How does the new tax law impact Soloists?
By Susan Johnston Taylor
The GOP’s tax reform bill made headlines last fall as Soloists and others wondered how the new tax code would impact them.
A slew of sensationalist headlines created panic and confusion over what deductions are still valid and what reform will mean for taxpayers. Some of these stories, particularly those written before the final bill passed, may contain inaccuracies or refer to changes proposed in an earlier version of the bill that was not ultimately passed.
Unfortunately, even the experts aren’t sure how tax reform might play out in its first year. “It’s still open for interpretation,” says Cathy Derus, CPA, owner of Brightwater Accounting in the Chicago area. “What was their intention with some of these things? One person was saying that anybody can be an expert and have an opinion and until it goes to tax court.”
Caveats aside, here’s a look at what we currently know about how the tax code is--and isn’t--changing under the new law.
Perhaps the biggest change impacting Soloists is a new deduction of 20 percent of qualified business income (QBI) for pass-through entities such as sole proprietorships, S-corporations and partnerships. Depending on the type of business, QBI might include income from selling a product or providing services. However, it excludes income from investments such as dividends or interest income or short or long term capital gain or loss.
Income paid through an agency as a W2 employee is not eligible for this deduction. However, you can still be eligible to take this deduction even if you also take the standard deduction. The deduction is calculated after you take the standard deduction, so often it doesn’t work out to a full 20 percent of all self-employment income.
For instance, Derus ran the numbers on a single sole proprietor with $50,000 in net self-employment income (assuming no capital gains). After deducting 15.3 percent for FICA taxes, this person would have $46,175 in adjusted gross income. Then with a standard deduction of $12,000, the taxable income (prior to QBI) would be $34,175. Twenty percent of that amount is $6,835, so this sole proprietor could theoretically deduct $6,835 in QBI.
This new deduction may mean you’ll owe less in taxes than under the old tax code, but there are some wrinkles based on the type of business and your income. For individual taxpayers with income above $157,500 or married couples who file jointly and have a combined income above $315,000, the 20 percent deduction may be reduced if you’re in a service-based business. Individual taxpayers with income above $207,500 and married taxpayers filing jointly with income above $415,000 do not qualify for this deduction.
The deduction is equal to the lessor of the combined qualified business income of the taxpayer or 20 percent of the excess of taxable income minus the sum of any net capital gain. “Things start to get complicated once you're in a specified service business like attorneys, accountants, doctors, and other service-based providers and over the income limit,” Derus says. “Businesses that aren't service-based are still eligible for the deduction, but it's a more complicated calculation that compares 20% of QBI income with W-2 wages paid and qualified property.” This deduction is set to expire in 2025 unless it’s renewed.
Another change applies to deducting meals and entertainment for business purposes. Under the old tax code, business-owners could deduct 50 percent of meal and entertainment expenses incurred for business purposes on their Schedule C. “Food you can still deduct, but if it’s that extravagant wine and dining entertainment, you cannot,” explains Derus.
Prior to tax reform, the IRS announced a one cent increase to the standard business mileage deduction. For 2018, you can deduct 54.5 cents per mile driven for business purposes.
Changes due to tax reform go into effect for 2018 and 2019, so they will not affect your 2017 tax return. When you or your accountant prepares your tax return for last year, the old tax brackets and deductions will still apply.
What isn’t changing
One of the rumors circulating the internet late last year was that self-employed professionals could no longer deduct business expenses. That’s not accurate, according to Derus. “As long as you have legitimate expenses that you need to run your business--professional fees, software, utilities, rent -you could still certainly deduct those,” she says.
However, and this may be where the confusion started, employees used to be able to deduct unreimbursed employee expenses such as dues for a professional association, classroom supplies for teachers or work uniforms on Schedule A of their tax return. That deduction is not available under the new tax code.
“If you’re an employee somewhere that paid for expenses out of pocket that your employer wasn’t going to reimburse them, you’re not going to be able to deduct those going forward,” Derus says. But for Soloists running their own businesses rather than working for someone else, legitimate business expenses are generally still deductible.
As before, Soloists are still responsible for both the employee and employer portion of FICA (Social Security and Medicare) taxes, also called self-employment tax. Prior to tax reform, the Social Security Administration lowered the wage base subject to a 6.2 percent Social Security tax from $128,700 to $128,400. There is no wage limit on the 1.45 percent Medicare tax. The total self-employment is 15.3 percent (6.2 x 2 + 1.45 x 2), subject to wage limits on Social Security taxes.
Soloists who’ve been in business for at least a year may still need to pay quarterly estimated taxes. You can pay quarterly taxes online through the IRS website or by mail.
Here are the quarterly payment deadlines for 2018:
Q1 - April 17, 2018
Q2 - June 15, 2018
Q3 - September 17, 2018
Q4 - January 15, 2019
Under-pay quarterly taxes and the IRS may penalize you, but if you over-pay you’ll get a refund once you file your tax return for that year. Unsure how much to pay in quarterly taxes under the new tax code? “You might want to talk with a tax professional to see ‘what is my new quarterly estimated tax payment?’” Derus says.
In general, Derus says it may be a smart idea to consult an accountant or tax preparer for tax year 2018, even if you’ve prepared your own tax returns in the past. “I would always say it’s always best to consult a professional,” she says. “People think it might be straightforward but there can be tax consequences [to misunderstanding something]. One of the biggest things is you want to make sure you’re keeping on top of your record keeping and your bookkeeping. Somebody who has experience working with people in your industry [can help identify tax deductions you might have missed].”
Feeling overwhelmed? Derus offers a 30 minute phone consultation that can help get you on the right track.