Retirement: New Tax Breaks for Retirement Income

Need an extra incentive to ease into retirement with a part-time gig? Or to earn some extra cash to supplement your Social Security and IRA payouts? Would the chance to treat 20 percent of your freshly found income as tax-free do the trick?

If so, say thank you to the U.S. Congress.

The new tax law creates a special 20 percent deduction for “pass-through entities,” a category that includes most businesses in the U.S., whether they are organized as a Subchapter S corporation, a limited liability company or a sole proprietorship – that is, simply working for yourself. Basically, you’re a pass-through if you’re not a regular corporation.

That, in fact, was the driving force behind this deduction. The new law slashes the corporate tax rate from 35 percent to 21 percent, but it only slices the top personal rate from 39.6 percent to 37 percent. Because pass-through income is hit by personal rates, the 20 percent deduction is an attempt to share the wealth by cutting small-business taxes, too.

YOU COULD BE A WINNER

So, how big a deal is this? It could be huge.

Cotty Lowry, a real estate agent in Minneapolis, reports that his accountant thinks he’ll be a “big winner” under the new tax bill. The 20 percent write-off can apply both to Lowry’s net income from his real estate business and to the rental income thrown off by several buildings he owns.

The deduction applies to “qualified business income.” It’s probably easiest to cite what does not qualify: earnings by an employee, earnings by a regular corporation and earnings from “specified service” businesses that provide service in fields such as health, law, accounting, performing arts and athletics.

You might wonder what’s left, but don’t worry. There’s a gigantic exception. The specified-services poison pill only applies to high-income individuals. If your income is less than $157,500 on an individual return or under $315,000 on a joint return, you can deduct 20 percent of your qualified business income even if it comes from a specified-service business. The write-off is gradually phased out as income rises above those levels.

The IRS is still figuring this all out, but it’s likely the new deduction will be figured on a special form and then entered on the Form 1040 as a subtraction from adjusted gross income.

What kind of pass-through-income work might make sense for you? Consider phasing into retirement by becoming a consultant for your former employer. Get creative. Do you make and sell crafts at local fairs or online websites such as Etsy? Drive for Uber or Lyft? Babysit, run a dog-walking service, tutor children or give music lessons? The new tax law gives you more incentive than ever to develop a new retirement income stream.

Kevin McCormally is a chief content officer at Kiplinger’s Personal Finance magazine.