Many people are wondering if it’s now more beneficial to be self-employed rather than an employee since the release of tax reform details. Two reasons this is coming up:
- The itemized deduction for unreimbursed employee expenses is no longer available for tax years 2018-2025.
- Passthrough income earners (self-employed people) may now potentially take a 20% deduction from their qualified business income on their personal tax return for tax years 2018-2025. This is a new complex part of tax law.
The unreimbursed employee expense deduction is important to W-2 folks who have a lot of business related costs they pay for themselves that are not reimbursed by their employer. Types of costs that would go under this category are business related:
- Travel and entertainment
- Uniforms, safety equipment, small tools and supplies
- Professional dues to organizations or chambers of commerce
- Use of Home Office
- Educator supplies expenses in excess of the $250 page 1 deduction
For this deduction to be worth much to the taxpayer, under tax law prior to 1/1/2018 these expenses needed to be substantial – greater than 2% of their adjusted gross income, and itemizing in general is required (versus the standard deduction). To tell if you’ll be affected by this change, look at your 2016 tax return to see if you have a form Schedule A: Itemized Deductions, then look to line 21, and ultimately line 27 to see if you got any benefit from those line 21 costs. If you did have benefit from these costs, and anticipate similar expenses going forward, then I’m sorry to say you may be affected in tax years 2018-2025. If you were in Alternative Minimum Tax (AMT), however, you actually didn’t get a benefit in the end (I know, tax is confusing).
Should there be a mass exodus to independent contractor from employee though because of these changes? For most people – probably not, here are some reasons why:
- Health care – being an employee is generally advantageous versus going it on your own. You may have difficulty finding individual coverage except on the Government Marketplace.
- Self-employment taxes – as an employee your employer pays half of the social security and Medicare taxes associated with your earnings, as a self-employed person you pay it all (with certain adjustments).
- Lower taxes in general: The increased standard deduction and overall lower tax rates are going to mitigate the effect of losing deductions such as the unreimbursed employee expenses.
- It’s not entirely up to you – The IRS and Department of Labor determine who is an employee versus independent contractor; you or your employer can’t really make that determination without looking at the rules those two governing bodies put forth. Some guidance can be found here: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
That’s not to say that in certain cases it wouldn’t be more beneficial to go it on your own! Regulations are not out yet giving the IRS guidance on implementing the new passthrough deduction, but preliminary rough calculations appear to show the more income you have, the more benefit you could see. But again, this is a complex new area of tax law, and the outcomes vary depending on income levels, business entity, and industry.
If you have been contemplating working for yourself and/or have substantial unreimbursed employee costs, now may be a good time to make your move. Remember that as an independent contractor, you’re now a business owner – if that didn’t interest you before, consider those same reasons now. If staying an employee, try to get your employer to reimburse you for your costs, or possibly discuss an arrangement that makes both employee and employer happy.
Again, everyone’s tax situation is unique, and so there is not always a sweeping answer that is one size fits all. If you’re still curious, talk with your CPA to weigh the options in greater detail.