Tax Reform Guide | FormSwift

FormSwift's Guide to Surviving Tax Reform as a Freelancer

You've probably heard a lot about tax reform lately. Scratch that. Unless you've been living under a rock or you've purposefully purged all news from your life in an effort to preserve what little faith you have left in humanity, you've definitely heard a lot about tax reform lately.

As a freelancer, any tax bill carries weighty implications. But this one seems to be particularly packed with, well, reform.

With all the noise and nuance, it can be tough to truly untangle what, exactly, the bill means for you. Self-employment of any variety always requires more legwork — generating invoices, arranging for healthcare, creating itemized deductions — and this impending tax reform adds one more fat stack to your already overflowing piles of paperwork.

That's why we're stepping in to help you make sense of it all. We're parsing out the pieces so you can tell up from down during this topsy-turvy tax season. In this guide, we'll be following the journey of two freelancers. Our first freelancer, Alex, is married. Our second freelancer, Genevieve, is single. Throughout the text, we'll be looking at how taxes differ for these two sole proprietors.

Without further adieu, here's FormSwift's Guide to Surviving Tax Reform as a Freelancer.

The Gist of It

Based on your social media feeds, your freshman RA thinks the tax reform bill is BS, that Republican from college is enthusiastically trying to convince his followers that it's actually a good thing, and your mom's second cousin twice removed thinks it spells certain death for the US as we know it. It seems like everyone's got an opinion. Even if those opinions are more or less exactly what their favorite politicians told them to think.

But like anything in life, the tax reform bill isn't purely positive or irrevocably negative. It yields wildly different outcomes for people based on their income, profession, sector, marital status, number of dependents, state, and more. Consider all the parameters, and the possible combinations are nearly endless, resulting in different percentages on an almost individual basis. As for its effects on the overall economy: the jury's still out on the cascading ramifications, but it seems it will do much more harm than good.

While the bill does largely do good for the ultra-rich and the corporations they own, it's also surprisingly favorable to "sole proprietors" i.e. the freelancers of America, offering lump sum tax deductions and deductions for health care. On the other hand, there are policies built into the tax bill that may stifle the work of independent contractors. It eliminates itemized deductions, a particularly devastating hit to artists and actors, who will no longer be able to write off routine expenses like travel, headshots, or gear.

If you're confused as to how to become a sole proprietor, here's a resource. Here's a little breakdown of the main points:

Become a business. This might be easier than you think, because as long as you are the sole owner, you are technically already a sole proprietor (without the need for any fancy legal footwork).
Chose a name and consider registering and trademarking it.
Make sure your financial structure follows that of a sole proprietorship.
Understand how your taxes will change - which we will explain in great detail in this guide.

So then, how many Americans are affected by this aspect of tax reform? We at FormSwift used our internal Google Analytics data to get a sense of how many people filed as independent contractors in 2017.

Methodology:

Our team wanted to create a ranking of the most freelance-savvy states of 2017. To do this, we used internal data to determine how many individuals in the major cities of the US completed the necessary tax forms for freelancers in 2017 — namely the 1040 and its variations. We subtracted the percentage of people who exited these pages before completing the forms from our total number of page users, as to account only for completed forms. We then obtained the total population of each state (as of 2016) from the US Census Bureau, with which calculated the number of individuals per 100,000 that completed business plans in each city. We organized our ranking into three tiers on the US map.

Users who completed the highest number of tax forms for freelancers per 100,000 people included:

Charlotte (80)
Nashville (72)
Jacksonville (46)
New Orleans (46)
Tucson (45)
San Francisco (41)

The states that completed the least freelance tax forms per 100,000 people included:

Philadelphia (6)
Albuquerque (5)
Portland (5)
El Paso (4)
San Jose (3)

As of Spring 2017, 16.78 million people in the US were self employed.

Source: Statista ⁵

It's estimated that by 2020, around 40% of the entier US workforce (approximately 60 million people) will be self employed.

Source: FormSwift W9 Guide ⁶

According to the US Census Bureau, the numeric change in gig economy workers between 2003-13 in top 7 industries was approximately 3,681,608.

Source: Bureau of Labor Statistics ⁷

The Good

With all the outcry over tax reform, it can be hard to believe that there's anything good here to cover. But if you're self-employed, it's worth a closer look. While it's impossible to categorize anything as objectively "good," freelancers will find a number of personal benefits buried in the bill.

Tax Deduction

First and foremost, let's start start from the top.

For anyone who isn't so familiar with tax terms, a deduction is an amount that you can subtract from your taxable income.

Under the new bill, sole proprietors can itemize deductions for business expenses, including office supplies or travel. So, if you spend $2000 on business trips, you can deduct that amount from your taxable income.

Where previously sole proprietors were taxed as individuals, they can now qualify as pass-through businesses. Thus, if you're a freelancer earning less than $157,500 (or $317,000, if you're filing jointly), you'll be automatically eligible for a 20 percent tax deduction on your pre-tax income if you file as a sole proprietor.

Basically, you'll be taxed as if you make 20 percent less than you actually do. So, take Alex and Genevieve, who are both earning $70,000 annually, as examples. Under the current tax plan, they both fit firmly into the $37,950 to $91,900 tax bracket, where they pay taxes at a rate of 25 percent. But now, under the new plan, the tax brackets' full facelift puts these $70,000 earners in the $38,701 to $82,500 bracket, where they're taxed at a rate of 22 percent.

But as a sole proprietors, it's not that simple — their 20 percent deductions means that each of their total taxable incomes is $56,000. So, if Alex and Genevieve were to pay taxes on their $70,000 like full-time employees, they'd each owe the full $15,400. But since they can leave 14k out of the equation, they only owe $12,320 a piece — allowing each of them to keep an extra $3,080 that would have gone to the government.

Since the upper limit doubles for those filing jointly, both Alex (our married freelancer) and Genevieve (our single freelancer) are affected equally.

And if your deduction knocks you down a bracket, it could yield even more tax savings.

For instance, if you're a freelancer earning $100,000 per year, you fall into the new tax plan's $82,501 to $157,500 bracket, which is taxed at a rate of 24 percent. But in this case, your 20 percent deduction knocks your total taxable income down 80,000 and into a new bracket with a tax rate of 22 percent. While your full-time counterparts owe $24,000 on their $100,000 salaries, a 20 percent deduction plus 2 percent saved from dropping down a bracket brings your total owed to $17,600, or just 17.6 percent, and saving you upwards of $6000.

So, as you can see, the Republican tax plan is making it very tempting to take your skills to the freelance market.

Genevieve isn't married, so for her, healthcare is going to be a significant cost — so her 20 percent deduction more or less offsets the cost of her health insurance. That is, as long as she's eligible: though her $70,000 income qualifies her for the deduction, an exceptionally good year (where she netted an additional $90,000 and surpassed the upper limit of $157,500) would ultimately cost her. Plus, now only $10,000 of state income taxes are deductible from federal income taxes, if she lives in a blue state (which usually have high state income taxes), her taxes will add up.

Alex is married by law, so he can hop on his partner's plan. In his case, the 20 percent deduction is all an additional monetary benefit. However, whether or not he qualifies for the deduction depends on his partner's income. The cutoff for eligibility is set at $315,000 for couples filing jointly; so if his partner nets $50,000, he could earn as much as $265,000 before hitting the ceiling of eligibility. On the other hand, if his partner earns $180,000, he won't be eligible for the deduction at all. Like Genevieve, his taxes will depend on where he lives, as the new laws seem to favor red states.

Healthcare

While the deduction clearly benefits sole proprietors, the story with healthcare is much more nuanced. There are some clear systemic failings when it comes to the new tax plan's treatment of healthcare for sole proprietors (which we'll discuss in the section below), but also some loopholes and workarounds to ease the burden. The catch? You've gotta put a ring on it. (And by "it," we mean a fellow legal US resident with a full-time job.)

The tax plan does away with the incentives for the young and healthy to buy health insurance, and thus, is predicted to cause costs to rise (don't worry, we'll get into the details later on). Yet, there is a silver lining: sole proprietors are eligible for a insurance through a parent or partner. So for those sole proprietors, the 20 percent deduction is well worth the bloated health care costs, financially speaking.

Plus, the new bill still permits independent contractors to deduct health care premiums as a component of itemized deductions. So hey, at least you'll get to write-off all that extra cash you're spending on health insurance.

The Bad

While the bill does happen to benefit freelancers, that wasn't exactly its intention. Rather, it's meant to benefit "pass-through companies" like LLCs, sole proprietorships, and S corporations, which are typically owned by the ultra-rich. It just happens that freelancers, contractors, and the self-employed are the bycatch inadvertently pulled up by this gold-plated net. And thus, there are a number of places where freelancers slip through the cracks.

Itemized Deductions

Remember those deductions discussed above? Well, not all deductions are created equally. In past tax law iterations, freelancers could itemize deductions — meaning that they could deduct certain expenses from their taxable income.

For instance, if an actor spends $200 per month traveling to auditions, he could subtract $2,400 from his yearly income. Assuming our actor in question is in the same tax bracket as Alex and Genevieve — taxed at a rate of 22 percent — that would allow him to pocket an extra $528 each year.

Now, freelancers can't file for miscellaneous itemized deductions for things like travel or marketing materials. A few itemized deductions that show up on the 1040 Schedule A form will be particularly affected in the 2018 year. For example, Job Expenses and Miscellaneous Deductions that exceed 2% of your adjusted gross income (AGI) will be eliminated. However, a sole proprietor or business owner will typically file a 1040 Schedule C form, so the deductions made will not be affected by the deductions eliminated on the Schedule A form.

So while $2,400 doesn't exactly seem like a lot compared to the 20 percent deduction, it can mean a world of difference to a freelancer who (a) works in a profession that requires many of these expenditures or (b) earns a low annual income.

Let's take a look at how salary might affect that outcome.

A young artist who earns $35,000 per year falls into the second lowest tax bracket, where she pays a 12 percent income tax, or a total of $4,200. With the new tax laws, the 20 percent deduction means that she'll leave $7,000 out of her taxable income, adding an extra $840 to her bank account. But art materials are expensive, and she frequently travels to shows — if she spends more than $7,000 annually on all professional expenses, the standard 20 percent deduction hurts her more than it helps.

Meanwhile, a more established artist might incur similar business costs while earning four times the income, meaning that her 20 percent deduction would be much more likely to make up for the difference. In her case, as long as she spends less than $28,000 per year, her standard deduction will be worth it.

Ultimately, this change disproportionately affects low-income earners and professionals who have more business-related expenses.

Healthcare

While healthcare isn't directly affected by the tax bill, it does face an uncertain future because of it. It eliminates the individual mandate, which taxes uninsured Americans. Now, at the outset, it might sound like it's intended to add insult to injury — but it's actually just the opposite. The individual mandate incentivizes everyone to purchase health insurance, so no Americans forgo coverage for the sake of the money. This adds more young, healthy Americans into the insurance pool, bringing down insurance costs for everyone. Doing away with the individual mandate is estimated to increase the healthcare costs by as much as 10 percent.

Since freelancers are typically tasked with paying for their own health insurance, they see and feel the full cost of their health care. Thus, if you're a freelancer in America, prepare for the cost increases that will follow the elimination of the individual mandate.

A Few More Things to Bear in Mind

Remember that income isn't everything. While cash is certainly nice, it's definitely not king. There are many more aspects of financial health that a 20 percent deduction just can't account for.

Think workers' compensation, pension plans, 401(k)s, or the ability to start a union. All of these things affect the way we save, spend, and live, and all of these things are contingent upon full-time employment. Plus, sole proprietors aren't able to bargain collectively or take advantage of federal worker protections.

Uber Driver vs Restaurant Server Study Methodology

As a result of tax reform, Uber drivers in various cities have the opportunity to claim a 20 percent tax deduction by filing as sole proprietors as opposed to filing as employees. We used Glassdoor to gather information on the average yearly salary of Uber drivers and restaurant servers in 15 of the biggest cities in the US, and then calculated how much Uber drivers would save with the 20 percent deduction if they filed as sole proprietors. We compared the difference between the two professions in terms of how much income they had to pay taxes on pre and post tax reform, to show how the tax plan will allow groups of individuals with similar or equivalent salaries to come out ahead of others based on filing status.

What Should I Do?

So, after hearing the good, the bad, and ugly of this new tax law, you've decided that you want to file as a sole proprietor and swipe 20 percent off the top of your taxable income.

How do you know if you're eligible to file as a sole proprietor? Where, exactly, does the government draw the line between a sole proprietor and a freelancer or full time employee?

Let's sort this all out with some scenarios.

First of all, when we say "income" we're talking about Qualified Business Income (QBI), which includes only money earned from your business. That means that you're gonna have to leave interest, dividends, capital gains from property sales, etc. off the table.

So, if your annual income as a freelancer is $70,000, but you earn $10,000 per year from renting out your extra bedroom on Airbnb, that makes your QBI $60,000, meaning that you can deduct $12,000 — or 20 percent — from your taxable income. Since your income falls below the $157,500 cutoff, this is all the math you'll need to do.

Things get a little more hairy when you add a few more factors into the mix. Let's say that you're married and running a business without employees or substantial assets. Things are going pretty well, and this year you've netted $600,000. Now, with a 20 percent deduction, you'd qualify to set aside $120,000 before taxes. But since you're well above the income eligibility ceiling of $315,000, you'll have to kiss your tax deduction goodbye.

If you're eligible, check out the tax calculator at the end of this guide to see what you can save.

Conclusion

Ultimately, most sole proprietors come out on top under this tax plan. But as we've shown, it isn't exactly black and white. There are a lot of exceptions, loopholes, and cutoffs, and the extent of the benefit depends on where you fall along various spectrums.

Like most of the tax plan, this section rewards those who earn more (to a point), and it penalizes those who earn less. At the end of the day, sole proprietors netting below $157,500 (or $315,000, if filing jointly) get through tax season with a little (or a lot of) extra money in their pockets.

It incentivizes full-time workers and freelancers to make the leap to sole proprietorship, taking American individualism to new heights, and makes it tempting for the young, healthy, and single to get by without health insurance.

It may not seem so significant, but its implications could change the face of employment in the U.S, and how it will affect the future of American work culture is yet to be seen.

Disclosure: After you read this guide, try to speak with a licensed accountant in your state who has experience in tax law. This guide is meant as an educational resource only and does not provide legal advice.

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