Retiring Military Officers May Have an Option
Most military officers return to the civilian workforce after retiring from the military. Many will become employees. A few will start businesses. Some might have a choice between working as an employee or as an independent contractor.
Tax Cuts and Jobs Act Helps Independent Contractors
You may have heard that the Tax Cuts and Jobs Act (TCJA) has added a 20% deduction on pass-through business income. Upon hearing that, you may be thinking that it would be nice to work as a contractor instead of as an employee and pocket the deduction.
Before you go down that road, let's take a look at the pluses and minuses.
To do that, I'm going to make a couple of assumptions...
- The work you do for your current or future employer, could be done under a contractor arrangement. This isn't automatic. There are several factors in making the determination whether you can be classified as a contractor. A couple of them are control of how and where the work is done and the potential for profit or loss for the contractor
- Since you'll get a 20% reduction in the amount of income tax you pay for the job, you see it as a win-win and agree to the same compensation your client would pay you as an employee
- Your combined military retirement and new self-employment income will equal $200,000
- $80,000 Military Retirement
- $120,000 Self-Employment Income
- You sit squarely in the 24% tax bracket
There are some advantages to making the change to becoming a contractor.
- As mentioned, 20% of your business income will be deductible. In the scenario above that equals $24,000. 24% of $24,000 and the tax savings are $5,760. Not bad.
- If you are an employee that has unreimbursed employee expenses you will not be able to deduct them under the TCJA (Yup...you too airline pilots). If you are a contractor, these expenses are now business expenses, so you will be able to deduct them
- You might be able to to deduct medical insurance premiums as an adjustment to income instead of an itemized deduction, which makes it much more likely you'll be able to deduct them.
- You will have the ability to contribute a significant amount of your income/profit to tax deferred accounts. Most likely more than you can contribute now (you might lose employer matching though)
Of course, it's not all sunshine and rainbows. There are some disadvantages...
- There is also this thing called Self-Employment Tax. If you are a contractor, you need to pay the "other half" of FICA that your employer pays. That would be 7.65% of the full $120,000 in self-employment income (assuming you don't have any business expenses). That's $9,180 in additional taxes and for those keeping score that is more than the $5,760 you'll save with the 20% deduction.
- You may have expenses you don't have now, like business license fees and personal property tax.
- You'll have to keep "books". If you don't have an accounting background you may need to outsource this.
Finally, if your business is a service business (it most likely would be), and your income exceeds certain limits, the deduction phases out. The limit is pretty high, but it is there.
There is one other concern, the concept of "reasonable compensation". You can't take the deduction on income that is reasonable compensation for the work done. That has always been an issue for S-Corporations, but it could become an issue for sole proprietors.
Complicated...you might want to get some help with this one.