Many freelancers, self-employed entrepreneurs and solo operators dread doing their taxes (especially as they must be done several times a year with the estimated quarterly returns). Yet a little preparation and organization is all that’s needed. Put simply, you are taxed on your profit, which is calculated by taking your income and deducting certain allowable expenses. And so, the ‘art’ is to make sure you maximize your legitimate expenses, thus reducing the amount of income that is taxed. With the following tips, you can be sure that not only are you complying with the law (and therefore keeping the IRS happy) but also not handing over more of your income than you have to.
Keeping good records is the number one priority. You can’t declare (or deduct) with certainty if you can’t clearly show your earnings or expenses. Throughout each quarterly tax period, save all receipts and proofs of expenditure, including office/stationery supplies, postage and shipping costs, professional fees and dues, subscriptions, and so on. Likewise, keep rigorous records of any business travel you undertake (hotels, flights, vehicle rentals, etc.). Make it easy on yourself at tax time by keeping orderly and separate records – i.e. don’t simply drop the receipts and invoices in a box or folder to be categorized and sorted later. Better yet, invest in a small business accounting software package, such as QuickBooks, inDinero or Expensify.
If you’re working from home, the cost of your home office is tax deductible – that includes the proportions of utilities, phone and internet lines, and rent or mortgage payments that correspond to business use. Calculating the proportion of rent/mortgage can be tricky so the easiest arrangement is to keep your office space separate from your living space. Then it becomes a simple matter of knowing what percentage of floor space your office takes up in relation to the whole house, then use that percentage to calculate the proportion of the cost that is deductible. As you can imagine, if the space overlaps, for example if your home office consists of using the kitchen table in the evenings, it becomes much more difficult to justify and prove the business expenditure should you ever be audited. Similarly for office equipment, it’s better to have dedicated home and office items as the burden of proof is on you to show that computers, phones, tablets, etc. are being used for business purposes (and if your laptop is the family computer as well then it becomes more difficult to establish the proportion of the cost that is deductible).
It’s worth looking into which expenses associated with your business are deductible for tax purposes. As a general rule, airfare, hotel fees, car rental and mileage are all completely deductible. The cost of food (including entertaining those essential business contacts) is only 50% deductible. As for attending conferences, you’ll need to demonstrate that it was relevant to your industry and likely to contribute to the smooth running of your business.
If you’re self-employed and business is going so well you’re headed for a higher tax bracket, you are allowed to defer some of your billing to shift the income into a different tax period. This can be helpful if you know that your income is seasonal or usually varies across different periods during the year. By deferring you can even out the income flow on paper and maintain a lower rate of tax.
The year-end might be a good time to make some business equipment purchases so as to increase your deductible items and therefore reduce your total tax liability.
This can be a money-saver because as a business owner, if you employ a family member you are allowed to deduct the whole amount of their healthcare cover premium, whereas for regular employees you are only allowed to deduct a proportion of the amount.
Under the Federal Insurance Contributions Act, the employer and employee both pay a contribution towards Social Security and Medicare. If you’re self-employed this means a double whammy as you are both employer and employee. However, according to the IRS, “You can deduct the employer-equivalent portion of your self-employment tax in figuring your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your self-employment tax.” (source: irs.gov) In other words, you can reduce the amount of income tax you’re liable for.
Not only is a retirement plan a good idea for later in life, payments into a retirement plan are tax deductible and can therefore give you a considerable tax break. If you’re self-employed, look into a SEP-IRA which allows you to contribute (and therefore deduct) up to 20 percent of your income. If you’re employed by your own corporation, the deductible IRA figure is up to 25 percent of your salary. Alternatively, investing in a Keogh plan allows you to put even more into tax-deferred savings which saves you money in the short-term.
All of the above pointers are good, solid advice; however, if you consider ‘outsourcing’ one element of running your own business from day one, it should be the accounts and tax elements. Excellent record-keeping and organization will serve you well but an expert will almost certainly prevent you from paying more tax than you need to.