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The 20% Deduction And Other Tax Changes for Freelancers, Contractors, and 1099 Workers

The Tax Cut and Jobs Act (TCJA) brought a lot of changes for small business owners – and that includes freelancers, contractors, and anyone with 1099 income (even if it’s a side gig).

The biggest of those changes is a 20% deduction on self-employed business income.

That means you will only pay income tax on 80% of your qualified business income.

The 20% deduction is for income tax only. Self-employment tax is still based on 100% of your business income.

Who Can Take the 20% Deduction?

All pass-through business entities qualify for this deduction. A pass-through business means that the business doesn’t pay income taxes – instead the income from the business “passes through” to the owner’s tax return.

Business that qualify include:

  • Sole proprietors (if you didn’t form an LLC or corporation, you’re a sole proprietor)
  • Single-member LLCs
  • Partnerships
  • Multi-member LLCs
  • S corporations

*C corporations do not qualify for the deduction.

How Does the 20% Deduction Work?

Business owners figure out their net profit for the year. As long as they meet certain income requirements and business-type requirements, they can deduct a full 20% of their profit from their taxable income. Of course, there are some weird IRS rules that may apply, but this is how the deduction will work for most 1099 workers.

If you use tax software and it asks if you have qualified business income, answer YES.

Here are the main rules that may affect 1099 workers:

  • Only income from U.S. sources count. (If you worked for overseas clients, that income does not qualify for the deduction.)
  • “Specified Service Businesses” (SSBs) have income caps that may reduce the deduction. Practically all personally performed services – including editorial, healthcare, legal, and accounting services – count as SSBs (a few exceptions apply).
  • The 20% deduction starts to get phased out for SSBs based on their total taxable income. Phase-outs start at $157,500 for Single and Head of Household Filers; and at $315,000 for Married Filing Jointly taxpayers.

To take advantage of this huge tax break, make sure that Line 9 of Form 1040 is filled in with your Qualified Business Income deduction.

Other Tax Changes That Impact 1099 workers:

  • The income subject to self-employment tax increased to $128,400.
  • Entertainment expenses (like taking a client to a concert) are no longer deductible at all.
  • You can deduct 100% of business assets (like laptops and tablets) bought in 2018 up to $1,000,000.
  • You can deduct business gifts that cost up to $25.
  • The 2018 business mileage rate is 54.5 cents per mile. For 2019 that increases to 58 cents per mile.

Have questions about whether your income qualifies? Contact me at michele@singlemomcpa.com and we’ll figure it out together.