NOTE: This post is a couple of years old, so the exact numbers of tax laws may be different today, but the principles and guidelines still ring true and are worth a look.
Contrary to common practice, April 14 is no time to do your tax planning. Year's end is, when there's still time to plan for the coming year. You can look over your income and expenses, stash cash for long-term investment planning, or make any last-minute purchases to help offset the checks from your clients.
— by Jeffery D. Zbar
First, a primer on why year-end tax planning is essential for the freelancer—even more than for the corporate employee. When our corporate-employed peers laud our freelance existence, we must remind them of the automatic 7.65 percent bonus they get each year, compliments of the U.S. Tax Code. You see, we, the people of the Free Agent Nation and self-employed ranks, are not only required to pay our own tax bill, we actually pay more than the corporate-employed brethren. In the corporate world, the Social Security and Medicare tax of 15.3 percent of a worker's income is split by the employer and the employee. This means W-2 bearers (or the traditional employees) pay out 7.65 percent of their wages in that tax.
On the other hand, the self-employed are both employer and employee, so we fund both halves—hence the moniker, the "Self-Employment Tax."
Keep more, give less
A sound tax strategy is not only to keep more of what we have earned, but to have it when tax time comes (quarterly for some, monthly for others—and in April for anyone who had a shortfall for the previous year).
One trick I've used is to fund a miniaccount within my business checking account. "Blind holdings" are a way for me to stash cash to ensure I have enough to pay my corporation's monthly estimated taxes. Here's how it works: Each time a significant check rolls in from a client, I deposit the check in my account, and immediately subtract around 25 percent of that amount from my checkbook balance. Not only do I have the funds on hand when I have to pay the estimated taxes, but I also have a buffer against overdrafts.
Stay one step ahead
Among the savvy tax practices to pull off before Father Time calls it a year on Dec. 31, you should consider:
- Powering up your technology. Buying new technology during December is beneficial for several reasons. First, you can reap savings from holiday sales for items like a new personal digital assistant, computer printer or scanner, or new software or upgrades. Second, since business is traditionally slower during the last few weeks of the year, you can spend time learning the new hardware and any new software you'll be using—instead of trying to get up to speed when the New Year brings a fresh rush of new assignments.
- Subscribe, furnish or broaden your horizons. Whether it's paying the subscription on a business periodical, buying a new chair, desk or file cabinet, or enrolling in a class to advance your business skills or expertise, paying for these before year's end means you'll be able to take the tax break during the current year.
- Tally those receipts. A 25-cent toll here, a parking fee there, the occasional newsstand magazine purchase—pretty soon, you could have several hundred dollars in receipts. And, depending on your income bracket, every dollar you claim in expenses could mean a third more in deductions. Also, don't forget to deduct mileage for the actual business use of your car, and all your long-distance phone calls (or the entire cost of a dedicated business line). Those expenses can add up quickly as well.
- Take my home office, please. If you use a room in your home "regularly and exclusively" as your business office (meaning it cannot double as a guest room or kids' playroom after hours), you can deduct the space on your tax return. Compute this by figuring out the percentage that the office makes up of the entire home. For example, in a 2,000-square-foot home, a 300-square-foot office would result in deductions of 15 percent applied to mortgage interest or rent payments, property taxes, insurance, and utilities and general upkeep (if you entertain clients or customers). Still, just because you can, doesn't mean you'll want to deduct the space. Some accountants believe attaching a Form 8829 (for the deduction of business use of the home) raises the red flag for an audit with the IRS. Others warn against the liability of capital gains once a home is sold.
- Meet with your adviser. Whether it's a certified public accountant, tax attorney, financial planner or enrolled agent, choose an adviser whose philosophy jibes with your own (for example, on whether to deduct the home office) and discuss your strategy. To learn more about taxes on your own, visit the IRS Web site (www.irs.gov) and download Publication 587 on "Business Use of Your Home."
- Invest for your retirement. If you fund your own IRA, year's-end is a good time to make a contribution. While you will be allowed to invest for the calendar year until April 15 of the following calendar year, investing before year's end lets you get a head start on next year's investing, and it gives you a better idea what your tax liability—if any—will be when it's time to write the check come April.
- Plan to pay. Whether you pay estimated taxes on a monthly or quarterly schedule, forgetting can be even more taxing. Penalties and fines can result from late or forgotten payments. Instead, drop a reminder into your calendar or scheduling software to remind you when taxes are due.
One key point to remember: In order to take a tax break, you must have the money to pay the expense to get the tax benefit. Overextending your wallet in order to take a deduction is not wise if it leaves you strapped for cash when the New Year rolls around.
Promise yourself you'll do a better job next year.
From collecting and logging receipts along the way to using financial management or accounting software designed to make tracking your income and expenses simple, December is too harried and April is too frantic to do this with any semblance of sanity.