The Tax Cuts and Jobs Act of 2017 (TCJA) included several provisions that affect how independent journalists are taxed on their business income. We asked Matthew Apodaca, a certified public accountant and executive vice president at NCH Tax & Wealth Advisors in Fullerton, California, to help us understand the current tax situation for freelancers.
Quill: The 2017 law made a number of changes affecting freelance journalists. Probably the most important is the one allowing many of us to write off 20 percent of our profit. Can you explain how this works?
Matthew Apodaca: The biggest benefit to freelancers is the Qualified Business Income Deduction (QBID). This is a 20 percent reduction in taxable income – the amount you potentially pay tax on. You qualify if you are an unincorporated sole proprietor, filing taxes on a Form 1040 Schedule C, or if you are set up as a limited liability company (LLC) and report your taxes as either a sole proprietor or an S corporation.
As a simple example, if you have $50,000 of net income (profit) from your business, the QBID will remove 20 percent of this ($10,000) from taxation, leaving you only $40,000 in taxable income.
This benefit phases out at higher income rates; if you have over $200,000 of income, this special deduction may be disallowed. At that point, it would be good to review your situation with a tax professional or do more in-depth research.
The QBID applies only if you report your business income on Form 1040, as a sole proprietor, limited liability company, or S corporation. It also applies to partnership income reported on Form 1040. C corporations don’t get to claim it.
Q: Some independent journalists formed corporations in the past, in part because it was better for them tax-wise. And, the TCJA lowered corporate tax rates. So, how should we be thinking about this now?
A: C corporations are generally not recommended for freelancers. Not only do they not qualify for the QBID, but they also have a double tax – one at the corporate level, and a second tax at the individual level. Also, the tax filings are more complicated, and that might raise your costs.
Q: The other reason independent journalists incorporate their businesses is that they need liability protection. What are some other options?
A: You have two: forming an LLC, or incorporating as an S corporation.
An LLC will have very similar tax treatment to being unincorporated. You still pay income and self-employment tax on your profit, and you can still qualify for the QBID.
An LLC with just you as an owner is reported directly on your federal tax return on Schedule C; no separate forms are required. This is usually the simplest way to provide some liability protection, but there is minimal change to net tax.
An LLC with two or more owners is reported on Form 1065, filed separately from your individual return. You still report the net income on your Form 1040, via Schedule K-1.
The advantage of an LLC is that it can provide some asset protection in legal situations. If you aren’t sure whether you need liability protection, it’s best to get advice on that from an attorney.
S corporations, which are generally for small businesses, can provide similar asset protection to an LLC and may offer tax savings. In addition to the QBID, the S corporation can help you reduce how much you pay in the 15.4% self-employment tax.
The benefit to this is lower taxes now, but the cost is that you’ll receive less in Social Security benefits later.
You would generally want $60,000 or more of net income before it makes sense to use a S corporation. Up to that amount, the cost usually exceeds any potential tax savings.
Each kind of business entity will usually cost between $500 to $2,000 to set up, plus additional cost (or your time) for the additional tax filing. It is important to weigh these factors before incorporating.
Figuring Net Income
Q: You said the tax reduction for the QBID is taken off of net income. Did calculating net income change with the 2017 law?
A: There were some minor changes, but the IRS still allows you to deduct all “ordinary and necessary expenses” to maintain and grow your business. This generally means anything you spend to keep business, get new business, or get work done. For example:
- Supplies and equipment used for work, including computers, cables, drives, audio and visual equipment, software programs, disks, internet and email services, pens and pencils, printers and copiers, paper, ink or toner, stamps, and delivery services. Under the new law, equipment no longer needs to be depreciated over time; it’s written off along with other expenses.
- Subscriptions and online fees paid to professional publications, including the ones to which you pitched story ideas.
- Travel, including gas and mileage or public transportation costs to meetings with clients and colleagues, for interviews, and to research stories.
- Meals and Entertainment. Under the TCJA, entertainment is no longer deductible. If you are taking a business partner to a front row Broadway show, it will not be allowed to be deducted. However, a lunch meeting to discuss strategy or editing would still be allowed as a business meal deduction.
- Advertising, including promotional expenses, including business cards, web hosting services, brochures, flyers, and ads. This also can include arrangements for meetings with potential customers.
- Professional development, including memberships, conferences, webinars, seminars, and online learning programs.
Home Office Deduction
Q: Did the new law change provisions for taking the home office deduction?
A: There were no changes this year, but here’s how that works: If your office is in part of your home that’s used exclusively for business, you may deduct some of your home expenses as well. This is easiest if you are filing your business tax information on Schedule C of your individual tax return because the IRS provides Form 8829 specifically for figuring the deduction.
The process became easier for tax year 2013 onward, as the IRS now allows a simplified method for claiming the home office deduction: $5 per square foot, up to 300 square feet ($1,500). Claiming a home office deduction used to be considered a red flag for a tax audit, but working from home is so common nowadays, this is less of a concern.
Q: How about S corporations and partnerships? Can they deduct expenses if they have an office at home?
A: Yes, you can still claim home office expenses if you are using an LLC or S-corp. It is still done on your Form 1040, connected to the Schedule K-1 from the business tax filing.
Q: You’ve mentioned that forming an S corporation can help reduce the amount independent journalists pay in self-employment taxes. How does that work, and what are the pitfalls?
A: As a sole proprietor, you are considered self-employed. This means you are responsible for the share of payroll taxes that employers cover for Social Security and Medicare.
As an S corporation, you can take some of your earnings as salary and some as a distribution. This doesn’t make much difference in terms of income tax – you still have to pay taxes on it – but you don’t have to pay self-employment taxes on the amount taken as a distribution.
Use caution here, though. The IRS expects owners of S corporations to take a “reasonable” share of their money out in salary. And, states may have other rules for S corporations, including taxes.
Also, consider this as a double-edged sword: It is painful to have to pay this extra tax, but when you pay into Social Security, you are usually increasing your benefit. Some people spend most of their freelance careers aggressively minimizing their income and Social Security tax, only to regret it when they see their Social Security benefit reduced to a much smaller amount than they planned on.
Social Security should never be your only retirement resource; you should be saving other money toward retirement. However, building up a good benefit provides some stability for retirement. The average Social Security payment is $1,200 a month. For most people that’s not enough to live on, but it is nice to receive that money, guaranteed by the government for the rest of your life, just for waking up every day.
Apodaca and Becker, SPJ Freelance Community Resources Coordinator, used information from the SPJ publication “On Your Own: A Guide for Freelance Journalists.” The freelance guide is available to SPJ members at www.spj.org/freelance.asp. For more information about Apodaca’s practice, go to: http://www.nchwealth.com/MatthewApodaca.shtml, or email him at email@example.com.