Tax reform legislation enacted at the end of 2017 reflects the most sweeping change in the tax code in several decades. We will discuss some of the key provisions that will impact many of you regardless of what you do for a living, as well as how some of these aspects of the new laws might impact you as a freelancer.
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Generally lower tax rates
For 2018, most personal tax rates are lower than in 2017 across the spectrum of personal income levels and filing statuses. For freelancers, some portion of your business income generally flows into your personal tax return as a pass-through, and these lower rates will be beneficial to you in that regard. Additionally, any salary that you earn via your business will be taxed at a lower rate.
Reduction of taxable business income
The new law contains a 20 percent reduction on business income passed through to your personal return. This might be via a Schedule C for sole proprietors, or for the income for an LLC or S-Corp that passes through to your personal return. In addition, as mentioned above, the remaining 80 percent of your pass-through business income will be taxed based on the lower personal income tax rates for 2018.
Home office deduction
For those who are self-employed and who are able to deduct expenses relating to a dedicated home office, this was left unchanged in the new tax law. However, for those who are employees, the ability to deduct these costs as an unreimbursed business expense have gone away as part of the new tax law.
Section 179 deduction
The section 179 deduction enables businesses to immediately deduct the cost of certain business equipment versus depreciating it over time. The new tax law retains this deduction and increases the limits. As a practical matter, the biggest impact for most freelancers will surround the purchase of equipment like a new computer, printer and other items of this type.
Increased standard deduction
A key component of the tax reform bill is an increase in the standard deduction for 2018 and beyond. The standard deduction for single filers increases from $6,350 to $12,000. This increases for those married filing jointly from $12,700 to $24,000.
The main implication for many will be a reduction in the ability to itemize deductions. For married couples who might have $20,000 in expenses that could be itemized in past years, they would now just claim the standard deduction. This of course benefits those whose deductible expenses would normally have fallen short of the $12,000/$24,000 thresholds.
The personal exemption will be going away under the new rules. The amount for 2017 was $4,150 for each person claimed (including yourself and a spouse), so this at least partially offsets the benefits of the increased child tax credit (see below) and the standard deduction.
SALT stands for “state and local taxes.” The provision to cap the deduction for state income taxes, any local income taxes and property taxes was one of the most controversial and politically charged ones in this legislation.
The cap on itemized deductions for all of these taxes combined is now $10,000. This will impact those of you who live in areas with high property taxes and high state income taxes. States like California, New York, Minnesota, Illinois and much of the Northeast are among the areas where this is a big issue.
If you own a home and live in a state with high state and local taxes, it is easy to incur taxes that exceed the cap. This is an increase in your after-tax cost of living. This may also dovetail into the impact of the higher standard deduction and serve to make it harder to itemize individual deductions, such as mortgage interest and charitable contributions.
A number of itemized deductions have gone away or have been changed for 2018, including:
- The ability to deduct professional services, such as tax preparation, financial advice and some others.
- Unreimbursed employee expenses.
- Theft and personal casualty losses in most cases.
Medical expense deductions and those for charitable contributions remain and were both enhanced a bit.
A key strategy to consider is bunching deductions into a single year. If you find that your itemized deductions will fall short of the level where you can itemize, defer or accelerate things like charitable contributions, medical expenses and others into a single year to help your reach the level where itemized deductions exceed the standard deduction for that year.
Another strategy here is to see if any personal expenses that may not be deductible under the new law would be legitimate business expenses. Be sure to consult your tax professional to ensure that you don’t commit tax fraud.
Child tax credit
The child tax credit increases from $1,000 to $2,000. This now includes a provision for parents who don’t earn enough to pay any tax to claim up to $1,400 in credits. Remember a credit is a direct reduction in the amount of tax that is due and is worth more than a deduction to income.
The income levels for eligibility to claim the credit have been increased to $400,000 from $110,000 for a married couple filing jointly, allowing more of you to take advantage of the credit.
Related to this, the new rules allow for a tax credit of up to $500 for the care of each non-child dependent. This can include aging parents, an increasingly common situation.
Mortgage interest deduction
The tax reform package includes a cap on the amount of mortgage debt that is eligible for a mortgage interest deduction. Mortgages that are currently in place are grandfathered. For new mortgages starting in 2018, only the first $750,000 of mortgage debt will be deductible. While this might seem like a high amount, those living in high cost areas can easily have mortgages in this range or higher.
Also new for 2018, the interest on home equity loans is no longer deductible unless used for home improvements. This increases the cost of this type of borrowing, if this is a source of funds for your business or personal needs you may want to consider another avenue.
Retirement plan contributions
Several proposed versions of the new tax law included provisions to cap the amount that could be contributed on a pre-tax basis to retirement plans such as a 401(k).
The good news for freelancers and everyone else is that the new tax law included no changes to retirement plans. The contribution limits for retirement plans such as a solo 401(k), a SEP-IRA and Roth and traditional IRAs all remain the same.
The items discussed above are just a few of the changes made in the new tax law. Be sure to research how the new rules impact you both positively and negatively. Better yet, consult with a qualified tax professional.
While most of the changes are on the personal side rather than having a direct impact on your business, we ultimately pay taxes on much of the income we generate from our business via our personal returns.
One point to remember, many of these new provisions expire after 2025.