Self-Employment Deductions Under the New Tax Law
The new Tax Cuts and Jobs Act, which went into effect on Jan. 1, has sent an unambiguous message that the current GOP-dominated Congress and Presidential Administration are decidedly pro-business. Fortunately, they included provisions in the new legislation that enhance tax advantages for many self-employed sole proprietors.
The following offers an overview of both new and old tax deductions that benefit self-employed workers.
When you work for yourself, you must pay both the worker and employer portions of FICA taxes. In 2018, the Social Security tax is 12.4 percent (6.2 employer + 6.2 percent employee) of the first $128,400 of net income. The Medicare tax is 2.9 percent (1.45 percent employer + 1.45 percent employee) on every dollar of net income. This means a self-employed business owner must pay 15.3 percent in taxes in addition to his or her regular income tax rate. The good news is that the employer portion of the FICA employment tax is deductible.
Qualified Business Income Deduction
The new tax law reduced the corporate tax rate from 35 percent to 21 percent. However, this does not affect self-employed business owners because their income is taxed based on their personal income tax bracket. Legislators did throw in a last-minute provision to help level the playing field: a 20 percent deduction of personal income. Technically, this is called “pass-through qualified business income” (QBI), a term which basically refers to business revenue that the sole proprietor uses to pay everyday household expenses.
This new deduction is available to businesses structured as a sole proprietor, partnership (including an LLC) or S corporation. It essentially allows certain self-employed workers to reduce their taxable income by an additional 20 percent. The new rule applies to taxpayers who earn less than $157,500 ($315,000 for a married couple filing jointly). This tax break phases out gradually and is not available for taxpayers filing singly who earn more than $207,500 ($415,000 if married filing jointly).
Home Office Deduction
The home office deduction remains in place for small business owners who use their home as their principal place of business. In most cases, there must be a designated space devoted exclusively for the business.
When the self-employed save for retirement with an individual 401(k) plan, simplified employee pension (SEP) or other type of qualified plan, contributions may be deductible and earnings have the opportunity to grow tax-deferred until withdrawn.
While the usual business expenses such as office supplies are deductible, supplies that have a lifespan of more than one year are deductible as a depreciated capital expense. The new depreciation rate was raised from 50 percent to 100 percent on equipment bought and placed into service after Sept. 27, 2017.
If you take classes, attend workshops or seminars, pay dues to join a professional organization or even purchase books and periodicals to help you learn about your business, these expenses may be deductible.
Studies show that more than one-third of small business owners work at least 60 hours a week, so it’s common for those who travel to catch a little rest and relaxation while on a business trip. Fortunately, IRS regulations provide for this type of situation.
The first rule is that the travel must actually qualify as a business trip. Once that criterion is met, the following guidelines apply:
- Days spent traveling to and from the destination qualify as full work days
- For travel inside the United States, the majority of time must be spent on business
- For travel outside the United States, only 25 percent of time must be spent conducting business
- If the business owner spends a smaller percentage of time on work, he or she might still be able to claim deductions based on a comparable percentage of that time (e.g., 20 percent of work-related expenses if 20 percent of the trip is spent working)
To qualify as deductible, expenses must be considered “ordinary and necessary”—meaning no luxury sports car rentals or $500 bottles of wine. Business-related meal expenses qualify for a 50 percent deduction (keep receipts and record participants and topics discussed). The new tax law no longer allows for the deduction of entertainment expenses.
To learn more about how the new tax law changes will impact you and your business, contact your Lewis & Knopf tax advisor or visit our tax services page to find out how we can help you develop a personalized tax plan.