The new tax law of 2018 brings good news for contractors and a reason to change from a W-2 salary-based employment to a contracting-based payment. The reason for the change is the 2017 Trump tax reform. Categorizing your job as a “1099 contracting” would be, in most cases, a better choice than keeping the salaried job. The pass-through Deduction is the magic word.
Are you, boss?
What are 1099 and W-2
If you are an employee or self-employed, work full-time or part-time, you define it as a W-2 salary. 1099 are those that work as independent or freelancers. You can have a regular job with a W-2 wage and do some freelancing simultaneously under a 1099 contractor.
Before the last tax reform, W-2 was a better option as it had lower tax rates than a contractor’s taxation.
The W-2 employment conditions had more benefits like 401K matching and healthcare. Their employment was considered safer, so it was considered a safer situation.
The radical tax reform made by Trump changed the situation for 1099 contractors. They still need more benefits and more job security. The change for contractors and self-employed is about paying fewer taxes on the same earnings; it is so long you are at high-income levels that you can keep more money in your hand as compensation for the higher benefits and security of regular employment under W-2. Before you leave your permanent job, remember that part of the extra money you can have by paying fewer taxes you must keep in savings or pay better health insurance or similar benefits as a W-2 employee.
1099 tastes better
How to compare the equivalence of the Pay? W-2 vs. 1099
Equivalent Pay is not only putting one dollar in front of one and a half dollars. A dollar paid under a W-2 regular employee is worth more than the dollar spent under a 1099 contractor. The difference is that the employer pays half of the Social Security tax on behalf of his regular employee. For example, a $100,000 salary is equal to $107,650 for a contractor pay only because of the 7.65% Social Security tax paid by the employer. The contractor with the same $ Income of $100,000 will have to deduct all the 7.65% tax on his salary as a Self-Employment Tax. Additional money needs to cover the 7.65% and more for the benefits. Health care as an independent is one crucial issue to cover—2018 Instructions for Form 1099-MISC.
Now we have a new factor to take into account; The tax reform permits the Pass-Through deductions for a 1099 contractor to save thousands of dollars in taxes; you can see below how:
Looking for a freelance job?
Pass-Through Deduction under the 2017 GOP tax reform:
The new bill calculates a 20% Pass-Through deduction of the “qualified business income,” though it can not exceed 20% of the difference between taxable Income and any capital gains. Large itemized deductions and capital gains will limit your beliefs.
Business owners of S-corporations, LLCs, and partnerships can use the pass-through deductions; the 1099 contractors, freelancers, side hustlers, and sole proprietors can also enjoy the pass-through deductions.
Anyone receiving the payment in another way that is not W-2 or owns a C-corporation can qualify for these deductions.
Calculating Deduction for pass-through is as below:
1. The 20% of qualified business income minus your business expenses
2. The 20% difference between the taxable Income (before pass-through Deduction) plus your capital gains.
The 1099 contractors or self-employs that have no other substantial sources of Income have more limited benefits from the new law pass-through deduction. The reason is that the 20% taxable income before the pass-through Deduction and fewer capital gains is a smaller amount because taxable Income is after all deductions. One more issue is if you have large itemized deductions or capital gains, it can shorten your pass-through Deduction. We will see below that the pass-through Deduction can be a huge advantage for being a 1099 contractor or self-employed.
Your self-employment tax will not be lower based on your Adjusted Gross Income (AGI) before the pass-through Deduction. The amount of state income tax you owe will vary depending on the state in which you are paying taxes.
Have you chosen 1099 freelance or contractor? Be happy! A few thousand dollars will reduce your federal income tax. See below.
Saving good Dollars in Taxes
Exploit the 1099 low tax rate and save your Dollars from being devoured by taxation. Here’s what that looks like for an individual earning $100,000 as an employee or the equivalent of $107,650 as a 1099 contractor:
Table of compassion: W-2 vs 1099
W-2 Salary1099 Contractor or Self-Employed
Gross Income $100,000 $107,650
Social Security or Self-Employment Tax FICA ($7,650) ($15,210)
Self Employment Tax Deduction $0 ($7,605)
20% Pass-Through Deduction $0 ($17,608)
Amount of standard Deduction ($12,000) ($12,000)
Total taxable Income $88,000 $70,436
Income Tax ($15,300) ($11,435)
Happy 1099 contractor
We expect this for the 2018 tax year. In this model, the 20% pass-through deduction is limited by 20% of the excess of taxable Income before the Deduction, resulting in fewer capital gains. The way to calculate it is 20% x (AGI minus the standard Deduction). It includes all self-employ.
1099 can be a good option for all the gig industry people. Many people are writing, doing graphics or SEO for websites. All these jobs are paid directly to the gig working persons by credit cards or other internet payment options. The tax must be paid correctly to avoid hard question from the IRS. A micro company or another way of financial organization shold be used to make tax payments.