Did you know that you can deduct 20% of your business income on your personal tax return?
You can, thanks to the Tax Cut and Jobs Act (TCJA). The TCJA brought a lot of tax changes for small business owners. And if you’re self-employed, a freelancer, contractor, or had any 1099 income – even from a side gig – that includes you.
The biggest tax change: A 20% deduction on self-employed business income called the Qualified Business Income Deduction.
That means you will only pay income tax on 80% of your qualified business income.
The 20% deduction is for income tax only. Self-employment tax is still based on 100% of your business income.
Who Can Take the 20% QBI Deduction?
All “pass-through business” entities qualify for this deduction. A pass-through business means that you pay taxes on your business income, rather than the business filing its own tax return. Basically, the net profit from the business “passes through” to your personal income tax return.
Pass-through businesses include:
- Sole proprietors (if you didn’t form an LLC or corporation, you’re a sole proprietor)
- Single-member LLCs
- Multi-member LLCs
- S corporations
*C corporations do not qualify for the deduction.
How Does the 20% QBI Deduction Work?
To deal with your taxes, you – as a business owner – have to figure out your net profit (sales minus expenses) for the year. As long as you meet certain income requirements and business-type requirements, you can deduct a full 20% of their profit from their taxable income. Of course, there are some weird IRS rules that may apply, but this is how the deduction will work for most self-employed people.
If you use tax software and it asks if you have qualified business income, answer YES.
Here are the main rules that may affect you:
- Only income from U.S. sources count. If you worked for overseas clients, that income does not qualify for the deduction.
- “Specified Service Trades or Businesses” (SSTBs), meaning most personally performed services – including writers, editors, bookkeepers, virtual assistants, and nutritionists, for example – may only be able to take a partial QBI deduction based on total income.
- The 20% deduction starts to get reduced for SSTBs if total 2020 income from all sources exceeds $163,600 for Single and Head of Household filers and at $326,600 for Married Filing Jointly.
To take advantage of this special tax deduction, you’ll have to fill out Form 8995 (or Form 8995-A if your income is over the limit) with your tax return. Then the amount you can deduct for QBI goes on your regular Form 1040, line 13.
Other Tax Issues That Impact You If You’re Self-Employed:
- You have to pay self-employment taxes on $137,700 of your business profit.
- You can’t deduct any entertainment costs as business expenses.
- You can deduct 100% of business assets – including things like laptops and tablets – bought in 2020 (up to $1,000,000).
- You can deduct business gifts that cost up to $25.
- The 2020 business mileage rate is 57.5 cents per mile. For 2021 that drops to 56 cents per mile (yep, it’s decreasing).
Have questions about whether your income qualifies? Contact me and we’ll figure it out together.