Got a side hustle? Then you should know that the Tax Cut and Jobs Act provides a tax gift to side hustlers. This law created a new break that is likely to significantly cut the federal income taxes you pay on your self-employment income.
Tax gift to side hustlers
“The new law takes 20% off the top of your business income,” says Gene Zaino, president and chief executive of MBO Partners, a consulting firm for independent workers. “That’s a pretty good deal.”
This tax break is called a “pass-through deduction.” For many, claiming it is simple. You fill out your return as usual, but apply a 20% deduction against your net self-employment income. That reduces your taxable income and your tax. But, if you earn more than $157,500 when single or $315,000 when married, filing a joint return, things get more complicated.
Here’s what you need to know about this new tax break, in question and answer form.
What is the pass-through deduction and how can you claim it?
The pass-through deduction is a special break meant to help small business owners, who often pay tax at high personal income tax rates. Corporations, on the other hand, pay tax at corporate rates were cut drastically in the Tax Cuts and Jobs Act.
Why would small business owners pay corporate tax at personal rates?
Because many business owners and side hustlers don’t create a formal corporation to receive their business income. Instead, they file taxes as “pass-through” entities, such as sole proprietorships, Subchapter S corporations, and partnerships. (If you have side hustle income, but have not formed a corporation, this applies to you.)
Until this new tax law, it made little difference whether you were corporation or a sole proprietor because top rates were the same. However, when the TCJA passed, it cut the top corporate income tax rate to 21% from 35%. The top personal tax rate was only cut to 37%, which would have placed small business owners at a disadvantage.
How does the pass-through deduction work?
Business owners fill out a Schedule C (“Profit and Loss from a Business/Sole Proprietorship”). This form allows you to subtract business deductions from income to produce a net profit from your business or side hustle. Multiply that net profit by 20%, and subtract the result from your business income.
To clarify: If your business or side hustle brought in $100,000 in revenue, but you had $20,000 in expenses, you would have a net profit of $80,000. You would multiply $80,000 by 20% and subtract the result ($16,000) from the $80,000. You only pay tax on the remaining $64,000 in business income.
What if I also have income from wages?
Claim wage income, as usual, on the front page of the 1040. The 20% pass-through deduction does not apply to wages — only self-employment income.
You said it’s only simple if I earn less than $157,500 when single or $315,000, when married filing jointly. What if my total income is greater than that amount?
Yes. That’s because your ability to claim this new pass-through deduction will depend on both what you do for a living and how much you earn doing it.
By and large, highly-paid “service” professionals — doctors, lawyers, athletes and entertainers, for instance — are only able to claim partial deductions once their income exceeds those thresholds. And at higher income levels the deductions are eliminated for those in these “service” professions.
What if you’re not in a service business?
Then you need an accountant. The law has an obtuse reference to phase-outs of deductions for small businesses depending on their income, the number of people the business employs and the value of the business assets. The IRS has promised to clarify exactly how this provision works, but the agency has not yet provided guidance and the details are complex and cloudy, says Luscombe.
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