Tax Reform 101 for Self-Employed
The Tax Cuts and Jobs Act overhauls the Internal Revenue Code and provides broad tax relief to workers, families and businesses of all sizes. Beginning in tax year 2018, tax rates are lowered for individual and business taxpayers, and various tax deductions and credits are changed. A typical family of four earning $73,000 a year could receive a tax reduction of as much as $2,000.
On-demand work is a rapidly growing alternative to the 9-to-5 job, and companies such as Lyft, HomeAway and TaskRabbit are effectively reshaping the economy.
In the eyes of the IRS, self-employed people, such as freelancers and independent contractors, are treated as small business owners, and the newly passed tax reform law provides some generous tax benefits for this segment of the workforce. Review the tax changes in this article and pass these along to your clients. The following infographic gives a glimpse of the impact on a typical single, self-employed filer before and after the tax changes are applied (these are mock scenarios and your results will differ).
Highlights of Changes Pertinent to Self-Employed Workers
Lower Tax Rates
The new tax act retains the seven tax brackets found in current law, but lowers a number of the tax rates by about 2 percent on average. The new law also expands the income thresholds at which the rates apply. Because the overall federal income tax rates were lowered for the majority of taxpayers, self-employed workers should benefit and realize a lower tax bill. Here are the rates and brackets for married filing joint filers.
New 20 Percent Deduction for Self-Employed Workers
One of the key tax reform measures provides a 20 percent deduction beginning in tax year 2018 on pass-through income from self-employed, sole proprietors (Schedule C on Form 1040), limited liability companies, partnerships and S corporations. This deduction allows self-employed to keep more earnings tax-free, and helps curb high tax rates and the 15.3 percent self-employment tax. Self-employed qualifying for the 20 percent tax deduction could see their effective marginal tax rate reduced to 29.6 percent.
For example, a single Uber driver, without kids, earning $26,000, will see about $623 tax savings in 2018 due to the 20 percent deduction from qualified business income, thus further lowering their tax rate. There are some additional rules surrounding this deduction, including a phase-out of the deduction for high-income earners (over $157,500 for single filers and $315,000 for joint filers).
Ramped up Depreciation Benefits
Business owners are now allowed to fully write-off the entire cost of new purchases (100 percent bonus depreciation), such as computers, furniture and equipment, in lieu of depreciating the cost of the asset over a number of years. In prior years, you could deduct only 50 percent of the cost in year one.
Under a companion measure, the government has doubled the popular Section 179 tax break from $500,000 to $1,000,000, which represents the amount of assets you can deduct in the first year. Business property qualifying for this deduction has been expanded to now include fire protection, alarm systems and security systems.
Self-employed folks who place passenger vehicles in service for their business – pay attention, Uber and Lyft drivers – will see an increase in the maximum allowable depreciation expense. The auto limitation has increased from about $13,000 in the first four years to over $40,000 in the first four years (the amounts are greater if you choose bonus depreciation). Sports utility vehicles carry a $25,000 limitation.
Don’t Miss Out on Deductions
These additional deductions allow self-employed to reduce their taxable, self-employment income and tax liability:
- Home office deductions: If you use a home office for the purpose of your business, you can claim tax deductions on that space. You may be able to deduct a portion of rent, mortgage interest utilities, insurance and repairs based on the square footage of your home used regularly and exclusively for your business. You may also be able to write off certain office supplies such as your printer, computer or furniture. Business owners are now allowed to fully write off the entire cost of new purchases (100 percent bonus depreciation), such as computers, furniture and equipment, in lieu of depreciating the cost of the asset over a number of years. In prior years, you could deduct only 50 percent of the cost in year one.
- Business trip expenses: If you’re traveling primarily for business, you can deduct 100 percent of the flight costs. You can also expense your hotel or lodging and 50 percent of your meals, though this can only be deducted for the days you’re spending on business.
Set Aside Money
The biggest difference between filing taxes as a full-time employee and filing taxes as self-employed is that no taxes are withheld from your paychecks. To prepare for your yearly tax bill, set aside a few hours per week to track your income and expenses so you can figure out your net income and estimate your taxes on a monthly basis. Consider using online tools such as QuickBooks® Self-Employed to streamline the process and make the process easy come tax time. Generally, if you expect to owe $1,000 or more for the year, you have to make quarterly estimated payments.
Editor’s note: This article first appeared on the Intuit® ProConnect™ Tax Pro Center.