Tax Day may have come and gone, but it’s likely that some of the key numbers from your 2017 return are still in your mind—especially if you had to pay more tax than you were expecting to. While you are still in a “taxation” state of mind, it’s a good idea to consider how you might lower your freelance tax bill for the current tax year.
For instance, you’ll want to pay attention to one of the most anticipated provisions of the Tax Cuts and Jobs Act (TCJA) passed late last year: the 20 percent pass-through deduction for businesses. Like many tax rules this deduction is more complex than it sounds at first, so let’s start with the basics and then we’ll delve a little deeper for those of you who want to take a closer look at the potential savings.
Here are the basic rules of the new pass-through deduction which applies to sole proprietorships, S-corporations partnerships and LLCs (that did not elect to be taxed as a corporation):
Let’s look at each of these rules as it applies to a freelance business:
So how do freelancers calculate the TCJA’s 20 percent pass-through deduction?
You should first determine if your business is an SSTB as mentioned above. The first two examples below assume that your business is not an SSTB. In both of these cases, you would calculate the Qualified Business Income (QBI) from your business. This is simply the net income of your business excluding any salary, wages or payments made to you, the owner. If you have a sole proprietorship, this would be your Schedule C income.
You will need to determine the ratio of the income you may have over the threshold limitation of $157,500 for single taxpayers and $315,000 for Married Filing Jointly taxpayers.
Keep in mind also that if your taxable income reaches $207,500 (single filer) or $415,000 (married joint filer), the QBI deduction is limited to 50 percent of your W-2 wages from that business or the sum of 25 percent of W-2 wages from the business, plus 2.5 percent of any qualified property. Then, using the income threshold stated above and the phase out amount of $207,500/$415,000 to calculate the limitation on a prorated basis.
Here is an example of how to do it assuming:
Given this hypothetical situation, your maximum pass-through deduction is 20 percent of your $300,000 QBI, which equals $60,000. With your taxable income being over $415,000, any pass-through deduction you claim is limited to the greater of (i) 50 percent of the W-2 wages paid to your employees, or (ii) 25 percent of W-2 wages plus 2.5% of your office building’s $250,000 basis. (i) is $100,000 (50% x $100,000) = $50,000; (ii) is (2.5% x $250,000) + (25% x $100,000) = $31,250. Since (i) is greater than (ii) you would have to take the greater amount of $50,000 as the pass-through deduction.
A Non-Specified Service Trade or Business would calculate the deduction this way:
For our example, assume:
To calculate, multiply your deduction prior to the phase-out—in this case it is limited to 50 percent of the W-2 wages you paid since there is no qualified property. This is equal to $30,000 (50% x $60,000 W-2 wages = $30,000). With your phase-out percentage being 31 percent you get 69 percent of the full deduction which is equal to (69% x $30,000 = $20,700).
This new pass-through deduction may offer significant tax savings for your freelance business, but it is also somewhat complicated. Could it save you 20 percent? Maybe—it depends on how the specific rules of this deduction apply to your situation. This is where enlisting a tax professional to do some tax planning and calculations may be helpful. Whether you choose to work with a tax pro or to go it alone, it’s worth considering whether this new tax deduction can reduce your freelance tax bill.
Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.
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