It’s Time to Think About Taxes
Independent contractors and those who are self-employed should prepare now for the upcoming filing season
Taxes are in the news right now as part of U.S. political discussions, but they should already be on your mind if you currently work as an independent contractor or are self-employed. Thanks to the pandemic extensions, many of us just completed our 2019 tax filings in July. To suggest that we start working on them again so soon may be irksome, but with the end of the year upon us, there is no better time to evaluate one’s tax situation than now, while positive changes can still be made.
DISCLAIMER: This article is intended for American taxpayers. I am not a CPA, nor should anything in this article be considered legal or professional tax advice. Always follow IRS and state guidelines for filing taxes, and if you are unsure about something tax-related, consult a qualified tax professional in your area.
Tip 1: Keep a daily log
This log can be digital or manual. How you keep it is not as important as the fact that you have it and that it’s thorough. Track everything related to your business or contract work. This includes expenses, mileage and even the hours you spend on each project. Also consider tracking the time you spend on website development, marketing activities, research and reading business-related books and articles.
If you intend to claim home office space or mileage as business expenses on your taxes, this log is a must. Not only will it help in the event of an audit, some tax forms require you to attest to the presence of this log as part of the filing process. You can create your own spreadsheet or download any number of free templates online. Just be sure that you have ample documentation to back up your time and expenses.
Tip 2: Know what you can deduct
Business needs will pop up throughout the year, and you may be unsure of what you can deduct. It’s wise to buy supplies or equipment that you must have and hold off on anything extra until you have some insight into your profit or loss for the year. If your profit is healthy, you will have more leeway for the items on your wish list. If your year has been slow or you’re barely breaking even, consider saving some of your “extras” for next year and start making plans now for how you will make it more profitable.
A great way to determine your current profitability is to use tax software or tax forms from the previous filing season. Create a draft return and plug in as much data as you can — earnings to date, expenses and deductions you typically take. The totals are only estimates, especially when updates to tax laws are forthcoming, but they will give you a better picture of your financial status than just reviewing your checking account or invoice log.
I have used electronic filing software for years. The newest version typically comes out around Thanksgiving, and I always buy it as soon as possible so I can prepare a draft return. Although this requires extra effort at a time of year when my attention should be elsewhere, it’s worth it to know how much I’ve made or how much I might owe before year-end.
A quick note: If this is your first tax year as a self-employed business owner, you have the additional option of deducting start-up expenses. Be sure to brush up on the IRS Business Expenses documentation before year-end so you know what equipment and start-up items like business licensing fees are deductible.
Tip 3: Use your financial overview as a roadmap
The estimates you pull together will be helpful as you make financial decisions before the end of the year. If you are showing a profit, this could be the justification you need to take some guilt-free time off. If you are just getting started or things have been slow, this could be your motivation to put in more time and finish the year strong. This information may also help you to determine whether to accept or decline a project that you haven’t quite committed to yet.
If your return indicates a strong profit for the year, you have the added benefit of evaluating whether to make some of those “extra” purchases. Play with the numbers in your draft filing to see if it helps you to make these purchases now rather than waiting until next year.
Keep in mind that purchases such as computers, printers and office furniture have additional depreciation options in their first year of use. Be sure to factor this in when running your numbers. (When calculating depreciation, it is best to use the latest software to ensure that you are using the most accurate calculations.) The IRS FAQ on Depreciation is a good place to start if you are unsure of what you can claim.
Tip 4: Understand the difference between state and federal deductions
What you can deduct for state and federal taxes may not be the same. Knowing the difference will let you take advantage of the tax breaks to which you are entitled and ensure that you are not surprised when you cannot deduct something on one return that you deducted on the other.
I realized a few years ago that I was missing out on a state deduction because of how I was saving money in a 529 plan for college tuition. I made the necessary change and now get a credit for money I was already putting aside (just not in the right place). Small things like this can impact your returns, as can the aforementioned depreciation expenses, which are often calculated differently at federal and state levels.
Tip 5: Stay up-to-date on the latest tax laws and deductions
I can’t think of a tax year in which knowing the latest laws and deductions is more relevant than 2020. Any changes to the tax code likely won’t happen until closer to filing time, so it’s important to check frequently for updates. If you use tax software, you should be prompted to download any update upon launch. You can perform a manual update from within the tool, as well. Be sure to refer to the IRS web page on businesses, as valuable information will be posted here as it becomes available.
Tip 6: Save your receipts, including those for online purchases
A longstanding staple for tax prep, this warrants repeating: Keep your receipts! If you make digital copies and intend to shred the originals, be sure you have ample backups first. The last thing you want is missing documentation when you need it to prove the legitimacy of your deductions.
I find nothing more frustrating than knowing I have an email receipt but not being able to find it when I need it for tax prep. Yes, search tools are helpful, but they aren’t always reliable. Just this past filing season, for example, I spent at least 30 minutes trying to track down an expense in which the billing service was different than the vendor. Find a central place to store your receipts, and if you can manage to organize them as you go, even better! Also be sure to review IRS limitations before discarding any tax-related documentation.
Tip 7: Keep a positive attitude
Last, but not least, stay positive. If you dread taxes, of course, every moment you spend on them is going to be awful. Starting now will help to alleviate the stress that comes from putting them off — and it could also save you some money.
I try to make tax filing as pleasant as possible rather than focusing on the tedium of inputting numbers, calculating business costs, etc. Every year, I watch a specific 13-episode mini-series as part of my tax filing ritual. It helps me to not get too wrapped up in the task at hand and while also giving me something to look forward to. My family knows when they see this show on the TV that it’s tax time and they need to give me some latitude.
Remember, most of what you spend for self-employment impacts your profitability, for better or for worse. If you plan as you go, making only necessary purchases to start, paying all required taxes along the way and organizing your tax documentation as it comes in, you will be in a much better position come tax season. And, even if you don’t file taxes yourself, having everything nice and neatly compiled for your accountant is a win-win. It might even help you to get your refund faster!
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