If you work for yourself, either as an independent contractor or as owner/operator of a small business, then you're probably worried (or confused) about the effect your tax bill has on your bottom line. Here are some strategic tax planning tips to help you make smarter choices for your financial health, not just on April 15th but all year round.
Paying Your Quarterly Taxes
Independent contractors are supposed to report and pay their federal income tax on a quarterly basis by returning a 1099-ES form. Each quarterly payment is an estimate based on year-to-date or previous-year income figures; any remaining balance due the following April 15th will also include a penalty (usually ranging from 6 percent to 8 percent) for late payment. Many contractors don't want to be bothered with this issue four times a year, so they opt to pay what they owe on April 15th and take the penalty. This might save you a little time and trouble, but it sure won't save you money -- and the longer that late payment is delayed, the higher the fees pile up. Do you really want to shoulder two years' worth of tax payments concurrently?
Paying your estimated quarterly taxes is one those basic tax strategies that every small business owner, contract worker or freelancer should adopt as early as possible. If your income is relatively stable, then all you have to do is divide last year's income by four and pay those amounts. If it's highly variable, then look into annualizing your income by filing a Form 2210, which may help you avoid penalties for underpayment.
Choosing the Right Business Structure
The legal structure you select for your business can make an enormous difference in your future tax burden. For instance, many independent contractors operate as sole proprietors more or less by default; this status costs nothing to set up, and the tax preparation process for a sole proprietorship is relatively straightforward (and therefore inexpensive). But while you're avoiding the legal costs of assuming a different business structure, you're also taking on the full burden of self-employment (SE) tax. This tax, which compensates for the Social Security and Medicare an employer would normally pay on your behalf, currently runs at 15.3 percent. By structuring your business as an S-corporation, you can significantly soften the blow of SE tax by allowing the business to absorb some of it.
Incorporating your small business can also save you indirectly from an insurmountable tax debt. If you've somehow managed to rack up an enormous pile of back taxes and other debt, then filing for bankruptcy may be your only way out. But if you're a sole proprietor, your own assets could be liquidated to help pay the IRS and other creditors, and your future personal tax refunds may be garnished as well. If you've incorporated your business, you can liquidate or restructure that business as a separate entity, without your personal assets or tax refunds being impacted.
Getting Your Home and Family into the Act
Small or single-person businesses can and should take advantage of certain allowances granted the by the IRS at tax time. For example, did you know that providing medical coverage to your spouse can reduce your self-employment tax liability? That's because when you put your spouse on the payroll and pay health benefits accordingly, the cost of those benefits can be listed as a Schedule C deduction -- which reduces your taxable SE income. This can save you money over taking the standard health coverage deduction on your own Form 1040.
Strategic tax planning can apply to how you use your home as well. By setting up a home office, independent contractors and small business owners can deduct a percentage of their rent/mortgage, utility, insurance, maintenance, remodeling and other payments. The percentage is based simply on the office's percentage of your residence's total square footage. You can also deduct or depreciate office equipment and supplies used in your home office. Taking every possible tax deduction is the hallmark of a wise business owner.
In addition to these strategic tax planning tips, the smartest single move you can make is to align yourself with an experienced, reputable CPA. This professional keeps close watch over the ever-changing tax laws and advises you on how to adjust your tax strategies from year to year. Remember, good tax planning is good for business!Share