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Investing Blog Roundup: “Floor and Upside” Retirement Planning

There are two broad schools of thought when it comes to funding retirement: one that plans to use volatile assets to fund the bulk of necessary spending (and which therefore focuses on “safe” withdrawal rates) and another that prioritizes locking in a safe “floor” of income before allocating retirement funds to volatile asset classes.

Dirk Cotton recently provided a clear walk-through of the “floor and upside” strategy that may be of interest to retirees and near-retirees.

Other Money-Related Articles

Thanks for reading!

What *Didn’t* Change as a Result of the New Tax Law?

Quick book-related update: The 2018 edition of Social Security Made Simple is now available (print version here, Kindle version here). The changes are minor, so I’m using the same ISBN as the 2017 edition, which means that the Amazon page will still show the 2017 publication date.

And the writing is finished for the 2018 edition of Taxes Made Simple. My estimate is that the book will be available in roughly 2-3 weeks.

The single topic that readers have asked about most often over the last month or so has been the new deduction for pass-through business income. To my surprise though, there has been another type of email that has been even more common: questions about various things that haven’t changed at all. That is, people want confirmation that certain things weren’t changed by the broad new tax law.

“Is Social Security taxation changing?” (Nope.)

“Has the premium tax credit changed?” (Nope.)

And so on.

So, with that in mind, here’s a non-exhaustive list of things that are essentially unchanged as a result of the new law. (I say “essentially” unchanged, because many of these these deductions/credits/etc. involve dollar amounts that are inflation-adjusted each year. And, going forward, they will be adjusted based on chained CPI-U rather than CPI-U.)

  • The calculation that determines how much of your Social Security benefits are taxable
  • Retirement accounts (aside from the new inability to recharacterize — undo — a Roth conversion)
  • Cost basis tracking/reporting (i.e., the proposed change that would have forced people to use the FIFO method for identifying shares did not occur)
  • The step-up in cost basis that occurs when property is inherited
  • The 3.8% net investment income tax
  • The 0.9% additional Medicare tax for high earners
  • Medicare and Social Security taxes in general (including self-employment tax)
  • Health Savings Accounts (HSAs)
  • Deduction for self-employed health insurance
  • Deduction for student loan interest
  • Itemized deduction for charitable contributions
  • American Opportunity Credit
  • Lifetime Learning Credit
  • Child and dependent care credit (not to be confused with the child tax credit, which has changed, and which in some cases can now be claimed for dependents other than your children)
  • Retirement savings contribution credit
  • Premium tax credit
  • Earned income credit
  • Credit for purchasing a plug-in electric drive vehicle
  • Residential energy credit (for purchasing solar panels or a solar hot water heater for your home)

Hopefully, this should wrap up our discussion of the new tax law — at least for now. I’m looking forward to discussing some non-tax topics in upcoming articles.

For More Information, See My Related Book:


Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Investing Blog Roundup: Just Now Getting Back Into the Market?

“What should I do now, if I bailed out of the market in 2008?”

I hadn’t heard that question from anybody in a while, though I heard it all the time from readers from probably 2011 to 2015 or so. Jim Dahle recently gave a great answer for anybody who took their money out of stocks in 2008 and still hasn’t reinvested.

Other Money-Related Articles

Thanks for reading!

Small Business Entity Selection (2018, New Tax Law)

A reader writes in, asking:

“How does the new tax law affect the decision of how a small business should choose to be taxed?”

As a bit of background, for a business with one owner, the three taxation options are:

  • Sole proprietorship (or LLC taxed as such),
  • C-corporation (or LLC taxed as such), or
  • S-corporation (or LLC taxed as such).

And for a business with multiple owners, the taxation options are:

  • Partnership (or LLC taxed as such),
  • C-corporation (or LLC taxed as such), or
  • S-corporation (or LLC taxed as such).

Sole Proprietorship/Partnership Taxation

As before:

  • Income from a sole proprietorship or partnership is taxed at normal individual income tax rates, and
  • Sole proprietorship income (as well as partnership income if the partner is active in the business) is subject to self-employment tax (i.e., a tax of roughly 15%, to replace the Social Security and Medicare taxes that would be paid by the employee and employer if this were wage income instead).

What’s new is that those individual income tax rates are now, in most cases, lower for a given level of income than they would have been prior to the new law.

In addition, income from such businesses will also qualify for the new deduction for pass-through business income (subject to phaseouts), which makes sole proprietorship/partnership taxation somewhat more advantageous than previously.

C-Corporation Taxation

C-corporations are taxed at their own rate (now a flat rate of 21%, whereas before they had progressive tax brackets like individuals). Then, when they distribute income to shareholders in the form of a dividend, the dividend is taxed at 0%, 15%, or 20% tax rates depending on the taxpayer’s level of taxable income. The dividend may also be subject to the 3.8% tax on net investment income.

Previously, C-corporation tax treatment was not usually advantageous because of this double taxation (i.e., taxation of income at the corporate level, plus taxation of the dividend paid to the shareholders). While the new flat 21% tax rate means that C-corporation income over $50,000 will now be taxed at a lower rate than previously, the overall concept of double taxation still applies. And the net result is that C-corporation tax treatment will still be undesirable for most small business owners.

S-Corporation Taxation

Profit from an S-corporation:

  • Is taxed at individual income tax rates,
  • Qualifies for the new deduction for pass-through business income (subject to phaseouts), and
  • Is not subject to self-employment tax.

In other words, it’s the same as income from a sole proprietorship or partnership, but without self-employment tax.

However, S-corporations are required to pay their owner-employees a “reasonable” level of compensation (i.e., wages/salary) before there can be any profits. And such wages:

  • Are taxed at normal income tax rates,
  • Are subject to regular payroll taxes (i.e., Social Security and Medicare taxes that are essentially the same thing as paying self-employment tax), and
  • Do not qualify as pass-through income for the new deduction.

In other words, the wages themselves are not very tax-efficient. So the savings from S-corporation taxation only kick in once there is enough income from the business to pay a reasonable level of compensation to owner-employees and still have a sizable profit left over.

So, in short, for people whose income level is such that they would be in or below the 24% tax bracket (and therefore unaffected by the phaseouts for the new deduction for pass-through income) sole proprietorship/partnership taxation is now somewhat more appealing relative to S-corporation taxation, because all of the sole proprietorship/partnership income would qualify for the deduction, whereas the wages that the S-corporation would have to pay to the owner-employee(s) would not qualify for the deduction.

Of note, however, is that the opposite conclusion may apply for people in the phaseout range (as well as for non-service business owners who are past the phaseout range). That is, S-corporation taxation may be relatively more advantageous, because it would be advantageous to have the business pay wages to somebody (i.e., the owner-employee), to minimize the impact of the wage-related limit for the deduction.

More than ever, discussing the matter with a qualified tax professional is likely to be advantageous.

Investing Blog Roundup: Investing Made Simple, 2018 Edition

Administrative note: There will be no articles next week, to give me more time to work on updating my various books to reflect the recent tax changes. (Publishing every other week may turn out to be the ongoing schedule for a few months.)

Investing Made SimpleOn a related point, the 2018 edition of Investing Made Simple is now available (print version here, Kindle version here). For anybody who hasn’t read the book, it’s exactly what it sounds like: an easy-to-understand, concise introduction to the topic of investing.

As far as the other books, the 2018 edition of Social Security Made Simple is coming along, and I’m in the very early stages of updating Can I Retire and Taxes Made Simple. I have not yet begun work on the two largest projects (i.e., updating the two books about small business taxes).

Recommended Reading

Thanks for reading!

How to Calculate the Deduction for Pass-Through Business Income

With regard to the new tax law, by far the most common topic of questions from readers has been the new deduction for pass-through business income (i.e., income from sole proprietorships, partnerships, S-corporations, or LLCs taxed as any of the above).

What follows is my best attempt to explain the new deduction clearly. Unfortunately, it is complicated. So if this deduction will be relevant to your personal tax planning, I’d encourage you to meet with a tax professional, read the applicable part of the new law for yourself, and/or read articles on the topic by other sources (e.g., Steve NelsonMichael KitcesKelly Phillips Erb).

One point before we get started: I’m simplifying here by assuming that you have no qualified cooperative dividends, qualified REIT dividends, or qualified publicly traded partnership income. Each of those types of income gets special treatment under this new Code section.

Basic Calculation

If your taxable income* is under a certain threshold amount, the deduction is 20% of the pass-through income from your business(es), but it cannot be greater than 20% of your taxable income excluding net capital gains.

The threshold amounts are $315,000 if you are married filling jointly or $157,500 if you are single, head of household, or married filing separately. (Of note, this is the top of the 24% tax bracket for each filing status.)

When your taxable income exceeds the threshold, two potential complications kick in:

  • A wage (or wage + property) limit, and/or
  • A phaseout for “specified service businesses.” 

Wage (or Wage + Property) Limit

If your taxable income exceeds a certain phaseout range (i.e., the threshold amount from above, plus $100,000 if married filling jointly or $50,000 if single/head of household/married filing separately), then your deduction for each business will also be limited to the greater of:

  • 50% of the W-2 wages paid by the business**, or
  • 25% of the W-2 wages paid by the business**, plus 2.5 percent of the unadjusted basis immediately after acquisition of all “qualified property” (basically, depreciable tangible property that is used by the business or held by the business and available for use).

If your taxable income is in the phaseout range, the calculation basically says, “If you were past the phaseout range, how much would the wage (or wage + property) limit reduce the amount of your deduction? Now, instead of reducing your deduction by that whole amount, we’ll multiply that reduction by a percentage that is the percentage of the way you are through the phaseout range.”

Example: You are single and you have $150,000 of pass-through income from a sole proprietorship. Your taxable income is $182,500 (i.e., halfway through the phaseout range). The business has no qualified property. The business has two part-time employees to whom it paid a total of $40,000 of W-2 wages over the course of the year.

Without regard to the limitations, your pass-through business income deduction would be $30,000 (i.e., 20% of $150,000). But your taxable income is past the threshold amount of $157,500. If you were past the phaseout range, your deduction would be limited to $20,000 (i.e., 50% of the wages paid by the business). That’s a $10,000 reduction relative to what it would be without the limitation.

But you aren’t past the phaseout range. You are halfway through it. So your deduction ($30,000) is reduced by half of that $10,000 — for a total deduction of $25,000.

Specified Service Business Phaseout

If your business is a “specified service business,” there’s another limitation that can come into play. A specified service business is:

  • Any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its owners or employees; or
  • Any trade or business which involves the performance of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.

If your business is a specified service business, then we again calculate how far your taxable income is through the same phaseout range (i.e., the same threshold, plus either $100,000 or $50,000).

If you are past the phaseout range, you get no deduction for pass-through business income.

If you are in the phaseout range, then we calculate the deduction as normal, except we only consider a pro-rata share of all of the amounts from the business (income, gain, deduction, loss, W-2 wages from the business). So, for example, if your income is 70% of the way through the phaseout range, everything is 70% phased out, so only 30% of your income from the business would be counted for calculating the deduction.

A key point here is that this affects the amount of wages counted for applying the wage and wage+property limits! And this is where the complexity starts to get ugly.

Example: You are single and you have $150,000 of pass-through income from a sole proprietorship. Your taxable income is $170,000 (i.e., 25% of the way through the phaseout range). The business has no qualified property. The business has two part-time employees to whom it paid a total of $40,000 of W-2 wages over the course of the year. The business is a specified service business.

Because you are 25% of the way through the phaseout range, all of the amounts from the business are 25% phased out, meaning we use 75% of each of them. So instead of calculating 20% of the income from the business, we calculate 20% of 75% of the income from the business (i.e., 20% of 75% of $150,000). That gives us a deduction of $22,500 before applying the wage-related limit.

As in the prior example, to apply the wage-related limit, we calculate what the reduction to the deduction would be if you were all the way through the phaseout range, then we apply only a portion of that reduction, based on how far you are through the phaseout range.

Again, the wage limit is 50% of the wages from the business, but because of the specified service business phaseout we are now calculating 50% of 75% of the wages from the business (i.e., 50% of 75% of $40,000). That gives us a limit of $15,000. That’s what the limitation would be if you were past the phaseout range. Relative to the $22,500 deduction you’d have without the wage limit, that’s a $7,500 reduction.

But you aren’t past the phaseout range. You’re 25% of the way through it. So we calculate 25% of the $7,500 reduction, which gives us a reduction of $1,875. So we take your initial $22,500 deduction and reduce it by $1,875 for a total allowed deduction of $20,625.

Other Assorted Points of Note

The deduction for pass-through business income is not an “above the line” deduction (i.e., it does not reduce AGI). But it is also not an itemized deduction; that is, you can claim it as well as the standard deduction. In other words, it works much like personal exemptions did prior to 2018.

As far as first-glance tax planning thoughts, I’ll offer three brief points:

  • For business owners below the phaseout range, this new deduction is usually going to be a point in favor of keeping sole proprietor taxation (or partnership taxation) rather than electing S-corp taxation, as the wages that the S-corp would have to pay to owner-employees would not be pass-through business income.
  • Business owners below the phaseout range will have two different marginal tax rates for different types of income. (Normal taxable income will have a normal marginal tax rate, and pass-through business income will have a lower marginal tax rate because it results in a larger deduction.)
  • For business owners in the phaseout range, those two marginal tax rates will be higher, because each additional dollar of income (whether from the business or not) will cause partial phaseout of the deduction.

*For brevity’s sake, I’m referring to “taxable income” throughout this article. In reality, we are concerned with taxable income without regard to the deduction for pass-through business income.

**For multiple-owner pass-through businesses (i.e., partnerships, S-corps, or LLCs taxed as either of the two), “W-2 wages” only includes that one owner’s allocated share of total wages paid. For example, if the business paid $60,000 of wages and there are two partners each with 50% ownership, $30,000 would be the amount of wages each partner would use when calculating the deduction.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."
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