2019 Tax Prep + Deductions

The Holidays are upon us and there is so much to do! Shopping (remember to buy gifts for special clients), holiday cards (everyone you’ve worked with over the past 5 years will receive one), parties and catching up with dear friends and colleagues. You may also find it advantageous to change your health insurance plan before open enrollment ends in your state, or make a retirement account contribution before January 1. It also makes sense to review the years’ invoices to calculate gross revenues and decide how to handle December billings.

Especially for invoices that are due on or after the 15th, should you keep those earnings in this year and invoice at the usual time, or invoice on January 2 and push earnings into next year? If you earned more than expected this year, consider pushing earnings forward, to limit taxable income. You could also make a retirement plan contribution, if you haven’t reached the year’s maximum amount (whether you bill clients in this year or the next). Here are a few more tax season preparation tactics to consider:

Find all invoices and confirm that they’ve been paid. Send a reminder to those clients who have not paid up. As noted above, calculate your revenues (i.e., income before deductions) and determine whether to invoice on time or later. Of course you can do other good things with your windfall, if you have one, such as registering for a class that will be held in the new year and paying for it now (and taking the deduction in this tax year).

Calculate your self-employment tax. In addition to our regular income tax, Freelancers are responsible for paying the 15.3 % self-employment tax levied on the first $132,900 of net income and 2.9% of net income beyond that amount. This tax represents the Social Security and Medicare taxes that traditional employees have taken out of their paychecks automatically. The amount includes as well the employer portion of those taxes, since Freelancers are considered both employer and employee.

Freelancers are able to write off business expenses for these categories:

Business-related travel, meals and lodging

Membership in business and professional associations

Office required equipment or materials

Home office. Most Freelancers work from home and are therefore eligible to take this deduction. The Internal Revenue Service allows independent workers to write off a corresponding percentage of rent/mortgage and utilities when our home is also our office. Get out your measuring tape and determine the dimensions of your workspace as a percentage of the square footage of your home to calculate the amount of your deduction. Be advised that office space must be used exclusively for self-employment work. One cannot, for example, “borrow” a child’s bedroom from 9:00 to 5:00 and consider that your home office.

Office equipment and supplies. One of the downsides of being a Freelancer is that we are unable to use an employer’s computer, scanner, printer, staples, or paper clips. We pay for that stuff out of our own budgets. But since we need certain resources to do client work, the IRS allows us to deduct their cost from gross sales revenues. To avoid IRS problems, keep your business and personal expenses separate. For example, check in with a smart accountant before you decide to deduct your cell phone or Internet service while using them only partly for work.

A real benefit for those who will buy office equipment is the Section 179 Deduction, which allows the business owner (or Freelancer) to write off the entire purchase price of qualifying equipment for the current tax year, up to $1,000,000. Qualifying items include office furniture, computers and software programs such as QuickBooks and InDesign.

Travel, meals, lodging. This category of deductions is the most confusing for Freelancers and business owners. We are allowed to deduct the costs of traveling to our work assignments, client meetings and conferences, including gasoline, tolls, parking, trains, planes, buses, or Uber/ Lyft. One cannot deduct costs associated with commuting to your separately leased or owned office space. Hotel/ airbnb/ B&B rooms are 100% deductible, except for personal expenses such as movie rentals or the mini-bar.

The cost of taking clients and prospects out for a meal are deductible at a 50% rate, while costs associated with company-wide parties, picnics and restaurant meals when at least half of your employees attend are 100% deductible. Keep all receipts —take a picture with your phone as back-up.

As with all Freelancing expenses, deductions must directly relate to one’s business. We cannot write off the tuition for a workshop on baking or flower arranging if one is a website developer, nor can we write off education that trains us for a new occupation. But if we take classes to earn certifications in our field or to enhance business knowledge, then we can typically write off all associated costs. The same is true for any licensing, registration, or certification costs that we incur.

Thanks for reading,

Kim

Illustration: Henry Holiday The Tax Collector at Work, created for the Lewis Carroll poem The Hunting of the Snark (1876)

2015 Year-End Tax Planning Thoughts

It’s mid-November and time for Freelancers to think about how much money we will hand over to the tax man this year. Tax planning is usually at top of mind as the year ends, but be advised that obsessing over taxes is not always useful. New York City CPA and small business tax specialist Michael Hanley recommends that you take a breath and consider the impact that aggressive tax strategies would have on your financial circumstances.

Hanley cautions small business owners and Freelancers against inflated spending on business expenses just to give themselves a lower tax bill, because tax deductions are not a dollar-for-dollar benefit. Every dollar written off as a deduction yields on average only 30 cents in tax savings (depending on your tax bracket and legal structure of the business). If you have a big-ticket item to buy and you anticipate that this year’s income and next year’s will be about the same, then buy when you can get the best price on the item, be it in this year or next. Your savings could be worth more than the tax deduction.

Hanley also addresses the apparently common tactic of zeroing out one’s business bank account by December 31. Paying for business expenses, adding to your retirement account, or purchasing business equipment or supplies will likely make the zero balance bank account tactic work. Paying yourself a bonus, taking a shareholder distribution if your business is a corporate entity, paying down your credit line at the bank, or paying off business credit cards will not give you legitimate tax deductions.

Professional development education is tax-deductible, so if you’re holding money and there is a potentially useful workshop or symposium offered late in the year, do register and attend. You might also consider throwing a Christmas party for clients, prospective clients, referral sources and selected business colleagues (meaning, no one who might steal a client!). Your Christmas party could turn out to be a networking bonanza that creates billable hours for you in the coming year (and beyond).

Clients and referral sources could come away with more business as well and that will make their relationship with you more valuable to them. If you can grab a big table or a private room in a restaurant that needn’t be fancy, but has a good reputation, then plan your party with Evite, even if a Monday night is all you can reserve.  Allow 7-14 days for the RSVP—last minute invitations can be just fine. Spontaneity has its charms, especially at this time of year.

To make sure that the social swirl and networking will be effective, invite 30 and expect 12 to show. Set out five or six finger foods and arrange for a signature cocktail. If someone asks for beer or wine, let them have it. Your party can run 6:00 PM – 8:00 PM. Most people will have two drinks, the restaurant will tell you how much food to set out. You will probably spend $60/pp, meaning that a table of 12 will cost less than $750.

You might also consider inviting your Linked-In connections to a party. It would be a wonderful way to introduce your colleagues to one another and billable hours could be created as a result. You may want to make this a pizza, salad, beer and wine affair, but so what? It’s a great idea, regardless. If you have 100 connections, plan on 25 showing up.

If it’s too late to host a party this year, the cards and stamps used for the December greetings that you’ll send to clients and referral sources are tax-deductible. If you act now,  there will be time to order specially printed cards for your business (you will still add a personal message).

Thanks for reading,

Kim

Year-End Tax Planning: Freelancer Options

It’s never too early to start a retirement plan and Freelance consultants are encouraged to set aside money whenever possible.  Be advised that contributions to a self-funded retirement plan are guided by your net earnings from self-employment.  If you net $80,000 this year,  then you may contribute 20%  of that amount,  or $16,000,  to a SEP IRA or Solo 401K plan.  If you are age 50 +,  a  “catch-up”  contribution of maximum $5,500  (in 2014)  can raise your total allowed retirement fund contribution  (and tax deduction)  to $21, 500.  The maximum amount that one can contribute in tax year 2014 is $52,000 and $57,500 for those age 50 +.  However,  if you are a high earner and you consult with a savvy tax specialist,  it may be possible to divert lots more tax-deductible dollars to a Solo 401K than is allowed with a SEP IRA.

 

SIMPLE IRA

The Savings Incentive Match Plan for Employees Individual Retirement Account is a type of traditional IRA that is tailored for small business owners and self-employed Freelance consultants.  As with a traditional IRA,  contributions are tax-deductible and savings held in the account are tax-deferred until retirement withdrawals are made  (age 59 1/2 the youngest and age 70 1/2 the oldest).  If you have employees,  they may contribute to the SIMPLE IRA themselves and you the employer are required to make annual contributions as well,  whether or not the employee chooses to contribute.  You may make a 100%  match of the employee’s contribution,  but the maximum is 3% of your  net earnings,  or you may limit your employer contribution to 2%  of your  net earnings.

Any business entity that employs 100 or fewer workers may establish a SIMPLE IRA for employees and the owners,  too.  If you anticipate growth in your business that will likely cause you to hire even one full-time employee,  then consider a SIMPLE IRA,  because adding employees to the plan is relatively easy,  unlike other retirement plans.  The big downsides to SIMPLE IRA are 1).  the $12,000 annual contribution limit is considerably lower than that of SEP IRA and Solo 401K and 2). the  $2,5000  “catch-up contribution”  for Freelancers and business owners who are age 50 + is paltry by comparison as well.

However,  as a business owner or self-employed Freelance consultant,  you are your own employer and you may contribute to your SIMPLE IRA as both employer and employee.  You may add in up to 3% of net earnings,  in this example up to $2,400,  to contribute $14,4000 in 2014 and $2,500 extra if you are age 50 +.  Finally,  if you don’t make much money but you still want to set aside a little something for retirement,  if your net earnings from self-employment are $12,000 or less,  you may contribute 100% of the amount of your net earnings to your SIMPLE IRA.

ROTH 401K

A designated Roth Retirement Account is an individual retirement account that exists under the umbrella of your 401K,  solo or traditional  (if the 401K is set up to allow it).  Unlike SEP and Solo 401K,  Roth 401K contributions are made with after-tax income and when you are ready to access the account,  you will draw down tax-free money.   The 2014 maximum Roth 401K contribution is $5,500  ($6,500 for those age 50 +).

Your selection of a Roth designation within your 401K will depend upon your financial circumstances and you should meet with a reliable financial adviser in advance.  An individual or couple might choose a Roth when there are insufficient deductions to itemize at tax time,  thus negating the tax deduction benefit of the other retirement accounts .  The Roth,  paid with after-tax dollars,  gives account holders the benefit of tax-free income during retirement.   Wealthy Freelance consultants who are concerned about minimizing taxes during retirement may also benefit from the Roth.

You may have both a  (pre-tax)  Solo 401K and an  (after tax)  Roth 401K and it is permissible to use the salary-deferred portion of your Solo 401K to make a Roth 401K contribution.  Profit sharing Solo 401K contributions are not eligible to be made as a Roth 401K contribution,  since they are made pre-tax and are tax deductible and you cannot commingle the two.

While Roth 401K income-deferred contributions are NOT tax-deductible,  withdrawals made after age 59 1/2 are tax-free IF five years have passed since your first contribution to the Roth  (known as the 5 year rule).  One is NOT required to take distributions at least by age 70 1/2 and that feature may be useful for retirement cash flow planning.

Thanks for reading,

Kim

Year-End Tax Planning: Funding Your Retirement

Happy November.  The year will soon end and it is time to put together a tax planning strategy while there is still time to plan and execute.  There may be business equipment to purchase,  upgrades to make to your website or a seminar to attend,  but we self-employed workers must also fund our retirement.  Traditionally employed workers must also fund their retirement,  but they get help from their employers.  Freelancers are our own employers and we must step up and do all that we can to stash a few tax-deductible dollars in the cookie jar,  so that we can eat when we’re 75.

Whether you’ll squeeze a few thousand dollars out of modest billable hours or you’re looking for a place to roll the overflow from a lucrative year,  saving for retirement is a superb tax planning strategy.  It is also a superb life planning strategy.  Under no circumstances do we want to be old and broke in America.  If one is single,  that is a real possibility.  This is not Europe and the government will not give us any financial assistance in a time of need,  even though we have been tax paying citizens our entire lives.

The good news is that there are good retirement plan options available to Freelancers with a few thousand dollars to spare and the discipline to save.  Also,  the retirement money can be invested in stocks,  bonds,  mutual funds or even real estate.  You might get lucky and see your investment really grow.  Taxes will not be paid until it’s time to draw down on the account  (age 59 1/2 the youngest and age 70 1/2 the oldest).

SEP IRA

The Simplified Employee Pension Individual Retirement Account is modeled after the IRAs that every employer offers.  They are evidently the easiest type of retirement account to set up and there are minimal IRS reporting requirements involved.  Your job will be to find a brokerage firm that will set up the plan,  process your deposits,  maybe give you some investment advice and not kill you with administration fees.

Contributions are limited to 20% of your net earnings  (before the self-employment tax).  Contributions are capped at $52,000/year for tax year 2014 and the limit will increase every year or two,  to adjust for inflation.  A married couple who run a business together,  or are each Freelancers,  may open a joint account and save an annual maximum of $98,000 tax-deductible retirement dollars in 2014.  One cannot borrow against a SEP IRA.

SOLO 401K

The Individual 401K is modeled after a traditional 401K and once again,  the IRS filing requirements are uncomplicated and your job is to find a brokerage firm that will set up the plan,  process your deposits and not kill you with administration fees.  One may contribute money a little differently to a Solo 401K,  in that you may give yourself a  “salary deferral”  in a good year and stash up to 20% of your net earnings into the Solo 401K,  but the annual maximum contribution remains $52,000 in 2014  (the limit will rise modestly to adjust for inflation).  However,  Freelancers aged 50 +  can take advantage of the  $5,500 (max)  “catch-up contribution”  feature,  which allows those who are able to set aside more retirement dollars to do so and contribute up to $57,500/year in tax-deductible dollars.  Another big advantage of the Solo 401 K is that one may borrow against maximum one-half of the assets  (you must repay the loan with interest, to yourself).  Additionally,  a married couple who run a business together can start a Solo 401K retirement plan for the two and contribute up to $98,000 annually as of 2014 and $10,000 more with the catch-up contribution if both are age 50 +.

Next week,   we’ll look at the SIMPLE IRA and more retirement plan options.

Thanks for reading,

Kim

Taxes: The Home Office Deduction

Are you about to do your taxes,  Freelancer friend?  Read this post first and find out if you are able to deduct expenses for your home office.  The IRS sets a high bar for this deduction,  but if you pass the qualifiers,  it’s all yours.  Tele-commuters and outside sales reps might also deduct home office expenses.

1.   The space must be used exclusively and regularly for business purposes only and not for your personal life.  The space must be used regularly for business  and not just a few times a year.   Those who live in small apartments are at a disadvantage because no room can be consigned to business only.   However  if you use the space regularly for business,   it is not necessary to partition it off to demonstrate that you have established a separate workstation.   A desk in a corner of a room qualifies as a workstation,  along with a  “border”  of a few square feet.  Outside sales reps who must store product samples and marketing collateral at home can also include storage space square footage in the home office deduction.

2.   Does your home office exist primarily for your convenience,  or for the convenience of your employer or clients?  If your employer or clients have provided a location at which you may regularly conduct business,  then you are not allowed to deduct home office expenses.  To take the deduction,  you must have no other work space available  (you and your computer at Starbucks is not a disqualification).  Employees and independent contractors may have to give documentation to the IRS.  A letter from the employer stating that there is no office space provided for you and/or receipts for un-reimbursed business expenses and supplies will suffice.

3.  If you have more than one home-based business,  all businesses must meet the first two tests:  you cannot have any office space made available to you by a client or employer and you must devote that space  exclusively and regularly to business.  If any entity for whom you work provides regular office space for you,  then you are not allowed to claim the home office deduction and it’s an all or nothing proposition.   However,  disqualification from the home office deduction does not mean you cannot deduct other business expenses.  You are still eligible to file Schedule C  (Freelancers/Independent contractors)  or Form 2106  (outside sales reps and other employees)  to deduct other un-reimbursed expenses incurred while doing business.

Are you ready to complete Form 8829 Expenses for Business Use of Your Home?  To get started,  measure the number of square feet used at home exclusively for business purposes  (maybe measuring storage closets and the area of your desk,  plus a  “reasonable”  border,  instead of an entire room)  and divide that number by the total square feet in your home.  If your office is 12′ x 12′,  you have 144 square feet of office space.  Let’s say your apartment has 750 square feet of space.  Divide the area of your office by the area of your apartment: 144/750 equals 0.192,  or 19.2%.

That figure represents the percentage of your home that is devoted to business,  the percentage of the year’s home expenses you may charge off to the business and deduct.  There are direct expenses and indirect expenses to calculate.  The fraction applies to indirect expenses,  i.e. the total year’s utilities,  rent/mortgage,  taxes,  home insurance,  etc.  For example,  if you spent $800.00 on last year’s electricity,  you may deduct 19.2 %  x  $800.00 or $153.60 for that category.  Expenses incurred solely for the benefit of your workstation are the direct expenses.  Office supplies,  postage and office furniture are direct expenses.  Add your direct and indirect expenses.

The final test is,  does your home office deduction exceed the revenue generated/income?  Your home office deduction cannot exceed the money generated.  So if your business earned $1000.00 and your home office deduction adds up to $1200.00,  you may only claim $1000.00 for your home office deduction.  But that extra expense does not get wasted.  You may carry it forward to add to a future home office deduction in a year when revenue exceeds expenses.

The bottom line Form 8829 number is recorded on Schedule C  (Freelancers /Independent contractors)  or Form 2106 and Schedule A  (outside sales reps and other employees).  Employees must itemize deductions  (hence Schedule A),  to which the home office deduction is added to other un-reimbursed business expenses and all other Schedule A deductions.  Those deductions must exceed 2% of your adjusted gross income.  For more detailed information specific to your situation,  speak with an accountant or tax attorney.

Thanks for reading,

Kim

2011 Year-End Tax Planning

It’s about that time,  folks.  2011 ends in 7 weeks and it’s time to plan how to handle your taxes.  We all have to pay something  (except if you’re a multimillionaire or billionaire, in which case you pay nearly nothing!),  so before December 31 it’s important to enact a strategy that will work well for you.

Tax planning boils down to either accelerating or deferring income or deductions.  In other words,  do you want to report and pay taxes on more money or less in 2011 and do you want more or fewer write-offs?  The road you follow will depend on many factors,  including what you did last year,  how much money you will make this year,  whether you expect to make rather more in 2012 because a big project will start then,  or you expect to make rather less next year because an important project will soon conclude and you have nothing big on the horizon.

Take a look at your 2010 tax forms and 3rd quarter 2011 P & L statement to see what your financials say about your options.  What do fixed and variable expenses look like?  That will impact your decisions about deductions.  What does net profit look like?  That will impact whether you choose to accelerate or defer income.

If you want to accelerate income,  start by collecting outstanding receivables.  Pick up the phone or send an email and ask clients to pay ASAP,  or at least before December 31.  Tell them it’s a tax-planning matter (it sounds so much more dignified than telling clients that you plain old need the money!).  If you’ve got a contract in the works,  ask for a bigger retainer.

If you opt to defer income,  perhaps because 2011 has been a good year and you’re not sure what 2012 will bring,  then wait until January to collect receivables and ask for a smaller retainer fee.  BTW,  it’s possible to defer up to 25% of your income through your Solo 401K and it’s tax-deductible.

If you need write-offs,  scout for year-end deals on office furniture,  computers,  iPads,  office supplies,  software and whatever else you need to do business,  including enrolling in a course or attending a conference.  Office furniture,  computers,  company vehicles and other big-ticket items can be written off in a lump sum,  or depreciated over a period of years  (which is in reality deferring the deduction since it’s being spread out).

If you elect for fewer write-offs,  hold off on shopping until the calendar turns.  Alternatively,  if you are presented with office or business equipment deals that you cannot refuse,  then choose the depreciation method and spread out your deductions.

Speaking of deductions,  remember your retirement plan.  Solo 401K and SEP-IRA are funded with pre-tax dollars and are tax-deductible up to $16, 500.00  If you’re 50+,  the catch-up contribution feature raises the maximum to $22,000.00.  Remember the tax-deductible income deferral feature if you’ve had a very good 2011,  but expect to have a less lucrative 2012.

Further,  you might want to make an appointment with your accountant or business attorney and confirm that you are enrolled in the best legal entity for you.  Your exit strategy can impact  the legal entity you use.   For example,  if you want to take on a partner and eventually sell out,  or pass the business to offspring,   niece or nephew,  a different legal entity may be preferable.

Finally,  the end of the year is the time to assess what’s happened this year for you,  professionally and personally. Review your successes and challenges.  What will you do differently in 2012 and what will you continue to do?  Did you meet your financial goal?  Did you manage to sign a dream client or get a wonderful proposal approved?  What should you reach for in 2012?

Thanks for reading,

Kim