Timely Tax Planning
Imagine sitting down to do your taxes in the early spring and realizing, “I should have done X in December.” Tax planning is what many people vow they will do by the end of the year but just never get around to doing it. Tax planning is not as odious as you’d think. It is an opportunity to see how your year is going, how much money has come in and what you project to come in by December 31st. It’s also the chance to determine what you’ve spent on and plan to spend on expenses that will benefit your business and lower your taxes. In a nutshell, it’s an excellent opportunity to clearly see your tax situation.
Many freelancers do not focus on how much they have actually made in the year. Some may avoid it because they’ve made less than they actually wanted to. Others, however, may have made so much more than they predicted that they have not put in a sufficient amount for estimated taxes. Still others may not want to face it because they have not paid quarterly taxes and fear for their bottom line. Being a freelancer means running a business. Everyone who runs a business should know where their business stands throughout the year, not just at tax time.
I suggest that you actually do most of the work required for your taxes in December, not April! Take out all your receipts, credit card statements and checks, divide them into appropriate categories, then see the lay of the land of your business. Make notes of what checks have not been returned to you and what income you expect by year end that hasn’t come in yet. If you have computerized your income and expenses (with Quickbooks or your own Excel worksheets) and have inputted your income and income and expenses during the year, you’re one up at this point of the year.
Once you’ve seen where you are, you might buy the new piece of equipment that you are sure you need and that you will be using by December 31st so that you can take the deduction for the year. Just know that because you spend a dollar in expenses does not mean that you will get a dollar deducted from your tax bill. An expense is an expense which counts as a deduction from your income, not a credit against your taxes.
If clients owe you money , there is no law that says you must force them to pay you by year end. If you had a fabulous year and you feel the following year may be a bit leaner, you may want to wait until after year end to press your clients who owe you money for payment. Income received by December 31st counts for the present year for those of you on the cash basis (which most freelancers are on). If, however, you have a side business that has not brought in significant income, it may behoove you to press clients for payment by year-end so that you can show income for that business.
If you do not have a pension plan, look into opening one. You have a potpourri of choices between different kinds of IRA’s, Keogh’s, solo 401(k)’s, SEP’s and SIMPLE’s. It is important to investigate your choices before year end because some of your choices must be opened in the year for which you want to fund your pension (eg profit sharing plans) as opposed to those that can opened up by April 15th following the year for which you want to fund the plan (eg SEP’s and IRA’s).
If you do tax planning before year end, you will not know all of your income or your expenses to the penny. Estimate! If you’ve gotten this far with guessing, you will probably be off by only a tiny bit when the actual figures are done. Then, figure out what your taxes will be, what your pension contribution will be, and compare these numbers to what you had projected the previous spring when you did your estimated taxes for the year. (You may want to have a tax planning session with your tax professional to ascertain these numbers.)
Fourth quarter state and city estimated tax payments that are paid by December 31st are deductible in the current tax year on your federal return. See if paying early is useful for you.
Remember to take into account local business taxes that you may be responsible for like the New York City Unincorporated Business Tax.
Another advantage of early tax planning is that if you don’t have the money to pay your taxes, at least you have the time to get it together. If you feel the early preparation is too much, sit down and estimate everything you’ve made and everything you’ve spent. Ball parking numbers are better than no numbers at all! Don’t let April hit you with an uneasy feeling because you have no clue where you stand. Be prepared!