How GOP House tax bill could help the self-employed

Among the many provisions included in the House GOP's proposed tax plan are several that could be potentially valuable tax breaks for small-business owners.

Getting the most attention so far is the new tax rate proposed for "pass-through business income" earned by a business organized as a sole proprietorship, partnership, limited liability company (LLC) or S-corporation. These are also known as "pass-through entities." This provision would allow a pass-through business to characterize a portion of its income as "profit" and enjoy a potentially lower rate of 25 percent on it, while the owner's salary income could be taxed at the regular rate of as much as 39.6 percent.

But the Republican House proposal also aims to provide additional tax benefits for the self-employed. Here are the key points:

When you're self-employed, there's no employer but you to pay your share of employment taxes on your salary income. These consist of the Social Security and Medicare taxes (also known as the self-employment tax) assessed on your salary or wages at a rate of 15.3 percent on income up to $127,200. However, if you're an employee of a business, you pay Social Security and Medicare taxes at a rate of 7.65 percent, and your employer pays the other portion on your behalf.

The legislation would change the rules so that self-employment taxes of 15.3 percent generally wouldn't apply to income qualifying for the new 25 percent rate. Combined with the new lower rate on pass-through business income, this provision could save almost 30 percent in tax on a portion of income for many self-employed people.

Another tax break already used by the self-employed is expanded under this plan. Self-employed business owners can currently deduct the full cost of qualifying equipment purchased or financed in 2017. The limit on this deduction in 2017 is $510,000, and it can be used for qualifying business-related items purchased such as computer equipment, office furniture, tools and even vehicles used for business (some restrictions apply). 

The expensing limit would remain as it is now until 2023 and then gradually rise to $20 million. The current and new limits would be indexed to inflation, and the eligible property would be expanded to include qualified energy-efficient heating and air conditioning equipment placed in service after Nov. 2, 2017.

The House GOP tax plan also proposes to reduce or eliminate several above-the-line deductions. Two of the most commonly claimed above-the-line deductions by the self-employed -- health insurance costs and retirement plan contributions -- aren't affected under the plan.

If you're self-employed, you'll still be able to take a tax deduction for the premiums you pay for medical, dental and even qualifying long-term care insurance for you and your family. This is done via an adjustment to income and is claimed under the adjusted gross income section on form 1040. So it's available to you even if you don't itemize deductions.

Also, the self-employed can set up and fund their own retirement plan. The deduction for contributions made into the plan can still be claimed as an adjustment to income on the front of form 1040.

My favorite type of retirement plan is the self-employed 401(k) profit-sharing plan, which allows you to make contributions both as an employer and as an employee. Using this type of plan, which is easily set up at any major brokerage firm, you can make an additional contribution that's a percentage of net profit (this is the employer's profit-sharing component of the contribution) and a fixed-dollar amount up to the 401(k) contribution limits (which is $18,000, or $24,000 for those over age 50 in 2017). 

For an individual who declares about $80,000 net profit from self-employment, the total amount claimable as a contribution to this type of plan is about $32,870 in 2017. If you're 50 or older, you can contribute about $38,870. For those 50 or older with a profit of $190,000 or more in 2017, the maximum pretax contribution is $59,000. 

Make sure you establish the self-employed 401(k) plan before year-end to be allowed to make a deductible contribution into on your 2017 tax return. Do this now, before things get hectic at year-end.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.