The Tax Cuts and Jobs Act has certain provisions that may affect people with a side gig. These include pass-through deduction, which allows those in the gig economy or with side hustle to keep more extra cash. To see if you qualify for the deduction, learn more about it.
In this article:
- What Is the Purpose of the New Deduction?
- How to Calculate the Qualified Business Income Deduction
- Examples of Qualified Business Income Deductions
- How Do You Claim the Qualified Business Income Deduction?
- Tips for Preparing for Tax Season if You Have Side Gigs
Got a Side Gig? | Here Is a Deduction That May Save You More Money
What Is the Purpose of the New Deduction?
For those with a side gig, here is why the tax cut is there in the first place.
During the creation of the tax reform law, corporate tax went low to a rate of 21%. Because of the decrease, there was a fear LLCs, partnerships, and sole proprietorships will convert to a corporation.
The government wants to keep the same balance between corporations and pass-through entities, so it decided to give pass-through entities a tax break of their own. This took the form of a 20% deduction of their business income.
How to Calculate the Qualified Business Income Deduction
Whether you have a part-time job to earn extra money or a full-time job as the sole owner of a company, your additional income will be subject to pass-through taxation. This means you can deduct 20% of your earned income from your side gig.
Whether can claim it will depend on your type of business and total income, including your wages from your day job.
If your total income is under $157,500 for single filers and $315,000 for married taxpayers filing jointly, you may claim the full 20% deduction for an unincorporated business income.
When you get close to the higher-income limit, the deduction goes down. This is unlikely to happen, however, since your taxable income will most likely be higher than your business income.
If you are a high-income taxpayer or your income exceeds $157,500 for single filers and $315,000 if you filed jointly, your ability to claim the deduction for the side gig may be affected.
You may also be unable to take the deduction at all if you are a high-income taxpayer and have a business that falls under certain professional services such as the following:
- Actuarial Sciences
- Performing Arts
- Brokerage Services
- Financial Services
If your business does not fall into one of the above categories but your income is higher than the threshold level, you can still take the deduction.
In this situation, the qualified business income deduction will have limitations. The amount of your deduction will be based on either:
- 25% of the W-2 wages your business paid out along with 2.5% of your businesses depreciable property
- 50% of the W-2 business wages your company paid
The first limitation is typically geared toward real estate companies, which tend to have fewer employees but bigger assets.
Examples of Qualified Business Income Deductions
To understand the impact of the deduction on the side gig, here are some examples.
Say, your day job earns you $80,000 a year in taxable income. Aside from that, you earn money up to $12,000 in business income from gig work in which you are the sole proprietor.
You can take the full 20% deduction on your pass-through earnings of $12,000. This will result in a $2,400 deduction.
Now let us look at the situation if you are a high-income earner. Say, your taxable income is $210,000 and you earned the same $12,000 from a side job.
If your source of income comes from one of the barred categories, you will not qualify for the deduction as your income is too high. If your business is in a different category, you will be subject to the W-2 limitations.
Let us assume your business has one employee with a W-2 for $2,000 earnings. Your deduction is limited to 50% of that total, which will be $1,000.
How Do You Claim the Qualified Business Income Deduction?
Even though the 2018 tax forms are not yet released, the Internal Revenue Service (IRS) has stated the qualified business income deduction will not be an itemized deduction.
You can still take the standard deduction while benefiting from the new business income deduction. This will allow sole proprietors to avoid having to itemize deductions, which may be the better option in the upcoming tax year.
Tips for Preparing for Tax Season if You Have a Side Gig
Whether you are an independent contractor or a daytime employee with a side gig, you can already start preparing for these changes and anticipate the deductions with these tips:
1. Budget for What You Expect to Owe
As an employee, you handle all the withholding and quarterly taxes paid on the income earned in your paycheck. When you are the sole proprietor of a business, you must keep track of and pay taxes on the money you make.
Keep track of all your income and expenses and be sure to pay your estimated taxes if you expect to owe more than $1,000 on your upcoming tax return. If your income is not consistent, you can make adjustments to avoid incurring a penalty at the end of the year.
2. Make Sure You Get Every 1099 Form
You need to record all income you make from your side gig and be on the lookout for any 1099 that will come from companies where you have made at least $600.
Double-check your 1099s for accuracy and make sure you report all the income you received from your job on your Schedule C.
3. Keep Track of Business Expenses
Fumbling through piles of receipts looking for your business write-offs and deductions is not only time-consuming but also harmful. It puts you at risk of missing some important expenses.
Keep your receipts organized and in one place. By recording all expenses, you can ensure you have your business expenses ready when it is time to file.
If you have difficulty recording transactions, consider using a separate business credit card or bank account.
4. Be Prepared for How Your New Income Will Affect Your Personal Taxes
Determine how the additional income will affect your personal taxes. The income from your side gig can cause you to lose earned income tax credit and also push you into a higher tax bracket.
If you are a student earning extra income to pay off student loans, you may want to consider how these additional funds may affect your financial aid.
5. Do Not Be Afraid to Call a Professional
Taxes are complicated and can become even more so when you are earning money on the side. By hiring a professional, you will protect yourself if you get audited.
A professional can help you find deductions you may not have realized and maximize your return. They can also prepare your quarterly tax statements for the upcoming year and keep you updated on changes in the tax law.
Whether you make some money on a side gig or have steady part-time work for a business you own, taking advantage of the new tax reform law can save you a lot on the taxes you owe. Stay on top of it, however, by following the tips above including getting help from a tax professional.
Do you think the deduction is beneficial for people with a side gig? Let us discuss in the comments section below.
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