The 2017 tax law permits self-employed people to get a 20% tax break on their income. What if you have a salaried job, which doesn’t allow you to get this special deduction, and have a side hustle, where you pay no withholding (unlike the salaried job, where taxes are withheld every pay period)? The good news is that you can get the special deduction on your moonlighting income: You only have to pay taxes on 80% of it. Tax expert Bruce Bell, an attorney at the Chicago office of Schoenberg, Finkel, Newman and Rosenberg, explains how this works.
Larry Light: Let’s say I am a salaried employee and I also receive self-employment income from a side business unrelated to my salaried employment. Am I entitled to a qualified business income tax deduction for my earnings?
Bruce Bell: Taxpayers meeting certain requirements are entitled to a deduction of 20% of their qualified business income. Qualified business income, or QBI, generally consists of income derived from sole proprietorships and so-called pass-through entities such as partnerships, limited liability companies and S corporations where business income is reported on the owners’ personal income tax returns.
Your self-employment income may be eligible for the QBI deduction. No QBI deduction is allowed for your salary as working as an employee. The fact that you are employed does not prevent you from claiming a QBI deduction for your self-employed income.
Light: Give us an example of how this works.
Bell: Consider Joe, a single tax filer, who earns $85,000 from his job as an artist in an ad agency. Based on his income, Joe is in the 24% marginal income tax bracket for tax year 2019. Joe also has a side business designing brochures for real estate firms for which he receives $20,000 per year after deducting any business expenses. He has no withholding tax taken out of the side job income.
Without considering his QBI deduction, his standard deduction and other possible deductions, Joe’s federal income tax for 2019 would be $19,375, including both regular and gig income. Because Joe’s side business income is eligible for the QBI deduction, he can write off 20% of the outside gig income, meaning that he only pays taxes on $16,000 from his side business. (Joe’s $85,000 salary is ineligible for the QBI deduction.)
This results in a total tax liability of $18,415. Joe has saved $960.
Light: Are there income ceilings that affect taking the deduction?
Bell: Your QBI deduction may be limited or eliminated if the taxable income on your personal tax return exceeds certain threshold amounts. The thresholds are adjusted each year for inflation. For the 2019 calendar year, the threshold for joint tax filers is $321,400 and the threshold for other filers is $160,700.
Light: What if your income is over those thresholds?
Bell: A somewhat complex formula limits the QBI deduction for taxpayers whose income exceeds these thresholds. The limitation is the greater of (a) 50% of the aggregate wages paid by the business or (b) the sum of 25% of the aggregate wages paid by the business and 2 .5% of the business equipment and other property for which depreciation deductions may be claimed. These limits are phased in for the first $100,000 or $50,000 of taxable income in excess of the threshold, depending on your filing status. Less common circumstances can also impact your QBI deduction. Certain dividends from real estate investment trusts and publicly traded partnership income are included in the QBI calculation.
Light: What about capital gains? That would result from your selling stock or some other kind of asset. Any limits there?
Bell: Another limitation on the QBI deduction takes effect if a taxpayer has capital gains for the tax year as the QBI deduction is further limited to 20% of the excess of a taxpayer’s taxable income for the year over the amount of net capital gain the taxpayer incurs for the year.
In our example, where Joe is earning W-2 income from his ad agency job, this additional limitation is unlikely to take effect. Taxpayers who are affected by this limitation may have the opportunity to control the amount of their QBI deduction based on when they sell stocks, bonds and other capital assets.
Light: Are there any limits on what kinds of jobs you can take this deduction for?
Bell: The 20% QBI deduction is unavailable to the owner of a specified service trade or business where the owner’s taxable income exceeds the thresholds. If you practice medicine, law, accounting and a number of other service-oriented businesses, and your income exceeds the applicable threshold, then you are ineligible for the 20% deduction. No architects or engineers are allowed to take it either.
As with many complex tax provisions, there is no substitute for advance planning. You should carefully review your personal situation with your tax advisors to estimate the amount of your tax liability. In the right circumstances, however, you can benefit from a 20% deduction on your self-employment income.