. For example, single filers who earn less than $157,500 and married filers who earn less than $315,000 may take the deduction regardless of their field of business. However, after taxable income passes those thresholds, individuals operating service businesses, such as doctors, lawyers, and financial advisors, may not be able to take the deduction.

A financial professional can help you determine which of these options is best for your business.

What You Need to Know about Capital Gains

No one likes to pay taxes, especially on an appreciated investment.

With careful planning, you could avoid or minimize capital-gains taxes. Here are three tips.

Hold investments for at least 366 days

How long you keep investments in your portfolio before selling them determines the taxes you pay on your gains. Short-term capital gains are taxed as ordinary income. Long-term capital gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket.

Invest in a low-turnover fund

Mutual funds realize capital gains just as individual investors do. Any time your fund sells a security at a gain, that gain is taxable. Since the law requires mutual funds to pass most of their net gains on to investors, you realize a capital gain. This is either long-term or short-term, depending on how long the mutual fund held the securities. You can avoid these types of gains by investing in a low-turnover mutual fund.

Use capital losses to offset capital gains

Do you have a losing investment in your portfolio? You might want to sell it and use the loss to offset gains. For example, if you have $4,000 in capital gains, and you take a $4,000 capital loss, the two will negate each other, and your tax liability on the gains will be eliminated.

Plus, if your investment losses for the year exceed your gains, you can use the balance to offset your ordinary income, up to a $3,000 limit.