Freelancing? Know the Tax Rules

Are you a freelancer? If so, it pays to know how the tax code can work for you. For example, one of the biggest perks of the 2017 Tax Cuts and Jobs Act is a new 20% deduction on the so-called pass-through business. This is available to a wide variety of gig economy workers: owners of an LLC or an S corporation, a partner or a sole proprietor. The deduction is available even to workers who take the standard deduction.

These earnings are characterized as pass-through income because the income you earn passes through to your personal tax return rather than being taxed first as business earnings and then as wages.

The 20% deduction reduces the amount of income you have to pay taxes on, and it could possibly drop you into a lower tax bracket, yielding savings. Deductions reduce your taxable income, and your tax rates go down because it's a graduated rate.

In general, gig, freelance and/or small-business owners qualify for it. But if you're selling your macramé creations on Etsy or your homemade beeswax candles at a Renaissance festival, you probably won't be able to take the deduction because it's money you make from a hobby.

The IRS distinguishes a hobby from a business using nine criteria — with record keeping and intent for profitability among them.

A good rule of thumb to follow is that if it's something you've engaged in and made money in over the years continually, the IRS may be more inclined to view it as a business.

Because we're talking about the tax code, there are plenty of exceptions and limits. For example, there is an income-based phaseout for certain types of businesses characterized as specific services. This covers professionals such as doctors, lawyers, accountants and other financial service providers, among others.

There's no definitive test that makes it totally clear who is and who isn't subject to this, but an IRS document, Publication 535, addresses it. If you are in a field with a business income higher than certain limits, you are subject to limits on how much of a deduction you can claim.

It gets complicated when your taxable income exceeds that. The benefit phases out completely for people in these fields who make above a certain threshold.

And things get muddier if you're an owner of S corporations or partnerships: You have to account for wages paid to employees and the value of business real estate holdings to determine how much deduction you can claim.
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If you are working freelance or are in some way a part of the gig economy, you are not alone; it's becoming the new norm today. Taxes for independent workers get complicated, however, so don't assume that the provisions listed here will necessarily apply to you. And there may be other tax breaks you can take advantage of. So don't make assumptions — work with a tax professional.