Part 1 of this 2 part post introduced the new tax bill, rated each major change and suggested that, if you aren’t already self employed or running a small business, you might want to give some serious consideration to making a change.

If you haven’t read Part 1, you should check it out.

In this second part, I will layout several examples of how the changes in the tax rules will impact average, middle class Americans.

I also demonstrate how much each person would save on their income tax bill if the income they were earning from their job was instead earned from self employment or a small business they owned.

The Scenarios

In each of the following scenarios, I give a brief description of the taxpayer’s financial situation.

I explain what their tax profile means on a 2017 tax return and compare it to what it means on a 2018 tax return under the new rules.

Then, I show you what the tax impact would be if the taxpayer’s income was from being self employed or owning a business instead of being from a wage.

You should get a good idea of how your tax situation might change from 2017 to 2018 if you are a middle class worker by reviewing these examples.

But I will tell you up front, the business comparisons are simplified examples.

They don’t take into consideration several real-life factors that would be too complicated and confusing to include in this basic analysis.

Small business owners are subject to self employment tax on their earnings and often have to provide their own health benefits if they don’t have another source for them.

However, it is also not totally fair to compare $50,000 in wages to $50,000 in business income, because business’s are able to deduct most of their expenses and it isn’t really an apples to apples comparison.

With that said, you should gain some insight into how the changes in the tax rules may impact you.

Let’s take a look at the scenarios.

Parker, the Successful Young Salesman

Parker is a 28 year old single sales guy.

Most people would consider him a financially successful young professional.

He makes $90,000 a year.

He has to travel a lot for his job, so he spends a fair amount of time away from the home he was able to purchase a few years ago.

Skip to Parker’s example here.

Caleb and Sophie, the Typical Family of Four

Caleb and Sophie are in their early thirties.

They both work to support their family financially and earn a combined income of $140,000.

They own their home and donate a modest amount to charity each year.

Skip to Caleb and Sophie’s example here.

Adam and Mandy

Adam and Mandy are working professionals in their late twenties.

They are focussed on their careers and have progressed pretty rapidly in their jobs.

They have combined income of $175,000 and rent a condo in the city.

In the past, they have not itemized their deductions.

Skip to Adam and Mandy’s example here.

Parker, the Young Salesman

A recap and some additional details about Parker’s financial situation:

• Earns $90,000 a year.
• Paid an auto allowance by his employer for his sales job and travels 30,000 miles a year on business.
• Owns his own home and pays $10,000 in mortgage interest and $3,000 in real estate taxes.
• Has $6,000 in state taxes withheld from his paychecks for state income taxes.
• Pays $500 to have his tax return prepared.

2017 Tax Liability Under the Old Rules

• After deducting his personal exemption ($4,050) and all of the itemized deductions he would be entitled to in 2017 ($33,250), Parker would have taxable income of $52,200.
• Under the old rules, he would have tax liability in 2017 of $8,789.

2018 Tax Liability Under the New Rules

• Parker would no longer get a personal exemption deduction.
• His total itemized deductions would be reduced to $19,000:
  • The new rules eliminate miscellaneous itemized deductions, including tax prep fees and the deduction Parker received in 2017 for business miles. In 2017, these deductions would have totaled $14,750. In 2018, they are worthless for employees.
  • Parker can still deduct all of his state income taxes and real estate taxes, as they are below the new $10,000 limit.
• His taxable income under the new rules would be $71,000.
• Under the new rules, Parker would pay $11,559 in tax, a $2,770 increase.

If 2018 Income Was Self Employment or Small Business Income

• If the $90,000 of income Parker earned in 2018 was self employment or small business income instead of wage income, his taxable income would be reduced from $71,000 to $39,760:
  • For purposes of this calculation, I reduced Parker’s income by 20% to account for the new small business passthrough deduction available to small business owners.
  • I also deducted all of the tax prep fees and business mileage that he would not be able to deduct as an employee in 2018.
• Under the new rules, if Parker’s income was from self employment or from a small business, he would only have income tax liability of $4,686, nearly 1/3 of what it would be as an employee.

This is the most drastic example of the three I provide.

It shows how not all taxpayers will benefit from the new tax rules.

Salespeople who are paid an auto allowance by their employers and who previously deducted their business mileage on their personal return are a prime example of a group of middle class, working taxpayers who will be negatively impacted by this bill.

Furthermore, this is a drastic example of how, if the income Parker earned was self-employment or small business income, he would pay a lot less income tax.

Caleb and Sophie

A recap and some additional details about Caleb and Sophie’s financial situation:

• Earn a combined $140,000 per year.
• Have two children.
• Own their own home and pay $8,000 in mortgage interest and $4,000 in real estate taxes.
• Have $8,500 in state taxes withheld from their paychecks.
• Donate $1,000 to charity.

2017 Tax Liability Under the Old Rules

• After deducting their personal exemptions ($16,200) and all of the itemized deductions they would be entitled to in 2017 ($21,500), Caleb and Sophie would have taxable income of $102,300.
• Under the old rules, they would have tax liability in 2017 of $16,552.

2018 Tax Liability Under the New Rules

• Caleb and Sophie would no longer get personal exemption deductions.
• They also would not benefit from itemizing their deductions. The standard deduction is greater than their itemized deductions of $21,500.
• Their taxable income under the new rules would be $116,000, which is higher than in 2017 because of the elimination of the personal exemption deduction.
• Under the new rules, Caleb and Sophie would still pay less tax. Their tax liability would be $13,399. This is due to the lower overall tax rates and change in child tax credit rules.

If 2018 Income Was Self Employment or Small Business Income

• If the $140,000 of income Caleb and Sophie earned in 2018 was self employment or small business income instead of wage income, their taxable income would be reduced from $116,000 to $88,000, as the income would be eligible for the new 20% small business passthrough income deduction.
• Under the new rules, if Caleb and Sophie’s income was from self employment or from a small business, they would only have income tax liability of $7,239, about half of what it would be as an employee.

This example is what I foresee happening to a lot of middle class families.

They will no longer benefit from deducting their mortgage interest, real estate taxes and charitable donations in 2018 because the standard deduction is higher.

In many cases, their taxable income will also be higher because of the elimination of the personal exemptions.

However, with lower tax rates and an increased child tax credit, they still come out better in the end.

Of course, they would come out better if their income was from self-employment or a small business.

Adam and Mandy

A recap and some additional details about Adam and Mandy’s financial situation:

• Earn a combined $175,000 per year.
• Live in a rented apartment and do not itemize their deductions.

2017 Tax Liability Under the Old Rules

• After deducting their personal exemptions ($8,100) and their standard deduction in 2017 ($12,700), Adam and Mandy would have taxable income of $154,200.
• Under the old rules, they would have tax liability in 2017 of $30,061.

2018 Tax Liability Under the New Rules

• Adam and Mandy would no longer get personal exemption deductions.
• Their new standard deduction would be $24,000.
• Their taxable income under the new rules would be $151,000.
• Under the new rules, Adam and Mandy would pay $25,099 in tax.

If 2018 Income Was Self Employment or Small Business Income

• If the $175,000 of income Adam and Mandy earned in 2018 was self employment or small business income instead of wage income, their taxable income would be reduced from $151,000 to $116,000, as the income would be eligible for the new 20% small business passthrough income deduction.
• Under the new rules, if Adam and Mandy’s income was from self employment or from a small business, their income tax liability would be reduced to $17,399.

This is a simple and straightforward example of how the new rules will impact a taxpayer who didn’t itemize their deductions in the past.

Their standard deduction will nearly double and, while they will no longer receive the deductions for their personal exemptions, they will still come out ahead because of the reduced tax rates.

Next Steps

A lot of the information presented in this two part post may be a bit overwhelming.

I do my best to break it down in a way that is easily digestible.

However, you may still may have questions about some of this information (or other business related tax questions).

Feel free to ask them in the comments section below or find me on Facebook or Twitter.

I’ll be answering questions about the new tax law throughout 2018.