It’s time to dig into how the new Republican tax law is actually going to affect you and yours this coming tax season. While it has been a while since the law was passed, it takes some time for the IRS to iron out the actual rules. Plus, you have to wait for the year to go by before you file your taxes. So, here we are, heading into 2019, and we’ll be doing our 2018 taxes. There are a lot of changes, but one of the biggies is Section 199A.
I’m going to take a quick look at the Section 199A Deduction as it applies to a freelancer, or someone who owns their own side business.
Section 199A Tax Deduction
As noted at the time, the Republican tax bill of 2017 was passed quickly in order to keep any opposition from building up and stopping its passage. As a result, it wasn’t very well thought through, and chances are that there are more than one or two bugs in the system. The IRS itself tried to iron some of those out as it created definitions, and rules and regulations, but there is still a lot of uncertainty about exactly how things will go down. But, let’s start by jumping in with the big parts.
First, the Section 199A Deduction is a 20% deduction on qualified business income for pass-through businesses.
And there are our first questions. What exactly is a pass-through business, and what kind of income is ‘qualified’?
What Is a Pass-Through Business
There are a lot of ways to defined this, and a lot of nuance, but the big idea is that any kind of business that “passes through” its income. In other words, a sole proprietorship, a S-corp, a trust, or estate, as well as most kinds of partnerships. This also includes most LLCs, which remember for tax purposes are treated as either sole proprietorships, or as partnerships.
While it isn’t the only criteria, for most taxpayers, if your business income comes through on a Schedule C or a Schedule K, it counts as pass through income. (Other income will too, but these are the big, basic ones.)
There are some phase-outs and limitations if your income is over certain amounts, namely $315,000 for married filing jointly, and $157,500 for everyone else. In this first look, we’ll ignore the folks making more than those amounts and focus on those under the limit.
In this case, you get to deduct 20% of your qualified business income (QBI).
There are also more rules for real estate and other business types. I’m going to not go into those either.
What Is Qualified Business Income (QBI)
Again, there are a lot of nuances here, but the most basic scenario is if you run a sole proprietorship, or LLC that is tax liked one, then the amount of QBI is generally going to the be amount of income you would report from your Schedule C. Then, the deduction is 20% of that amount.
So, if you own, say a freelance financial writing business, that comes out with $100,000 of income from the Schedule C onto your Form 1040, then presumably, somewhere later down on the 1040 will come a line that allows you to deduct 20%, or in this case, $20,000 from your eventual taxable income. However, the deduction cannot be more than 20% of your overall taxable income (not including capital gains.)
As you can see, if you generate some decent earnings from your business, this can be a very big tax deduction indeed, especially if you, or your spouse also has a W2 job.
I’ll keep reading and digging into the details, especially once the IRS starts putting out forms. Reading the tax code is fun and all, but nothing shows you how taxes actually work quite like seeing how you file them.