Working in the gig economy offers certain perks, such as flexible working hours, increased earning potential and an opportunity to pursue a side job or business idea that you are passionate about. Thanks to the latest round of tax reform, gig economy workers now have even more of an incentive to pursue short-term or freelance work in the form of a substantial tax break.
Tax Reform and the 20 Percent Pass-Through Deduction
The 2017 Tax Cuts and Jobs Act includes a number of tax changes that are designed to benefit individuals, but there are also several that are aimed at reducing tax liability for businesses. One of the most significant is the 20 percent pass-through deduction on qualified business income for eligible businesses.
Essentially, this deduction allows businesses to deduct up to 20 percent of their income right off the top. Less taxable income can reduce the amount of taxes a business owes. The deduction is designed specifically to benefit pass-through entities, including sole proprietorships, partnerships, S-corporations. and limited liability companies (LLCs).
There are some limitations on claiming the deduction for service businesses, such as doctors, lawyers, or financial services companies. Generally, any business can claim the full 20 percent deduction if they're considered a pass-through entity, file singly, and have a taxable income of $157,500 or less for the year. The income threshold increases to $315,000 for married couples filing a joint return.
Service businesses whose income exceeds these limits can still claim the deduction, but the amount of income they are eligible to deduct begins to phase out. Once a single filer hits $207,500 and married couples hit $415,000 in taxable income, the deduction goes away. Based on the income thresholds, the deduction is primarily designed to deliver the most benefit to smaller businesses that do not fall into the service business category.
The pass-through deduction is intended to offer relief to smaller businesses who do not directly benefit from the reduction in the corporate tax rate from 35 percent to 21 percent. Gig economy workers are now included in that pool of business owners who stand to be affected.
What the Pass-Through Deduction Means for Gig Economy Workers
Although the 20 percent pass-through deduction singles out service businesses, it does not bar gig economy workers from taking advantage. In fact, the new tax law effectively creates a loophole that allows gig economy workers or freelancers to claim the deduction and pay less in taxes, without specifically having to incorporate their business. You could benefit from the new deduction whether if you are an Uber driver, a freelance writer, or you moonlight as a coder.
So how does the deduction work for gig economy workers specifically? If you're reporting business income on Form 1040, you can deduct 20 percent of net qualified business income. Qualified business income is any income your business or gig work generates that does not come from an investment. Net qualified business income is your income after any losses or expenses are deducted.
While the deduction covers certain corporations, you do not have to incorporate as a gig worker to take the deduction. You just have to meet the income guidelines for your tax filing status and have pass-through income. This is income that is taxed at your personal tax rate, not the corporate tax rate. So if you are doing gig work as a sole proprietor with no employees, you could potentially claim the deduction.
Tax Planning for the Gig Economy
The new tax bill took effect at the beginning of 2018 and it is never too soon to start thinking about your tax strategy for next year. If you are part of the gig economy, one question you may consider is whether you should expand your gig activities to increase your income and snag a bigger tax break.
One thing you have to keep in mind, however, is that you still pay taxes on freelance or gig income. If you are working a regular job in addition to doing gig tasks, you will need to make sure that your employer is withholding enough in taxes from your paycheck to cover any extra tax that might be due on your gig income. If not, you'd be responsible for paying income taxes and self-employment tax on the money you earn. As of 2018, self-employment tax is due on income of $400 or more you earn from self-employment. The current tax rate is 12.4 percent for Social Security and 2.9 percent for Medicare taxes.
If you are planning on growing a gig economy business or going gig full-time, you will also need to think about estimated quarterly tax payments. Businesses (including self-employed sole proprietors) are required by the IRS to break up their taxes owed for the year into four quarterly payments. If you do not make these payments on time, or if you under pay, the IRS can tack on a penalty, which adds to the amount of tax owed.
It is a good idea to talk with a tax professional if you are not sure how to make the most of the 20 percent pass-through deduction as a gig economy worker. They can also help you pinpoint other tax breaks and benefits that could reduce your tax bill or potentially lead to a larger refund.