As a freelancer, small business owner, or solopreneur, staying informed about changes to the tax code that can impact your unique financial situation is critical. In this guide, we will discuss certain tax code changes from recent years and other important considerations going into 2023, including:
- The Tax Cuts and Jobs Act of 2017
- Impacts of TCJA and SALT on Alternative Minimum Tax
- Maximizing SALT Workarounds
- Understanding the Changes to Deductions
- Other Tax Considerations for Independent Workers
The Tax Cuts and Jobs Act of 2017
Signed into law in 2017 under the Trump Administration, the Tax Cuts and Jobs Act (TCJA) is one of the most significant tax code changes in recent years. Its goals were to reduce tax rates for businesses and individuals, simplify the tax code, and stimulate economic growth.
One of the main impacts of the Tax Cuts and Jobs Act (TCJA) for freelancers and small business owners was the introduction of the Qualified Business Income (QBI) deduction. This tax deduction allows eligible self-employed individuals to deduct up to 20% of their qualified business income from their taxable income, effectively reducing their tax liability. Another tax consideration for independent workers is the self-employment tax, which is a combination of Social Security and Medicare taxes that they are responsible for paying on their net income. It’s essential to keep accurate records of income and expenses to maximize business deductions and reduce self-employment tax liability.
Impacts of TCJA and SALT on Alternative Minimum Tax
The Alternative Minimum Tax (AMT) is a parallel tax system designed to ensure that high-income taxpayers pay a minimum amount of taxes. Under the TCJA, the AMT was retained but with increased exemption and phase-out levels. However, the changes to tax deductions, particularly the State and Local Tax (SALT) deduction, can still impact taxpayers who are subject to the AMT.
For example, the SALT deduction is not allowed for AMT purposes, which means that taxpayers subject to the AMT cannot benefit from this tax deduction. The reduction in the SALT deduction limit can also increase the likelihood that a taxpayer will be subject to the AMT.
Maximizing SALT Workarounds
In states with high taxes, taxpayers can use workarounds to bypass the limits on State and Local Tax (SALT) deductions. One option is to donate to a state-run charitable fund in exchange for a tax credit. This tax credit can offset state income tax liability and bypass the SALT deduction limit. For instance, in New York State, taxpayers can donate to the New York State Charitable Gifts Trust Fund and receive a tax credit equal to 85% of the donation amount.
Another workaround is the Pass-Through Entity (PTE) strategy, which benefits multi-member partnerships. Eligible partnerships can choose to be taxed at the entity level instead of the individual level, allowing them to deduct the full amount of state and local taxes paid without being subject to the SALT deduction limit. Partners’ share of the taxes paid by the partnership is treated as a reduction to their distributive share of income, resulting in lower tax liability. However, it’s essential to consult with a tax professional to determine eligibility and comply with state laws, as not all states allow PTE elections.
Understanding the Changes to Deductions
The TCJA made significant changes to tax deductions, some of which no longer exist. Here are some examples:
- State and Local Tax (SALT) Deductions: The SALT deduction is now capped at $10,000. This means that taxpayers can only deduct up to $10,000 in combined state and local income, sales, and property taxes on their federal income tax returns. This can be a significant reduction for individuals who live in high-tax states.
- Home Mortgage Interest Deduction: Under the TCJA, the tax deduction for mortgage interest is limited to interest on up to $750,000 of debt on a primary or secondary residence. This limit was previously set at $1 million. However, the $1 million limit still applies to mortgages taken out before December 15, 2017.
- Vehicle weight limits: Businesses can no longer claim a 50% bonus depreciation deduction for purchasing a vehicle with a gross weight of over 6,000 pounds. However, businesses can still claim a bonus depreciation deduction of up to $18,000 for the first year and $16,000 for the second year for such vehicles. Additionally, businesses can still claim a Section 179 deduction of up to $25,000 for the purchase of such vehicles.
- Business meals: In 2023, businesses can claim a full 100% deduction for business meals, a significant increase from the 0% deduction in 2021 due to the COVID-19 relief bill.
- Miscellaneous Itemized Deductions: Miscellaneous itemized tax deductions subject to the 2% Adjusted Gross Income (AGI) floor were eliminated, including deductions for tax preparation fees, unreimbursed employee expenses, and investment expenses.
Other Tax Considerations for Independent Workers
Aside from the aforementioned tax considerations, freelancers and small business owners should be aware of other tax-related issues that can affect them, including:
- SEP IRA and Solo 401(k): Self-employed individuals can contribute to a Simplified Employee Pension (SEP) IRA or Solo 401(k) plan, which can provide significant tax benefits. Contributions to these plans are tax-deductible and can reduce taxable income. These retirement accounts also have higher contribution limits than traditional IRAs, allowing individuals to save more for retirement while reducing their current tax liability.
- Charitable Donations: As a small business owner or freelancer, you may be able to deduct charitable donations on your tax return. Understanding the rules around charitable donations can help you maximize your deductions and support causes meaningful to you and your business. However, it’s important to keep proper documentation and ensure that the charitable organization you donate to is eligible for tax deductions.
- State Residency and Domicile: Where you live can have a significant impact on your taxes. Some states have higher income tax rates, while others have no income tax at all. If you’re a freelancer or small business owner, relocating to a more tax-friendly state could potentially save you thousands of dollars in taxes each year. However, it’s essential to consider other factors, such as the cost of living, availability of clients, and access to resources and support.
- Self-Employment Tax: If you are self-employed, you are responsible for paying self-employment tax, which is a combination of Social Security and Medicare taxes. The current self-employment federal tax rate is 15.3% on the first $142,800 of net income and 2.9% on income above that amount. To reduce your self-employment tax liability, maximize your business deductions, consider setting up a retirement plan, and keep accurate records of your personal and business income.
It’s worth noting that these tax considerations are just a few of the many that small business owners and freelancers may face. Therefore, it’s crucial to work with a tax professional to receive personalized advice tailored to one’s specific financial situation and goals.
Work with a Harness Tax Advisor
Navigating the tax code can be challenging, but with the right information and strategies, freelancers and small business owners can maximize their tax deductions and reduce their tax liability in 2023. Working with a tax professional who can provide tailored advice and help navigate the complexities of the tax code is highly recommended.
In addition to working with a tax professional, there are also online resources available to help freelancers and small business owners with tax planning. Harness Wealth is a platform that connects freelancers and small business owners with experienced financial experts who offer customized solutions for tax planning, investment management, and estate planning. Working with Harness Wealth can save you time and help you focus on your small business or freelance while getting tailored advice to meet your financial needs and goals. Find your freelance or small business tax advisor at Harness Wealth today.