The first thing you should know is that there is a difference between itemizing on a Schedule A for things like state and local income and property taxes, medical expenses, and contributions and listing expenses on a Schedule C which is where you put the income and expenses for your freelance business. A number of people have asked what they are going to do if they can’t itemize their business expenses. The answer is that they can pretty much take the same expenses they could before for their business. They may or may not be able to itemize any more depending on their particular circumstances.
The second thing is there is now a new passthrough rule that enables many freelancers to take a 20% deduction of their Qualified Business Income on their Schedule C’s. Effective tax year 2018, an individual taxpayer qualifies for this deduction for qualified business income (or pass-through entity deduction) This deduction does not change the amount of self-employment tax they pay but it reduces the income tax paid.
What is a pass-through? A pass-through is any entity that passes through the income to the taxpayer. What qualifies? Schedule C income, S-corporation income and partnership income. A freelancer can be a single member LLC or simply a sole proprietor.
What is Qualified Business Income (also now known as qbi)? Look at the last line on Schedule C. If there is a positive number on that line, that will be the first number to consider qualify for the 20% deduction. Subtracted from that number will be one half of self employment tax, retirement contributions, and/or health insurance deducted as adjustments to income on the new Schedule 1 of the 1040. The qbi will be the lesser of this number or of your taxable income.
How this works: the qbi deduction is a subtraction from what is known as “Adjusted gross income” along with the standard deduction or itemized deductions to arrive at “taxable income”.
Are there are any limits on this deduction: Yes. All passthroughs of earned income will qualify up to taxable income (before the qbi) of $157,500 for single or $315,000 for married filing joint people. Taxable income is not adjusted gross income on page 1 of the 1040. Taxable income is the amount after the standard itemized or deductions (and qbi) are subtracted from the adjusted gross income and appears on the top of page two. The exception here is if you are a sub-S corporation, you are limited to the greater of 50% of the W-2 wages or 25% of the W-2 wages plus 2.5% of unadjusted basis of property.
If the threshold amounts are exceeded, reduced amounts of deductions are allowed for taxable income up to $207,500 for single people and $415,000 for married filing joint people.
For whom do the threshold amounts matter? If you are a specified service activity and earn above the threshold amounts (and phase out), you won’t be able to take the deduction. What is a specified service activity? It means activity in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
What this means is that if you are in any of the named fields and your taxable income is more than the threshold amount or the phaseout amount, you are out of luck and don’t qualify for the deduction.
The IRS has narrowed down what it means by “where the principal asset of such trade or business is the reputation or skill of one or more of its employees” in the proposed regulations to 1) endorsing products or services and 2) appearing at an event or on radio, television, or another media format. I suspect how this will be interpreted will take years to unwind. However, it is much narrower than the open ended idea that anyone with skill or knowledge would be included in the specified service categories.
An area for writers has also been clarified. Anyone who writes a script or a book that is integral to the creation of a performing art, you fall under the category of performing art and are disqualified from taking the qbi deduction. This would mean if you sell your novel or article to the movies or tv, you can’t take the qbi deduction.
Also there still may be disputes as to who actually is considered in these categories.
If you earn over the threshold amount and you are in one of the qualified service categories, you may want to research being an S-corporation with W-2 wages to see if it’s worthwhile and possible to get a qbi deduction. The qbi is 20% of your qualified business income or limited to the greater of 50% of that businesses W-2 wages or the sum of 25% of the W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition of all that business’s qualified property.
If you already have an S corporation and have discovered that you will not benefit very much from the qbi deduction, you’re below the threshold amount and you’re thinking that you should go back to filing a Schedule C to get the advantage of being able to take the full qbi, be very careful. The IRS has specifically made doing this illegal and will not permit a qbi for anyone who has done this for work that is essentially the same for the same employer for three years.
If you are a W-2 worker and think that going freelance will get you the qbi deduction, be very careful. The three year lookback rule applies to anyone who has done similar services for the same employer for three years which would mean that you would not qualify foor the qbi deduction for three years.
Also work done outside the United States does not qualify as qualified business income and thus will not qualify for the 20% deduction. This makes sense for those people who live abroad and qualify for the foreign income exclusion and the foreign tax credit. However, it may adversely impact those who don’t.
What must be understood is that when tax bills pass, there can be years of uncertainty about certain things. This section of the law leaves many specific questions that will have to be worked out. This tax bill was passed without lengthy congressional hearings so that we don’t even have congressional intent as to what this phrase means.
These provisions expire after 2025.
Most states are not allowing the qbi deduction. Idaho, Colorado, North Dakota and Minnesota are allowing it; Iowa is allowing a partial deduction.
Otherwise filing for the 2019 tax year as a freelancer will pretty much remain the same as before. Remember the 2017 change that was made concerning not being able to take the entertainment part of the meals and entertainment expenses. Please see “Meals and Entertainment Deductions Under the New Tax Law”. https://www.freelancetaxation.com/meals-and-entertainment-deductions-under-the-new-tax-law
Filing as an individual or as married filing joint people has changed in many ways especially regarding itemizing on a Schedule A or taking a standard deduction and taking exemptions.
In this article, I’ve tried to cover the things that are most relevant for freelancers as freelancers. The other information is widely available and not covered here.