Got a side hustle? Then you should know that the Tax Cut and Jobs Act created a new break that is likely to significantly cut the federal income taxes you pay on your self-employment income. “The new law takes 20% off the top of your business income,” says Gene Zaino, president and chief executive of MBO Partners, a consulting firm for independent workers. “That’s a pretty good deal.” In theory, the so called “pass-through deduction” is simple. You fill out your return as usual, but apply a 20% deduction against your net self-employment income, reducing your taxable income and your tax in the process. But, in reality, this deduction is only simple if you earn less than than $157,500 when single or $315,000 when married, filing a joint return. After those income thresholds, a series of “exclusions” apply and it gets complicated. Here’s what you need to know about this new tax break, in question and answer form. What is the pass-through deduction and how can you claim it? The pass-through deduction is a special break meant to create parity between small business owners, who often pay tax at personal income tax rates, and large businesses that reaped a windfall from a big corporate tax cuts in the Tax Cuts and Jobs Act. Why would small business owners pay corporate tax at personal rates? Because many business owners and side hustlers don’t create a formal corporation to receive their business income. Instead, they file taxes as “pass-through” entities – sole proprietorships, Subchapter S corporations, partnerships and the like. (If you have side hustle income, but have not formed a corporation, this applies to you.) Until this new tax law, it made little difference because corporate rates were largely comparable to personal rates. However, when the TCJA passed, it cut the top corporate income tax rate to 21% from 35%. However, the top personal tax rate was only cut to 37%, which would have placed small business owners at a disadvantage. How does the pass-through deduction work? Generally speaking, what business owners will now do is fill out a Schedule C (“Profit and Loss from a Business/Sole Proprietorship”) form as usual, adding up gross receipts and subtracting out the relevant business deductions (and there are many of them, as our tax primer explains). That will produce a net profit from your business. Multiply that result by 20%, and subtract the result from your business income. That’s the amount you’ll pay tax on. To clarify: If your business brought in $100,000 in revenue, but you had $20,000 in expenses, you would have a net profit of $80,000. You would multiply $80,000 by 20% and subtract that result ($16,000) from the $80,000 and pay tax on the remaining $64,000 in business income. What if I also have income from wages? You claim wage income, as usual, on the front page of the 1040. You are not able to claim the 20% pass-through on this income. You said it’s only simple if I earn less than $157,500 when single or $315,000, when married filing jointly. What if my total income is greater than that amount? Then, your ability to claim this new pass-through deduction will depend on both what you do for a living and how much you earn doing it. If you do accounting, actuarial science, athletics, brokerage, consulting, financial services, health, law, the performing arts, or anything that involves the performance of service consisting of investment or investment management, trading or dealing in partnership interests or commodities, your ability to claim this deduction would phase out once you earned more than those threshold amounts, says Mark Luscombe, principal tax analyst with Wolters Kluwer Tax & Accounting. Single filers in these professions and any business where “the principal asset is the reputation or skill of one or more employees or owners” are able to claim partial deductions when their income is between $157,500 and $207,500. Married filers get partial deductions when they earn between $315,000 and $415,000. However, after those income levels, people in these “service” businesses lose the deductions completely. What if you’re not in a service business? Then you need an accountant, and likely, clarification from the IRS. The law has an obtuse reference to phase-outs of deductions for small businesses depending on their income, the number of people the business employs and the value of the business assets. The IRS has promised to clarify exactly how this provision works, but the agency has not yet provided guidance and the details are complex and cloudy, says Luscombe.