What the New Tax Law Means for Small Businesses and Freelancers
The GOP’s new tax law might have the country divided, but one thing’s for sure: Businesses of all sizes came out on top. New pass-through provisions and other potential deductions mean that it’s more appealing than ever to join the gig economy and take the leap to being your own boss.
There’s a lot we still don’t know about precisely how the new tax law will be implemented, but we do have an idea of the perks. Here’s what small business owners and freelancers should know.
There’s a new 20 percent deduction for pass-through income.
The headline on the tax bill for many businesses is the new treatment of “pass-through income,” or income that’s reported by individuals from smaller business entities (think LLC, partnership, S corporation or Schedule C). These types of businesses aren’t subject to any tax at the corporate level—instead, the businesses compute their profits, and then that income is passed through to the owners and taxed as ordinary personal income on their return. Freelancers who receive 1099 forms are generally also eligible for this deduction.
The old rule vs. the new rule: Before the new law, pass-through income was simply taxed as ordinary income. Whether you got $100 in wages or in pass-through income, they were taxed the same—at an ordinary graduated rate, up to a maximum of 39.6 percent. Now, there’s a 20 percent deduction for pass-through dollars that wasn’t in effect before—good news for small business owners and freelancers. Let's say you're a small business owner with qualifying pass-through income: Under the new law, the rate dropped from 39.6 percent to 37 percent.
But once you account for the 20-percent deduction, your taxes would effectively be 29.6 percent, says Joe Rosenberg, senior research associate at the Urban-Bookings Tax Policy Center, a nonpartisan think tank.
You can now write off the entire cost of most business equipment upfront.
How many “capital assets” have you purchased for your small business, or to use professionally as a freelancer? A capital asset is any sort of long-lasting piece of equipment you use for work that adds productivity over the years. (Think machinery and business equipment—this would cover things like computers, software or even cars.) The new law makes it much more attractive—and cheaper, come tax-time—to make these longer-term “investments” in your business.
The old rule vs. the new rule: Before the tax overhaul, if you bought business equipment, you had to depreciate it over a number of years on your tax return (meaning you couldn’t write off the full amount at which you purchased it in any one year, but had to spread the deduction out over many). Now, you can deduct the entire cost of “pretty much any capital asset” the first year you buy it, says Rosenberg. “If you’re already going to buy it, you can get a big bang out of it,” says Slott. Just make sure that you actually need the item and aren’t just buying it because of the potential tax benefits.
Employees—anyone that receives a W-2 tax form—can no longer deduct out-of-pocket expenses.
Independent workers, take note: Are you a freelancer in the colloquial sense, in the eyes of the IRS, or both? In conversation, a “freelancer” just means someone who often does work for multiple companies and isn’t committed to just one long-term. But as far as tax law is concerned, a freelancer is technically someone who receives income with no taxes withheld (and a 1099 form), while an employee receives their wages minus withheld taxes (and a W-2 form). “Be careful—a lot of people who consider themselves freelancers are actually paid as employees,” says Phyllis Jo Kubey, an enrolled agent based in New York, NY.
The new tax law has some key changes for deducting out-of-pocket expenses.
The old rule vs. the new rule: Before, people paid as employees were able to deduct out-of-pocket professional expenses on their tax return using form 2106. Now, “that has been completely eliminated with the new tax law,” says Kubey. But if you have gotten into the habit of keeping track of those business expenses, don’t stop quite yet—there’s a remote possibility that some states could come through with provisions for employees to deduct those expenses. If you're an employee, consider negotiating with your employer for reimbursement for business expenses you used to deduct.
If you’re considering striking out on your own, first make sure you’re armed with a robust emergency fund (you want to be able to stay afloat for a good six months) and a good idea of your risk tolerance. And make sure the new tax law isn’t your primary motivation. “These laws could change,” says Ed Slott, CPA. “Always do what’s best for your business regardless of taxes. It shouldn’t be the other way around.”
With Hayden Field