2020 Tax Changes for Small Business Owners and Partners

Are you self-employed? Most U.S. companies are self-owned, and of the more than 30 million small business enterprises, over a quarter of self-owned businesses are big enough to have employees. Being self-employed means dealing with many unique tax challenges, like tax withholding, additional reporting requirements, and more IRS scrutiny.

There are some changes that self-employed individuals can expect in 2020, outlined below.

Changes to 1099 Reporting

Beginning in 2020, there is a new form 1099 to report payments for non-employee compensation. Form 1099-NEC replaces reporting such payments in box 7, Nonemployee Compensation, on the Form 1099-MISC. The IRS hasn’t released a reasoning for the change, but it likely stems from confusion regarding filing due dates when filing Form 1099 for payments other than non-employee compensation.

Going forward, employers who make payments of at least $600 throughout the year to a non-employee individual, partnership, estate, or in some cases a corporation must use Form 1099-NEC. The due date is January 31, 2020. Employers making other payments should continue to use Form 1099-MISC and use the due date of March 31, 2020 to file.

Click here to view a draft 1099-NEC on the IRS website.

Increased Likelihood of Audits

The IRS is targeting some Schedule C filers for audits more in the 2020 tax filing season. Among other groups of tax filers, Schedule C taxpayers are largely responsible for what the IRS calls the “tax gap.” In other words, the IRS is aware that many Schedule C filers claim an excessive amount of business deductions or don’t report all of their income.

Be mindful of the following red flags if you claim business deductions on a Schedule C:

  • Substantial increase in income
  • Year-over-year loss deductions
  • Under-reporting all income
  • Excessive meals and entertainment deductions
  • Real estate losses
  • Vehicle deductions

As we’re heading into tax season, make sure all the documentation is organized and there are receipts for all business expenses. Especially considering the changes to the meals and entertainment deductions, thorough and accurate record-keeping is a must to protect against unwanted IRS attention.

Self-Employment Tax

On January 1, 2020 the Social Security wage base is increasing to $137,700, an increase from $132,900. Self-employed taxpayers must pay 15.3 percent on the first $137,700 of net income, plus an additional 2.9 percent on net income over $137,700. This higher amount should be factored into overall estimated tax payments for 2020.

Half of self-employment tax can still be deducted from gross income; however, keep in mind the impact this will have on the qualified business income deduction.

Estimated Tax and Tax Withholding

In 2020, the IRS is debuting a new Form W-4 to reflect code changes as a result of the Tax Cuts and Jobs Act. The new form is meant to be simpler and more transparent, with fewer worksheets and instructions. Among the more noticeable changes is that allowances are no longer listed on the W-4. Since personal exemptions have been disallowed under tax reform, allowances no longer make sense as a way to calculate tax withholding.

Instead, the new Form W-4 reflects a five-step process to capture all income to arrive at the correct amount of tax withholding. Though it’s not required to update the W-4, especially for self-employed taxpayers, it’s a good idea to go through the steps anyway to make sure that tax withholding is accurate.

Click here for a detailed FAQ from the IRS website on the changes to the W-4.

As a self-employed taxpayer, whether through business ownership or partnership, being aware of these changes now can set up your small business or entrepreneurial venture for success in the new year. For questions on these changes and any other tax-related issues, contact Naden/Lean today.