For many small business owners, the subject of taxes doesn't elicit the most positive emotions. In fact, if it makes you cringe, roll your eyes, or hide, you aren't alone. In 2019, there's a new layer of fun with the addition of learning about how tax reform will impact our small businesses. Since handling the finances is our favorite task to delegate, we thought it would be best to hand over this topic to an expert. That's right, we're going old-school interview-style.
We interviewed Cathy Derus, CPA and owner of Brightwater Accounting, to get her take on how tax reform impacts online business owners. If you need a great accountant who understands the world of blogging and online business, we strongly recommend chatting with Cathy.
As always, please keep in mind that this post is provided for informational use only and should not be considered tax advice. Please consult your account or tax preparer before implementing any changes or engaging in any transactions.
Now, let's learn all the things about tax reform.
As a small business owner, am I likely to be impacted by the new tax changes?
Yes! Everyone is impacted by the new tax laws since there’s an increased standard deduction, eliminated exemptions, changes to tax brackets, and parents may be able to take advantage of the expanded child tax credit, among other things.
And the distinction between a business and a hobby is even more important than ever. For tax years 2018 through 2025, miscellaneous itemized deductions (where you’d report expenses from hobbies) have been eliminated. Therefore, if you have a hobby, 100% of that income is taxed (though not subject to self-employment taxes) and you can’t offset any of that income with hobby expenses.
So how do the new tax laws impact small business owners?
The biggest change is the introduction of the Section 199A Qualified Business Income (QBI) deduction. Eligible pass-through entities (businesses taxed as sole proprietorships, partnerships, and S Corps) can deduct up to 20% of their QBI for income tax calculation purposes. However, if you are subject to self-employment taxes, that is still calculated based on your total self-employment income.
So what is QBI? Generally speaking, it’s a business’s net income. If your business is taxed as a sole proprietorship or partnership, you also need to subtract the deductible part of self-employment taxes, self-employed retirement account contributions, unreimbursed partnership expenses, and self employed health insurance deductions to arrive at QBI.
S Corps will have already deducted the employer portion of payroll taxes and self-employed health insurance, so just take K-1 income and any adjustments for Section 179 depreciation..
The 20% deduction applies to single individuals who earn $157,500 or less or married couples filing jointly earning $315,000 or less in 2018. Once you are over the threshold, the deduction may be limited as it takes into account wages paid by the business, qualified property, and whether you operate a specified service-based business (i.e. attorney, accountant, doctors, etc.). More on that later.
This deduction is also limited based on your taxable income in that the deduction can’t be greater than the percentage of taxable income.
If your business is incorporated as a C corporation, your business’s income tax rate is now a flat 21%. Previously, the tax brackets for C corps ranged from 15 to 35%.
How have business expense deductions changed?
There was a change to the tax laws around deducting meals and entertainment expenses for business purposes. Business owners can still deduct 50% of meal expenses if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. But business owners can no longer deduct entertainment expenses incurred for business purposes. So if you take a client to a basketball game or comedy show, the food and drinks you purchase are deductible, but the tickets are not.
Another change is around depreciation. Depreciation is the allocation of the cost of a large purchase, generally over several years. Some business owners choose to accelerate their deduction by electing to take advantage of bonus depreciation or Section 179. This gives them the option to deduct more (or perhaps all) of the expense in the first year.
Under the new tax laws, you can now elect to expense up to $1 million (rather than $500,000) for qualifying purchases in the first year using Section 179. This phases-out between purchases of $2.5 million and $3.5 million.
As for bonus depreciation, it’s been temporarily increased from 50% to 100% of an eligible product’s cost. With bonus depreciation, you may now be able to fully depreciate the cost of qualified property that exceeds the section 179 limits. Or, you may be able to carry over the deduction if your business didn’t qualify for a Section 179 deduction because it didn’t have a profit this year. The higher bonus depreciation limit will begin phasing out in 2023.
Are bloggers, virtual assistants, social media consultants, and similar online businesses considered a “specified service trade or business (SSTB)?”
Per the IRS, a “specified service trade or business” is “any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.”
“Consulting” can be defined quite broadly, but in the eyes of the IRS, it comes down to whether you provide professional advice and “counsel to clients to assist the client in achieving goals and solving problems.” Also, consulting services in connection with a sale or delivery of goods is not considering consulting for SSTB purposes.
When it comes to “reputation or skill,” I have a feeling this will be open for interpretation. But for now, the general consensus is that this provision has to do with celebrities. I’d imagine well-known influencers with partnerships at major retailers may also rise to the level of a SSTB.
A business is only considered an SSTB by virtue of the “reputation or skill” provision if, and only if, it generates fees, compensation, or other income via one or more of the following:
- Endorsements of products or services;
- Use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbol associated with the individual’s identity;
- Appearances on radio, television, or other media.
Here’s an example from the regulations that shows how narrowly the IRS has framed this “reputation or skill” provision.
H is a well-known chef and the sole owner of multiple restaurants, each of which is owned in a disregarded entity. Due to H’s skill and reputation as a chef, H receives an endorsement fee of $500,000 for the use of H’s name on a line of cooking utensils and cookware. H is in the trade or business of being a chef, and owning restaurants and such trade or business is not an SSTB. However, H is also in the trade or business of receiving endorsement income. H’s trade or business consisting of the receipt of the endorsement fee for H’s skill and/or reputation is an SSTB within the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section.
Of course, you’ll want to discuss with your tax preparer whether your business is an SSTB or not.
Do you now recommend that small business owners create an LLC, to take advantage of the new law?
An LLC is how your business is structured from a legal perspective. I always recommend having a conversation with an attorney about whether your business could benefit from the additional legal protection.
From a tax perspective, you don’t have to be an LLC to take advantage of the new qualified business income deduction. This deduction is available to sole proprietors, partnerships, LLCs (taxed as sole proprietorships and partnerships), and S Corps.
Does last year’s Supreme Court ruling mean that my online shop should be collecting sales tax?
This is a big “it depends.” Before the Supreme Court ruling in South Dakota vs Wayfair, a seller would need to collect and remit sales tax for state where they had nexus or physical presence.
Now, states may charge sales tax on purchases from out-of-state sellers, even if they have no physical presence in that state. States can now use economic nexus (significant sales activity) to determine whether sales tax should be remitted.
Each state may define economic nexus differently, but some are modeling theirs based on South Dakota. South Dakota had a specific requirement saying they wanted to charge sales tax on out-of-state sellers who had either over $100,000 in sales to South Dakotans OR more than 200 transactions a year to South Dakotans.
Since sales tax can be a blog post all on its own, I’m going to refer you to a fantastic one at Paper and Spark.
If my family goes on a trip and I write about it, can I deduct those travel expenses?
As in all tax-related conversations, it’s a big “it depends.” Since travel can be pretty darn fun, it’s extremely important to establish whether your travel blog is a business or hobby. Not to mention, the first blogger to bring a hobby loss case to the United States Tax Court is a travel blogger.
The general rule is anything that is related to your business and considered “ordinary and necessary” can be deducted. You can usually include transportation such as airfare, lodging such as hotel stays, and meals and entertainment. If there are conferences, seminars, or workshops related to your business you check out while on your trip, those can be included as a potential deduction as well.
To make your entire trip deductible, the primary purpose has to be business rather than pleasure. Therefore, be sure to document the purpose of your trip.
How about a comped trip that I write about? Do I need to pay taxes on those?
Yes. Any time travel or conference fees are comped or you receive free product for review. The other company will be deducting the expense on their side, so you will have corresponding income that should be reported on your tax return.
The best practice is to get the value in writing. This may also be the actual cost of the item to the company that sent the item to you rather than the retail price.
If I regularly involve my kids in my business (photos, videos, etc) is it a good idea to pay them and then deduct that income as a business expense?
If your kids help with your blog or business, you can hire them to shift some income to them. The job role and responsibility should be appropriate for their age. You should also write a job description and schedule and document their hours. Are they helping post to social media? Acting as models for photographs? Maybe they help you “test” recipes, projects, and/or products. If you sell physical products, they might help package and ship inventory.
Here's a great article from Enterpreneur about the topic of hiring your kids (FYI – the article was written in 2014 and the standard deduction is $6,350 in 2017) and an article from Parents about child models with a range of hourly rates.
From a tax perspective, it’s easiest to hire your kids if your business is taxed as a sole proprietor or partnership. Yes, you must report their income using a W-2, but no FICA, Medicare, or unemployment taxes are withheld. Your kids’ wages are now a deductible business expense. Plus, your child now has earned income that can be contributed to a Roth IRA!
What can I do this year to be better prepared for tax season next year?
Talk with an accountant ahead of time. They can help you get organized so that it’s easier for you to keep up with your bookkeeping. And please discuss big business decisions with an accountant prior to making them to that you’re fully aware of the tax impact!
Finally, I always recommend saving for and making estimated tax payments.
A huge thank you to Cathy for this interview. Here's a bit more about Cathy:
Cathy Derus is the founder of Brightwater Accounting. As a CPA and financial planner, she helps individuals and business owners eliminate stress and worry over taxes, business finances, and more. Anyone can throw numbers into tax software. She’s here to help her clients make sense of those numbers and create a better financial strategy for their businesses and lives. Her expertise has been featured in Entrepreneur, CNBC, US News & World Report, The Washington Post, Real Simple and Cosmopolitan.