What Freelancers Need to Know About the GOP Tax Plan
Business owners big and small are the unambiguous winners of the House and Senate tax bills currently being reconciled on Capitol Hill, causing some
Naturally, it's complicated, and completely dependent on your financial situation, though multiple experts advised not to do anything until a bill is actually finalized. Things are still changing, and we'll know more in the coming weeks.
But in a nut shell, here's why freelancers might consider incorporating. Currently, "pass-through" small businesses-specifically S corporations and limited liability companies/LLCs-are taxed at the owner's individual tax rate, which can be as high as 39.6% for 2017. Under the House GOP plan, however, the top individual tax rate remains at 39.6% while the tax rate for pass-throughs would be capped at 25%-a significant difference (the Senate bill does not lower this rate). Details of who/what type of businesses qualify as a pass-through (for example, law firms would not under the House bill) are still being reconciled.
Here's an example of when creating a LLC might pay off, according to David Hryck, a tax lawyer , assuming the House provision is adopted:
If you are the owner of an LLC that makes $300,000 per year you could choose to pay yourself a salary of $100,000. That salary would be taxed at your normal rate. As normal, you would pay Social Security taxes, Medicare and unemployment
taxeson that income. However, the remaining $200,000 of profit would be taxed at 25 percent, with no additional employment taxes. If you're in the 35 percent tax bracket, following this method would allow you to lower your tax bill.
Obviously, that won't be beneficial for everyone. It likely will only pay off if you earn a very high income-to be in that top 39.6% bracket, you'd need to earn at least $418,400 this year, or $1 million under the House plan. If you're in a lower bracket, creating a LLC/S Corp may not be worth the headache, says Susan Lee, a Manhattan-based tax preparer and financial advisor . You'll need to hire an accountant, an attorney, and pay hundreds of dollars in fees .
"Don't act based on an internet article written by someone you don't know," says Lee. "Consult a person you trust and don't make yourself crazy about this."
Besides, it's not just your taxes you have to worry about-there are also legal ramifications in determining which business entity is right for you. "Once you become a LLC or an S Corp, the rules get a little different and it may complicate your tax situation more than you're expecting," says Jenna Ivanoski, a product manager at TaxAct, a tax preparation company. "It could end up costing you a lot more to file your taxes, so in the end it might not be worth it."
There are, of course, worrisome aspects of the bills for freelancers and employees alike. The House's version taxes graduate student tuition waived by universities, and both bills are crafted in a way to encourage people to take the standard deduction (which is essentially doubled) rather than itemize personal deductions, which could have serious implications for charitable donations.
And there is true cause for concern for those in the individual health insurance market. Again, nothing is set in stone yet, but the Senate version repeals the Affordable Care Act's individual mandate for tax year 2019, meaning premiums will increase by about 10% for people in the individual market, per the Congressional Budget Office.
If you earn $48,240 or less (or your family of four makes less than $98,400), than federal subsidies, at least in the short term, can make up the difference. But if you're part of the roughly 15% of Obamacare enrollees who earn more than that, you'll likely be hit with the full premium increase. In that case, you may choose to eat the cost, or forego insurance all together.
One potential benefit for gig economy workers: the Senate proposal raises the cap on depreciation write-offs of business-use vehicles from $3,160 to $10,000 for the first year a vehicle is in service which could benefit Uber and Lyft drivers, according to Simon Filip, CPA.
In any event, Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, says there's no need to rush to do anything until a bill is actually passed. "We'll know more next year."