How The New Tax Bill Affects Freelancers

by Hannah Cole on January 22, 2018 · 1 comment You Got This

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It’s 2018, and you are likely starting to think about your taxes. You may also be wondering what’s in the newly passed tax legislation (officially the “Tax Cuts and Jobs Act” or TCJA) and how it’s going to affect you. Here is some help, specifically targeted for freelancers and creative economy workers.

To be clear, the 2017 taxes you file in the next few months will be based on the rules you already know. In other words, the old tax laws apply to the 2017 taxes you will file this year. The TCJA applies to 2018 and beyond, so this is for your planning for the coming year.

When you file your 2018 taxes (next year), most people will get an initial tax cut (that will expire in 2026), but the wealthy get most of the benefit. People in high-tax and high cost of living areas and those with kids may see their taxes rise. New York City artists with children, this means you. There are a lot of nuts and bolts reasons for this, which is what the bulk of this article is designed to address, but it’s worth spelling out the rationale for these changes. Your taxes may go up because Republicans are targeting blue states in an attempt to force us to cut our spending. They are giving a large, permanent tax cut to corporations, and the majority of individual tax breaks to the top 1%. This cues up a big deficit that they will later point to when they try to cut social spending. By delaying talk of spending cuts, they hope we will all forget who created this deficit and why.

The Tax Cuts and Jobs Act is the biggest piece of tax legislation passed since 1986, and there is a lot in this legislation that is untested. Our understanding of TCJA will continue to evolve as clarifying technical memos are issued from the Treasury, and ambiguities are tested in the courts. I will do my best to give a freelancer/artist-centric overview, but understand that its full meaning won’t be worked out for a long time yet.

First, there are new tax brackets, and most people will find themselves in a lower rate. For example, a married couple filing jointly with an income between $19,050 and $77,400 is now in a 12% tax bracket, whereas until 2018, that couple was in the 15% tax bracket. Like the vast majority of benefits to individuals and small businesses, these provisions expire in 2026. As I mentioned above, the corporate cuts (specifically the C-Corporations, outside the scope of this article) do not expire.

To understand how the new bill works, its important to review the basic tax setup. All taxpayers get an initial chunk of their income tax-free. You can choose to either take the standard deduction amount (a fixed amount) or the itemized deduction amount (variable based on your itemized deductions such as mortgage interest, state and local taxes and charitable contributions). If your itemized deductions are greater than the standard deduction amount ($6,350 for an individual or $12,700 for a couple in 2017) – in other words, if you pay more in mortgage interest, state and local taxes, and charitable contributions than the standard deduction amount, then you can itemize your deductions and get a larger tax-free amount.

On top of that first chunk of tax-free income, all taxpayers, whether they choose the standard deduction or to itemize, get an additional tax-free chunk called the personal exemption. This is a set amount per individual in the household ($4,050 per person in 2017)- so a bigger household gets a much bigger personal exemption.

In the new law, the standard deduction is roughly doubled. It will now be $24,000 for a married couple, $12,000 for an individual. This is up from $12,700 and $6,350, respectively. This sounds great, but there are several reasons why it isn’t as good as it sounds.

Reason number one is that at the same time, the personal exemption is eliminated. This will mostly offset your gain from that higher standard deduction. In 2017, you get a personal exemption of $4050 for each taxpayer and most dependents in your household. So you don’t pay tax on that amount plus either your standard deduction or itemized deduction. For example, in 2017, a family of four who takes the standard deduction is not taxed on their first $28,900 of income (that’s the standard deduction of $12,700 plus 4 personal exemptions X $4050 each). In 2018, under the new law, that number is reduced to $24,000 (1 standard deduction of $24,000 + no personal exemptions). In other words, their taxes just went up. The bigger the family, the worse the impact.

The other reason the doubling of the standard deduction is bad news to a lot of taxpayers is that it will push many people who are used to taking itemized deductions into taking the standard deduction. To review, you get to choose between itemizing and taking the standard deduction based on whether your itemizable expenses exceed the standard deduction amount – if they do, you can get that higher deduction by itemizing. In 2017, if you had expenses like mortgage interest, state and local property taxes, or charitable contributions that exceeded $12,700 (if married) or $6350 if single, you would get to take those as itemized deductions. In 2018, those expenses have to exceed $24,000 (or $12,000 if single) in order to itemize. It means that all those people no longer get to deduct mortgage interest, state and local taxes or charitable contributions at all. And remember, no one gets the personal exemption anymore. So, previously, if you had $10,000 of deductible income and added that to your personal exemption, you’d have a $14,050 total deduction. In 2018, if you had $10,000 in deductible expenses, you’d be forced to take the standard deduction, and now only have $12,000 in deductible income.  About 90% of all taxpayers will be taking the standard deduction on their 2018 taxes (up from about 70% now). So yes, as Paul Ryan bragged, the process of filing may be simpler for you now that you don’t itemize. But it’s a worse deal.

The child tax credit is doubled to $2000 per child under 17, and there’s a $500 credit for dependents who aren’t children (like college students, and aging parents).  The credits aren’t indexed to inflation, so they will diminish in value over time (and expire in 2026). This may help offset the loss of the personal exemption, but that will vary based on a host of other factors like your tax bracket. Despite efforts to repeal them, tuition waivers have been kept in place, and student loan interest deductions remain intact.

Mortgage interest, if you still qualify to itemize deductions, is limited to debt of $750,000 ($375,000 if single) after 1/1/2018. Debt incurred before that date is grandfathered in at a cap of $1 million ($500,000 if single). To be clear, you don’t get to deduct the amount of your debt (you never did) – this is the amount of debt on which you may deduct interest. People in high cost of living areas will feel this most acutely – the house-buying dollars that got stretched because of the generous mortgage interest deduction rules of the past will shrink in value if properties in your range are selling for more than this debt cap amount. This is going to hurt urbanites, especially those just entering the housing market.

The moving expense deduction is eliminated, except for active duty military.

The bike commuting deduction is eliminated, as is the employers’ deduction for transportation benefits, like Metrocards.

The most deliberately partisan item in the TCJA is a $10,000 cap on deductions of state and local taxes (they have historically been fully deductible). This is a calculated effort to pressure blue states to reduce spending. And funding at the state level primarily goes to education, healthcare and the social safety net. The original proposal eliminated deductions of state and local taxes altogether. Although the $10,000 limit on deductions is better than nothing, the reduction of this deduction is a calculated effort to cause citizens of high-tax states (read: blue states) to pressure their legislatures to cut spending on healthcare, education and social programs, since they will no longer get the Federal tax break on all of it.

Until 2018, taxpayers could deduct all of their state and local taxes, in aggregate (meaning state income tax, plus local property tax, city tax, etc). The impact of this limit will be felt most acutely by high-earning people (who pay substantial state income tax) in areas with additional city taxes (like New York) or with high property taxes (like the New York and New Jersey suburbs).

Governor Andrew Cuomo didn’t mince words, “New York will be destroyed.”

It is a Federal reach into states’ rights to set their own tax priorities. I think citizenship includes caring for our society and promoting community values through, yes, taxes. So when I see an underhanded tactic to strike at states whose citizens of their own right choose to value education and the social safety net, I feel compelled to call it out. The $10,000 cap was added back to the bill as a concession to blue-state Republicans, because any citizen of a blue state whose Republican member of Congress voted for this bill will be rightfully furious.

Some people in these states rushed to prepay their property taxes in 2017. There’s dispute among tax professionals about what will happen – the audits and court cases will tell us in time. But most professionals think that you’re not going to get away with itemizing your 2018 pre-paid taxes this year unless your state or locality actually assessed the tax. You can check with your local department of revenue to see when the assessments happen. If you just guesstimated, you are likely out of luck. Many people will still try, and those are the audits I’ll be curious about.

Another thing to look out for is withholding from your paycheck. The IRS has yet to issue wage withholding guidance based on the new law, so many taxpayers will end up owing money even though their taxes went down. The issue at hand is that since your taxes may be going up or down in 2018, your withholding will have to adjust with it if you want to prevent a big surprise on next year’s tax bill. You cannot rely on the withholding you have currently, since it is based on personal exemptions and itemized deductions that are now gone. When IRS guidance is issued – likely this February – it will be very important to check with your employer and adjust your withholding on a new W4.

But there’s some good news for pass-through businesses—businesses that do not pay corporate-level income tax, such as partnerships, S-corporations and sole proprietorships – and yes, artists and freelancers filing a Schedule C are included here. There is a new Deduction for Qualified Business Income (QBI) (which expires in 2026), that allows you to deduct 20% of your “qualified business income” from your total business income. So if I made $100,000 in profit from selling paintings as an artist, I get to deduct 20% of that – ie, $20,000. This benefit is phased out for individuals making over $157,500 ($315,000 if married) in a number of service-based fields* As good as it is (and it is!) there are a ton of details and restrictions in this particular new provision, so know that you need to do research or talk to your accountant before you apply it.

Another major outcome of the TCJA is the elimination of the individual mandate penalty for not having health insurance. Interestingly, Congress simply set the penalty to zero, rather than repeal the mandate altogether. So the legal structure remains. Note however, that this doesn’t take effect until 2019. So even for 2018, you still need to have health insurance each month to avoid the $695 per family member (or 2.5% of income) penalty. Despite the Trump administration’s efforts, the IRS is still enforcing this provision.

* Those fields that will be phased out are: “Health, law, 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 [hello artists!].” Oddly enough, engineers and architects are specifically omitted from that list (they must have a good lobbyist).

 

DISCLAIMER: True tax advice is a two-way conversation, and your accountant needs to hear your full situation to apply the rules correctly in your case. This post is meant for general information only. Please don’t act on this alone.

Bio: Hannah Cole is an artist and Enrolled Agent. She is the founder of Sunlight Tax.

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