Come the final quarter of the year, I’m always nervous as a freelancer.
I try to craft a tax plan ahead of time with enough deductions to offset my income, but health insurance and other essentials change each year. Also, I must pay Social Security and otherwise prepare for retirement.
Just what can authors and publishers do in the last financial quarter to keep all of this straight?
Taxation types: What difference does it make to you?
Understand tax systems and how they affect your accounting. At least three basic types of tax systems exist: progressive, regressive, and proportional.
The U.S. tax system is progressive, which means the rate varies depending on income, or the taxpayer’s ability to pay. So the more you make, the higher percentage of taxes you will be required to pay. In a regressive system, everyone pays the same amount of taxes regardless of income.
In a proportional tax system, everyone would pay the same percentage of their income for taxes, making at least the percentage “equal” for everyone. This would simplify accounting and help make sure you have enough saved to pay taxes each year.
A planning how-to
Here’s how to plan:
Determine your estimated income for the year
Be sure your estimate is high.
Assume proportional taxes. Set aside a percentage every time you get paid, whether from a contract or otherwise, factoring in what you need to pay in social security and medicare taxes.
For example, if you think you will make $35,000 gross, set aside 20% of every contract in an account exclusively tax savings, and do not touch it. At the end of the year, you should have $7000 in your tax account.
Review tax laws
You don’t have to be an accountant. In fact, once you reach a certain point, you should not do your own accounting, and certainly not your own taxes. You do at least have a tax accountant, right?
But you should know current changes in the tax law so you can shape your behavior and spending accordingly. Ask your accountant for direction, and they can help you.
New in 2016 are the following tax law changes that directly affect freelancers, authors, and small publishers”
Increased health insurance penalties: In 2014 the penalty for not having health insurance was relatively low. It has since gone up, and this year is 2.5% of income or $695 per adult, whichever is greater. The penalty for each child not covered is half of that of the adult penalty.
Finding affordable health insurance when you are self-employed can be challenging, but you can enlist the help of an agent. Also, explore options offered by organizations like Freelancers Union and the Authors Guild, both of whom have negotiated group rates for authors and freelancers in general.
Virtual currency counts as income: If you receive virtual currency as payment, you must report it to the IRS. However, bitcoin counts as property or an asset, not legal tender. Here is what the Internal Revenue Services has to say about virtual currency:
Virtual currency paid as wages must be reported on a W-2. These wages are subject to standard withholding procedures.
Self-employed workers must report any virtual currency payments they receive.
In some cases, virtual currency counts as a capital asset, which means that the currency may be treated similarly to stocks and bonds when realizing gains and losses.
Handling virtual currency may be tricky, but payment using bitcoin and other means is becoming more common, and handling taxes correctly will save you a great deal of trouble.
Increased limits on retirement: It is essential to understand that when you are self-employed, you do not receive matching social security funds from your employer, nor do you have the benefit of matching 401k contributions.
The limit of contributions to 401 k plans increased only slightly, as did limits for Roth IRA’s and catch up contributions for taxpayers over the age of 50.
When planning for your retirement, you should take a few simple steps:
- Calculate what you need
- Leverage 401k and IRA’s.
- Invest in the Stock Market
- Leverage your Current Investments
Be generous in your planning, and tailor your investments according to how long you have left until you anticipate retiring, usually a mix of long and short term investments. This will not only be good for your tax situation, but good for your future.
Give something away
One sure way to offset your tax bill is to give to charity. Fourth quarter gifts to charity are common, and many charities have fund raising dinners or other efforts around the Holidays, so it is a perfect time to donate.
Be sure to consult your accountant about your gift to ensure that it is tax deductible and your donation is in time to count for this tax year.
Buy new stuff
Need a new computer, desk, office chair, printer, or another high dollar item? Purchase it this year, and take a deduction on your taxes.
There are different ways to deduct new purchases, including deducting the entire purchase at once or depreciating it over a few years. The way that is best for you will depend on your circumstances, so be sure to do your research and consult your accountant.
Prepare for filing
Far in advance of the April deadline, you should prepare for filing taxes. At the same time, you can set up your expectations for the coming year, and get started on the right foot. When getting ready, here are five things your accountant will need from you:
Financial statements: Financial statements are a basic set of financial documents comprised of a balance sheet, an income statement, and a cash flow statement. The income statement is the most important for tax season, but your accountant will use the others as well.
If you need help creating these, you can use automated programs like Quickbooks that pull data directly from your checking account and have tools to help you do so.
List of capital asset activity: If you bought or sold assets, including bitcoin as a part of your business (see virtual currency section above) your accountant will need that information from you to detail and classify any changes.
Vehicle log: Did you use a vehicle at all for your business, even to travel for meetings or conferences? If you did, your accountant will need the vehicle log to detail what you used it for, and how much you can deduct for those expenses.
Summary of home office expenses: These expenses include a percentage of your utilities, repairs and maintenance, home insurance, and mortgage interest or rent.
You can calculate your home-office deduction a couple of ways: either you can divide the square footage of your office by the total square footage of your house, or you can divide the number of rooms your office is in (usually one) by the total number of rooms in the house.
To find your deduction, multiply your total home expenses by the home-office percentage. Some accountants will do this for you, while others will ask you to do the calculation yourself, and simply provide them with the information.
Form 10998 for mortgage and property taxes: This is not only so that you can take the mortgage interest deduction all homeowners are entitled too, but so that you accountant can use this information to calculate or verify your home office deduction.
Set yourself up for next year
Every December is a good time to review budgets and set up your financial plan for the following year, and this includes a tax savings plan, a plan for charitable giving, and a plan to purchase or upgrade equipment as finances allow.
The final financial quarter of the year is a great time to finalize what you need to do to be ready for tax season. Reviewing savings and tax laws, making final retirement and charitable contributions, and making final business purchases will help you get prepared for filing.
Taxes are never fun. However, we all have to pay them each year, and mitigating your burden is one of the best things you can do for your writing and publishing business.
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