How the New Tax Law Impacts Small Businesses and High Earners

Recent changes to the tax law have introduced new dynamics that are reshaping the landscape for small business owners and high-income individuals. While the revisions were intended to stimulate growth and streamline the tax system, their effects vary widely depending on income type, business structure, and individual circumstances. Understanding these impacts is crucial for effective planning and financial decision-making.

The 20% Pass-Through Deduction: A Key Feature

A major component of the revised tax code is the introduction of a 20% deduction on qualified business income (QBI) from pass-through entities. These include sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations. This deduction aims to reduce the overall tax burden for small businesses and encourage entrepreneurship.

However, the benefit isn’t automatic or universal. Certain professionals—such as lawyers, consultants, and financial advisors—may face limits on the deduction based on income levels and the nature of their services. For individuals in these specified service trades or businesses (SSTBs), the full deduction begins to phase out once taxable income exceeds $182,100 (or $364,200 for married couples filing jointly), with complete phase-out occurring shortly after.

Who Gains the Most?

Those who stand to benefit most are business owners outside the SSTB category, especially in capital-intensive fields such as real estate and manufacturing. These industries often generate qualified business income while maintaining a structure that aligns with the deduction’s requirements.

For example, a Utah-based S-corporation with $400,000 in qualified business income (QBI) could potentially claim up to an $80,000 deduction under the 20% rule, provided it meets the wage or property thresholds. This significantly lowers taxable income, making the deduction a substantial benefit for eligible businesses.

Real estate developers or investors operating through LLCs or partnerships may also claim the full deduction if they meet wage and asset-based criteria. This has led many high earners to reconsider their business classification or adjust their income streams accordingly.

Strategic Structuring Becomes Essential

The new law has created a wave of strategic planning among entrepreneurs and professionals alike. Many are re-evaluating their business entities or exploring restructuring to maximize the deduction. In some cases, individuals formerly classified as employees are transitioning to independent contractor status or forming LLCs to potentially qualify for the deduction.

Yet these changes are not without risk. Misclassifying income or reworking contracts purely for tax benefits could draw scrutiny. Business owners are advised to consider not only tax advantages but also liability protection, cash flow, and operational complexity.

The Role of Wages and Depreciable Assets

Another layer of the deduction calculation involves the number of wages paid and the value of qualified depreciable property. For taxpayers whose income exceeds the phase-out thresholds, the deduction is limited to the greater of:

• 50% of W-2 wages paid by the business, or
• 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified property.

This formula creates additional incentive to increase payroll or invest in capital assets. It also underscores the benefit for businesses with a strong employee base or significant investment in long-term equipment and property.

What High Earners Should Consider

High-income taxpayers may find that despite the lower top marginal tax rate—now 37% instead of 39.6%—the loss of key deductions such as state and local tax (SALT) deductions has tempered the gains. For many in high-tax states, this cap on SALT deductions may offset the advantages of the new rules.

Furthermore, some high earners may explore shifting income sources or adjusting compensation methods to fall within deduction thresholds. These tactics require detailed analysis and should be approached carefully.

Long-Term Implications

The full effects of the new tax provisions will unfold over time, particularly as taxpayers adapt and regulatory guidance evolves. For now, business owners and professionals must evaluate their current tax profiles and look for ways to optimize under the new structure.

Tax law changes often trigger innovation in planning, but they also bring complexity. Those who take a proactive and informed approach stand to gain the most from the current environment. With proper planning and professional guidance, both small businesses and affluent individuals can align themselves with the law’s opportunities while avoiding potential pitfalls.