Episode 3 - New Tax Law Changes

Welcome to the Painting Business Finance Podcast, where it's my mission to provide you with the strategies, tactics, and tools to making your painting business more profitable while creating more wealth for you and your family. How can you pay zero income tax with the 2018 tax law changes? This is your host Daniel Honan, and today we're going to talk about the new tax law changes, and we're going to run through a few scenarios on how you can actually pay zero income tax. As you probably are aware, there are big, big changes that go into effect in 2018. Thanks to a massive new tax legislation that lawmakers enacted late last year. Let's cover a few of those. I'm just going to highlight a few of the changes. This isn't— is not going to be a comprehensive review. I'm just going to hit some of the highlights that I think would apply to most painting business owners. And, and then we're going to go through some specific scenarios on how you can actually pay no income tax for the 2018 tax year. So to hit some of the highlights, first off, let's start with individual taxes. So first, first of all, the standard deduction has nearly doubled. It's $24,000 for couples, $12,000 for single individuals, and $18,000 for heads of household. This is definitely a good boost for taxpayers with this higher standard deduction. One of the downsides is that if you itemize your taxes, there's a few things that were taken out of itemized taxes. Like your state and local taxes is being squeezed a bit. You can deduct any combination of residential property taxes and income taxes or sales taxes up to a $10,000 cap. So that is a change, that $10,000 cap. And then there are several write-offs eliminated under the itemized deduction. Basically all the 2% of AGI thresholds, which includes employee business expenses. So any expenses as an employee incurred that was not reimbursed, that has been eliminated as an itemized deduction. Any investment fees, hobby expenses, and tax return preparation costs theft losses. All those have been eliminated on the itemized deduction. But one of the good things about the itemized deduction is that the medical expense deduction has been increased. So before, you had to have expenses over 10% of your adjusted gross income. Now it's down to 7.5%. And then obviously, you've probably heard of the tax bracket changes. For the most part, most most individuals in married filing jointly will pay less in tax under the new tax brackets in general. There are some folks that are in the higher brackets that might be paying a little bit more, but for overall, most, most folks will be paying less. A note on healthcare: Obamacare's individual mandate is on its way out, but the requirement that individuals have health insurance Health insurance is still a requirement for 2018. So if you don't have health insurance, you'll still have to pay that fee at the end of the year if you do not have health insurance. The child tax credit has doubled to $2,000 for each dependent under 17, with up to $1,400 of that refundable. There are some phase-out thresholds. Phase-out thresholds have been increased so more folks can take advantage of this child tax credit. So for couples, the phase-out doesn't— is over, uh, $400,000, and for single filers, it's, um, $200,000. In addition to the child dependent credits, you have a $500 credit for each dependent who is not a qualifying child. So that would include like an elderly parent or someone you take care of, a disabled adult child. So those are good things for sure. Now let's switch over to business taxes. If you have a C corporation, the— there's a flat 21% rate, and that's down from 35%. And then the biggest savings that business owners would get to enjoy if you're an S corporation, a partnership, or LLC or sole proprietor, generally up to 20% of qualified business income is deductible. And there's a lot of complexity with that, unfortunately. There's some limits applied to individuals with higher taxable incomes in excess of $315,000 for couples filing a joint return and $157,000 for all others. But the 20% deductibility of business income is definitely a good thing. So in order to illustrate some ways that you can actually end up paying zero in income tax, we're going to go through some scenarios. Now, paying zero dollars in income tax doesn't happen by happenstance. Generally, you have to plan for it and actually prepare for it. Let's go through a few examples. I'm going to assume 5 things in order to go through these examples. The first thing I'm going to assume is that your painting business is taxed as an S corporation. So you either have an S corporation or you have an LLC that's taxed as an S corporation. And the reason why I'm assuming this is because usually that makes the most sense for a painting business because it saves a lot of money on self-employment taxes. If you're a sole proprietor, every dollar that you make gets taxed at 7.65%, whereas an S corporation, only a portion does because you take a salary and then the other portion does not get taxed at that 7.65%. So it usually makes sense to be an S corporation or taxed as an S corporation. The second assumption I'm going to make is that you are in step 4 of the wealth-building process, meaning, uh, in episode 1 we talked about The Wealth Building Strategy, step 1 is to optimize your business income. Step 2 is to get rid of all your bad debts on your personal side. Step 3 is to save 9 to 12 months in cash reserves in case of emergency. And step 4 is to save for the long term. So I'm assuming you're in step 4, saving for the long term, in this scenario— in these scenarios, because saving in retirement accounts is usually your best, one of the best tax strategies you can do to significantly reduce the amount of taxes you pay. The other assumption I'm going to make is that your wife works, or your wife or your spouse works in the business with you and makes $18,500 and all of that amount is contributed to a 401(k) that the business has set up. Which we'll get into here in a second. The other assumption I'm going to make is that, that you don't qualify for any tax credits besides the child tax credit when applicable in each scenario, and you're going to take your standard deduction as well. So you do not itemize your taxes. So let's jump in the first scenario. This is married filing jointly, no, no children or dependents. You have $71,500 in gross income from your business. And the way that we'll break that down, you have $18,500 is from your, your wife, W-2 wages from the, the painting business. You have $23,000 that you took as a wage as the officer in the business, and then you had the other $30,000 coming to you as business income. And we learned that the new tax law you get a 20% deduction, so that $30,000 is reduced down to $24,000 of business income. So you add the— your $23,000 plus your $18,500 for your wife's wages, $24,000 for your business income, that equals $65,500 in gross income reduced from $71,500. So right off the bat, your gross income is reduced by $6,000 due to that. 20% deduction for business income. So what we need to do from here is reduce your gross income as much as we can and get your adjusted gross income down to as close to $24,000 as possible. The reason why we want to get your adjusted gross income down to $24,000, or as close to it as possible, is because you have your standard deduction of $24,000, which would basically remove all your taxable income and you would have no income taxes due. So we're at $65,500 right now. The way we can do that is if you have a 401(k) plan set up in your business, the maximum contribution is $18,500. So if you and your wife are both employees, you're— if you have an S corp set up, you would be considered an employee as the officer. Your spouse, your spouse is an employee, assuming that she or he is providing services to that business, and that's worth about $18,500. And you would contribute $18,500 to the 401(k) for you and your spouse, and that would equal $37,000. And this would be a tax-deferred program, a traditional 401(k). So that's $30,000, $37,000 that would be deferred in taxes. And then we have another option that you could do for healthcare. In this scenario, let's assume that you're— you and your spouse are healthy, and for healthcare you decide to do a high deductible, high deductible healthcare plan. And with that you can get a health savings account. The 2018 contribution limit for a health savings account is $6,850 for a family. But let's say in this case that you just contribute $4,500 to your HSA. So we had your $37,000 contributed to your 401(k)s, $4,500 to your HSA. That equals $41,500 in adjustments. This gets your— takes your gross income of $65,500 minus that $41,500 in adjustments to get your adjusted gross income down to $24,000. So that would mean that your standard deduction of $24,000 would reduce your taxable income down to zero. So you would owe zero income tax in this scenario. Now of course, the thing to note here is that you took in gross income of $71,500, but you contributed a lot to 401(k)s and your HSA, which that amount of money, that money is not accessible anymore because you're saving it. So you'd have to live off the difference. So in this case, you would have to live off of about $31,000, about $30,000 to $31,000 between you and your wife for a year period, which is completely attainable. Plenty of people do it, but it might take some budgeting and watching your expenses for sure. But that is a scenario, that's the first scenario we just ran through of if you're a married filing jointly, no children, how you could actually pay $0 in income tax. Alright, so the second scenario, let's assume that you're married filing jointly once again, but you have one child. So in this case, let's say that you have gross income of $90,000. Your spouse takes, that works in the business with you, takes a wage of $18,500 to max out the 401(k). You as the officer take a $36,000 wage and that leaves $35,500 as business income, which you get that 20% deduction. That $35,500 is reduced down to $28,400 $400 of business income. And let's also assume in this scenario that you're going to max out your 401(k)s, $37,000. You can contribute $3,450 to your HSA, health savings account, and that gets you about $40,000— $40,450 in adjustments. So that brings your adjusted gross down adjusted gross income from $82,000 down to $42,450. So in the first scenario, we just had this, the standard deduction of $24,000, but the difference here in this scenario is that we have the Child Tax Credit. That's $2,000 of dollar-for-dollar reduces your taxes. So you have a little bit more AGI that you can have. You can have about $19,000 more in adjusted gross income. So that, that definitely helps out significantly. So your adjusted gross income can, can be a bit higher. So in this scenario, you would have about $50,000 to live off of, and you need to contribute about $40,000 into tax-deferred savings accounts between 401(k)s and HSAs. And that, that would bring your gross income down to your— an AGI level that would basically allow you to pay $0 in tax. So let's go through. Let's say that instead of having 2— 1 child, you had 2 children. So let's say your gross income was $110,000. Your wife took an $18,500 wage from the business. You took a $50,000 officer wage, the other $41,500 was business income, which got the 20% deduction, which reduced it down to $33,200 in business income. So your reportable gross income is down to $101,700. Then you put money into your 401(k), max it out, $37,000, put money into, into an HSA of $34,500. So you had $40,450 in adjustments, so it reduced your $101,700 of gross income down to an adjusted gross income of $61,250. So that $61,250, you take your standard deduction of $24,000, and then the rest of the— so you would have taxable income, but then your 2 children of $4,000, $2,000 apiece, would wipe out your tax liability. So that would allow you to live off of about $70,000 and not pay any taxes with married filing jointly, 2 children. But you just have to make sure that you're, you're putting away that— the key is to put the— to max out your 401(k)s and your HSA. All right, and the last example, we have a single individual who has $38,000 in real gross income. They have an S corporation, they take a wage of $13,000 as the officer. The other $25,000 is business income. That $25,000 gets the 20% business deduction, which reduces that $25,000 down to $20,000. So your Gross income is $33,000 that is reported. Then you have, you max out your 401(k), contribute $18,500 to your 401(k), max out your HSA of $3,450. So that equals $21,950 of adjustments. So your adjusted gross income is actually $11,050. So in this scenario, you'd only need to get your adjusted gross income down to $12,000 to not pay any taxes. So this is a little bit more aggressive than needed, but this would provide about— allow you about $16,000-$17,000 to live off of, and you would pay no income taxes. So those are a few examples on how you can pay zero income taxes The key is to maximize contributions to tax-deferred or tax-advantaged accounts, especially 401(k)s and health savings accounts. You also have your standard IRA, simple IRA, SEP IRA. I used 401(k)s in this example because they have the highest contribution limit. If you're in step 4 of the wealth-building process, you know, you're saving for the long term, I definitely recommend you set up a 401(k) in your business. If you're the only employee in the business, a solo 401(k) would be a good option. If it's just you and your wife, a solo 401(k) is still a good option. If you have other employees involved, you'd have to set up a standard 401(k) plan. If everyone in your family is really healthy and you don't expect to have a significant amount of health costs, getting a high deductible healthcare plan coupled with a health, a health savings account is definitely a good strategy because it allows you to put that money in a tax-deferred account and you can actually access those funds once you hit age 65. The other key is knowing how much you need to show in taxable income. or how much you need to have shown as your adjusted gross income to avoid paying any tax, because that, that will allow you to actually make the proper amount of contributions. So with that, you know, you can search online for a tax calculator to help you with this, or you can get someone to help you through this process, a tax planner, to actually guide you through this and see how much see how much you want to pay in income tax. Because you can definitely pay zero if you want to, as we just went through and demonstrated. Or if you're willing to pay more, you could come up with a different plan. But everyone's situation is unique, and this was kind of a boilerplate, uh, scenarios that we just went through. But I definitely highly encourage you to take a look at limiting the amount of taxes you're paying, because that's going to be your number one expense in your lifetime is paying income taxes and taxes to the state, taxes to the federal government. So limiting that as much as you can will help you build wealth quicker. Hope this episode was informative and helpful. Until next time.