- Mike Segar/Reuters
- The Republican tax bill proposes a significant break for pass-through businesses.
- A new report from the Tax Policy Center showed how married couples making the same amount of income would pay a dramatically different amount in taxes due to the change.
- The TPC report highlights that the tax bill sets up winners and losers not just by how much money you make, but also by how you make your money.
One of the most significant tweaks to the federal tax code in the Republican Tax Cuts and Jobs Act could come from how people make their money.
The rules in the tax bill would make it possible for people making the same amount of income to pay wildly different amounts in taxes, based on the filing status of their income. People that receive a straightforward paycheck from their employer would likely end up paying more than those that work as a contractor or are self-employed.
That’s because many people that are self-employed or work as a contractor would be able to take benefits associated with so-called pass-through income.
A pass-through business is one that books the profits of the company as income for the owner. In the House tax legislation, pass-through income would be subject to a 25% tax rate, while the Senate bill would give a 23% deduction on that income.
A preliminary compromise between the House and Senate bills would give a 20% deduction to pass-through income.
Two different tax bills for two kinds of plumbers
For example, a contractor doing the same work as a plumber but booking that income to a limited liability corporation would get a significant tax break compared to a an employee working as a plumber for a company.
To illustrate this difference, the Tax Policy Center, a nonpartisan think tank, broke down how this little shift in how you work could make a big differences on your taxes.
TPC compared two married couples, both with no children and a combined income of $250,000.
“Both couples itemize their deductions under current law, claiming state and local income taxes of $17,500, property taxes of $8,000, and combined mortgage interest and charitable contributions of $20,500,” the TPC report said.
The only difference: One couple makes their money from wages and salaries, the other makes their money from self-employment and contract work.
The Senate bill’s deduction structure would make a huge difference:
- According to the TPC, the self-employed couple would get a tax cut of $11,497 compared to current law.
- The couple making money from wages would get a tax increase of $730.
The difference under the House bill wouldn’t be as pronounced, the TPC said. But the final compromise bill looks likely to include the 20% deduction structure like the Senate, so the gap would look more like it would under the Senate legislation.
“The self-employment couple would pay much less tax because they could deduct a portion (23 percent) of their business income in computing their adjusted gross income,” the TPC said. “The new deduction would more than compensate for the loss of personal exemptions and the loss of the state and local income tax deduction.”
Republicans argue the break for pass-through income will encourage more people to start their own business or grow an existing small business. Critics argue that many households could set up pass-through businesses to game the system and take advantage of the deduction. But Republicans say there are rules in the bill to try and prevent that.