Ed note: Tax planning can be complicated, especially when you work for yourself. It’s always best to talk about your specific situation with a professional to get advice, however, David Ning has a few helpful tips for things you should start thinking about now.
Are you a freelancer committed to paying less in taxes? Then start thinking about these tactics now in order to reap the rewards next April.
Paying less to the tax man is on just about every freelancer’s wish list. While it may be too late to affect how much you had to pay on your 2014 return, there are many things you can and should be doing now. Here is what you can do for the best tax outcome for this year.
Optimize your expenses.
If you believe higher income next year is likely, then try to delay purchases until the higher tax bracket year because it’s like getting a discount on the purchase. Let’s say you are in the 25% tax bracket this year and the 28% tax bracket next year. If you buy a $1,000 laptop, which is used for business and choose to fully expense it using bonus depreciation, then the laptop really costs $634 after tax savings (taking into account the change in both regular income and self-employment taxes*.) But if you can delay the upgrade until next year, using the same calculation, the net cost of the laptop can be seen as $607, because the amount you owe in taxes (both regular and self-employment) is not being forked over to the tax man. I realize not every purchase can be delayed or pulled in, but consider recurring expenses you can buy earlier or later, such as supplies, stamps or other goods. Each purchase won’t seem to make a big difference, but everything in aggregate will matter over time.
*Takes into account the change in self-employment tax, the change in the ½ of self-employment tax deduction and the change in ordinary income tax.
Take advantage of retirement accounts.
Freelance income can be unpredictable, so why are you wasting precious dollars paying Uncle Sam unnecessarily when you can be putting those dollars in your retirement account? Between 401k plans, traditional IRAs, Roth IRAs and other tax-deferred retirement accounts, some self-employed individuals can contribute as much as $50,000 or more each year. Investments in these tax-deferred accounts will grow tax-free every year on top of the immediate tax savings for contributions. And for those worried about not being able to tap into any pre-tax amounts within these retirement plans without penalty, just remember that you can convert or rollover those pre-tax dollars into a Roth IRA in low-income years. This strategy has two advantages. First, while the pre-tax amount transferred to the Roth IRA is included in income, you still may be able to pay 0% tax if your income that year is low enough, meaning some income will never be taxed. Second, contributions made to a Roth IRA are not taxable when withdrawn, and may not be subject to penalty either, depending on the source of the distribution and the account owner’s age. Additionally, there are workarounds such as taking substantially equal periodic payments from the IRA if you really need the funds before you reach 59 and a half. Just make sure you understand the rules before you take money out to avoid unnecessary penalties.
Start incorporating life into your work.
The IRS only allows deductions for expenses that are both ordinary and necessary to conduct business, but that doesn’t mean you cannot mix business with pleasure. Take a business trip for instance. You can’t deduct a personal vacation, but you can certainly go sightseeing during the nights of all the conferences you attend for work. Just make certain that the trip is actually business related, because there are strict rules on making sure people don’t abuse the rules and deduct a personal trip as a business expense. Or how about your hobbies? Those who like crafting may want to sell some of their creations online. I have a friend who loves crocheting. By selling some of the scarves she crochets, she gets the therapeutic benefits of creating the art while being able to deduct the expenses of the materials. Did I mention she actually gets paid handsomely for her work because people love those scarves and will pay top dollar?
Tax time is when many people drill the tax professionals about deductions, but the time to think about tax deductions is during the tax year when you can actually do something about them. Think ahead now. You can thank me later.