Tax season is upon us here at Almost Millions, the personal finance site for freelancers and the self-employed. This year, individuals have three extra days to file taxes–because April 15 falls on a Saturday and Monday, April 17 is a holiday in the District of Columbia, Tax Day 2017 is Tuesday, April 18.
With tax season here, we did the simple thing: Talk to a bunch of smart people about taxes, freelancing, and 1099ing. That means it’s Tax Week at Almost Millions, and we’re kicking off with a guest post from Michael McCauley of McCauley and Associates, a CPA firm servicing small to mid-size businesses.
Michael has some great advice for planning your freelance taxes next year, and with that…
Self-Employment Tax Tips: Self-Employment Tax
Self-employed individuals face steep tax rates due to the blend of not only income tax, but self-employment tax. Self-employment tax is comprised of Social Security and Medicare taxes that are typically withheld from wage earners plus the employer match. The larger portion of self-employment tax is on the Social Security wages which cap at $127,200 in the year 2017 ($118,500 in the year 2016). That is, in 2017, when you make your $127,201st dollar, you cease paying social security tax. Medicare tax does not cease for any income level.
A wage earner turned self-employed may not be aware of the employer match that had previously been paid sight unseen by his or her employer which was not referenced in his or her pay stub. Accordingly, there is often “sticker shock” for the tax owed on a tax return for a wage earner turned self-employed.
Self-Employment Tax Tips: Your Options
Tax is imposed on net (as opposed to gross) income for the self employed. Thus the tax plan hinges on net income from the self-employed venture. Some tips follow:
Make an entity choice analysis: Consider the pros and cons of whether to structure your business as an S Corporation, or C Corporation. There are myriad issues involved here and a qualified CPA or attorney should be consulted so as to weigh the many factors including but not limited to wages, dividends, payroll administrative costs, and the impact of state and city taxation on the entity.
Shift income and expenses: Consider accelerating or postponing year end billings and shifting expenses from one year to another.
Place assets into service by December 31: Consider accelerating or postponing major asset purchases. There are annual limits for expensing (vs. amortizing) the cost of business assets with useful lives of 20 years or less including machinery and equipment, and leasehold improvements made to the interiors of commercial realty. For 2016, businesses can expense up to $500,000 of new or used business assets in lieu of depreciating them (Note this limit is subject to phase-out if greater than $2,010,000 of assets are placed into service).
Keep good records: Retain supporting evidence for seven years. Keep tax returns in perpetuity. A major part of keeping adequate records might be investing time and expenses in a general ledger accounting program such as Quickbooks, Mint, or Xero.
Determine your qualified business expenses: Refer to IRS publication 535 Business Expenses for guidance.
Pay and file timely: Shifting from a wage earner to self employed requires the discipline to save a portion of your net income for tax payments quarterly. The goal of an estimated taxpayer is to pay the minimum quarterly amount required without incurring a penalty for underpayment.
Should you require more time to complete your tax returns an extension may be obtained, but this does not extend the time to pay the tax. An adequate estimate must be paid at the time of extension to avoid further penalty.
Make more robust retirement contributions: Self employed individuals have the opportunity to defer from income tax more than the typical $18,000 available to wage earners. The maximum retirement thresholds vary based on income. It is important to note that retirement contributions are not deducted for Social Security and Medicare tax above referenced.
Much more clarity will be available as the new 2017 tax code evolves. For this reason, it is not recommended to make any major changes to tax planning until the new tax code is finalized.