Tackle Your Taxes Like a Pro
My company, Freshbooks, recently collaborated with a research firm to survey more than 2,000 freelancers about their work and their challenges. Perhaps unsurprisingly, tax compliance emerged as a source of stress. A significant number of respondents preferred any of the following tribulations to filing taxes:
- Getting stuck in line at the DMV.
- Being trapped in the middle seat on a long plane ride.
- Undergoing major dental work.
- Coming down with the flu.
The Internal Revenue Service recognizes the issue as a known problem for self-employed individuals. According to one of the agency's reports to Congress: “The largest source of compliance burden for taxpayers -- and the IRS -- is the overwhelming complexity of the tax code." Elsewhere in the same report, the IRS acknowledged that small-business taxpayers "face a particularly bewildering array of laws" regarding compliance.
This convoluted system often leads to unintended results. Many who seek to comply in good faith make inadvertent errors that cause them to overpay or incur penalties. Conversely, the most sophisticated taxpayers find loopholes that greatly reduce their tax liabilities.
Our survey found the majority of small-business owners and freelancers believe the tax system doesn’t benefit them. There is no simple, consistent tax filing process for the self-employed, which is why a majority choose to outsource their taxes to a professional.
Two ways to think about compliance.
Given all the angst over tax compliance, many self-employed professionals avoid tackling the issue directly. It’s common to put off tax-compliance duties until the last minute, then treat it as a necessary evil.
This means part of the solution is a mindset shift. There are two important truths you should know.
1. You don't need to do everything. You're a professional in your field. You don't need to also be a tax professional.
2. You benefit from doing it the right way. Properly reporting your taxable income offers the opportunity to reduce the amount of money you give to the government. If you’re not actively managing your tax compliance, you’re likely missing deductions and other items that you could leverage to benefit your bottom line.
Three ways to take control.
Here are a few small but mighty tips to apply in your business:
1. Keep a running record of your income and taxes paid throughout the year.
Traditional employees have it easy -- at least in terms of tax reporting. They earn a steady paycheck with taxes withheld and receive a W-2 form at year’s end as a summary of taxable income and amounts already paid. Self-employed workers should re-create this experience as closely as possible.
- Keep a record of all your taxable income in one place. You might receive a 1099-MISC form from clients at year’s end to confirm your tax obligation, but you shouldn’t depend on them to follow the process or to send the form on time.
- Discipline yourself to set aside 30 percent of income for tax payments -- every time you’re paid, not in the final months of the year. Consider putting those dollars in a separate bank account.
- Pay your estimated quarterly taxes to the IRS like clockwork every three months.
Maintaining your own records helps keep you in control. Plus, it’s easy to do. You can create a simple spreadsheet or use affordable, cloud-based accounting software designed for self-employed professionals.
2. Identify all your business expenses and track them diligently.
Time and money are the most common expenses for most freelancers. Effectively tracking your time usually produces more billable hours, which enables you to earn what you’re really worth. Here, too, you can use a basic spreadsheet or find cloud-based solutions. Many options for the latter also can generate invoices to keep you and your clients accountable.
Tracking your time and expenses has other benefits as well. You’ll be able to see how productive you are by project or client. Come filing time, you more easily can spot patterns and categorize expenses that appropriately reduce your taxable income. This includes the money you’re spending on advertising, business supplies, business insurance, gas, conferences, professional services and travel. In short, you’ll have all the information you need to protect yourself from overpaying.
3. Hire a tax expert to complete your annual filing.
Most self-employed professionals do not need an accountant or bookkeeper to manage their year-round finances. Those internal finance roles are more appropriate for small businesses with complex sales-tax issues, payroll or other advanced reporting requirements.
However, partnering with a professional at tax time is a smart move. If you’ve done the work to keep track of your income, taxes paid and business expenses, a tax expert can make the actual filing virtually painless. He or she also can identify potential deductions to track in the future, reducing your taxable income for years to come.
Taking control of tax compliance removes one of the biggest barriers to sustained and successful career independence. It also opens the door to start thinking about other ways to maximize your success -- such as examining whether a sole proprietorship, LLC, or S-Corp structure makes the most sense and how you can incorporate retirement planning into each model.