Any time Congress passes a new tax law, accountants and CPAs everywhere scramble to make sense of it. But now freelancers and anyone else who’s self-employed is struggling to understand how the new law will affect them. Will it hurt their business – or give them a boost?
Not sure if the new rules will change your taxes – or how? Read below to see what our experts have to say.
Changes to Deductions
The biggest change that self-employed individuals will see on their taxes is the new 20% deduction on self-employed income. This applies to single individuals who earn $157,500 or less or married couples filing jointly earning $315,000 or less.
Here’s an example. Let’s say you’re married to a lawyer who earns $100,000 a year. You earn $100,000 a year as as self-employed illustrator. When you file your taxes jointly, you’ll be under the $315,000 threshold and will qualify for the 20% deduction.
That deduction will apply only to your self-employment income and not your husband’s income, so your taxable income will be $80,000 and his will still be $100,000. This doesn’t include any other deductions the two of you might qualify for.
CPA Cathy Derus of Brightwater Accounting says this change doesn’t mean freelancers will get a break on how much they pay for self-employment taxes.
“You’re still going to pay self-employment taxes on that full $100,000, but now your taxable income bracket will be based on that $80,000,” she said.
Like many deductions, there will be some limits on who can take that deduction. Once your income starts to exceed that $157,500 or $315,000 mark, the deduction will begin to phase out. Also, if you have any capital gains from selling a heavily-appreciated stock or antique vehicle, that will offset the 20% deduction.
A minor deduction change that may only affect larger businesses is the elimination of the business entertainment expense.
Previously, freelancers and other business owners could deduct 50% of the cost of eating lunch with a client or buying them tickets to the Warriors game. Now, the entertainment deduction portion of the rule has gone away.
The meals part is still admissible on your taxes. If you grab coffee with a client, you can deduct 50% of that latte. But if you’re at a conference and a few potential clients are going to a comedy club, you won’t be able to deduct admission. However, the drinks you buy at the comedy club are still eligible as deductions.
Derus says the purpose of this change was to stop businesses from deducting “extravagant expenses” like season tickets to clients.
Should Freelancers Change Their Business Structure?
The new tax bill has caused many freelancers to wonder if they should change their business structure. When you’re a freelancer, you can choose from the following options when deciding how to set up your business:
- Sole proprietor
- Partnership or LLC
- S corporation
- C corporation
If you’re working by yourself with no additional employees, you likely file your taxes as a sole proprietor. But changing your status to an S-corp could save you thousands of dollars in taxes.
When you file taxes as an S-corp, you pay taxes differently than when you’re a sole proprietor. Here’s how it works. Let’s say you earn $150,000 as a graphic designer, and you claim $150,000 in self-employment income as a sole proprietor.
You decide to file your business as an S-corp, which means now you’ll be getting a regular salary. The average graphic designer in your state makes $50,000 a year, so you pay yourself $50,000 divided in regular biweekly paychecks. That’s approximately $1,923 you get every two weeks. The other $100,000 you earn gets distributed throughout the year.
When you file your taxes, you will pay regular self-employment taxes on that $50,000, plus the normal taxes incurred in your tax bracket. However, you will not owe self-employment taxes on that $100,000.
Derus says the 20% self-employment tax deduction will make it slightly less beneficial to file as an S-corp, but it’s still better than being a sole prop. Again, if you want a specific answer to your situation, talk to an accountant or tax expert in person.
How to Plan Ahead
Overall, Derus said that many freelancers might find themselves paying fewer taxes this year. She told one of her clients that if her income and expenses remained the same as her 2016 financials, she would owe $7,000 less in taxes because of the 20% deduction and change in the tax bracket.
However, every freelancer’s situation is different, depending on their state, total income and other factors. Talk to your accountant and fiduciary advisor about how the new tax bill will affect you and if now is the right time to consider changing your business status and how your retirement planning can be impacted.
If you are currently looking for a fiduciary advisor or just have a question you’d like to ask one, get started here on GuideVine.