by Jonathan Medows
It’s the time of year that many freelancers hate—tax season. The time of year that you drag your dreaded tax documents and expense receipts into the light of day to support the preparation of your tax return. While you may not relish the obligation of filing your taxes, you shouldn’t overlook the opportunity to use it as a source of information about where you stand financially.
As a freelancer, there is a lot you can learn about your financial habits when you prepare to file your tax return. So as you are sifting through your paperwork and electronic documents, keep these six key questions in mind to help you decide if you need to make some adjustments in the future:
Are You Paying Enough (Or Too Much) Tax?
Once you are done filing your taxes, the answer to this question becomes pretty obvious. If you find yourself in the position of writing a large, unexpected to check to the IRS you know that you need to make your estimated tax payments larger. If, on the other hand, you are receiving a sizeable return you may want to consider reducing your estimated tax payments to give yourself some financial breathing room throughout the year, or to allow you to invest in an eligible tax-sheltered retirement savings plan.
Do You Know All of Your Available Tax Deductions and Credits?
There are some deductions and tax credits that many freelancers are aware of, and some that they are not. By taking the time to review your tax return with a tax professional, you can learn about all of the options you have available to you to lower your tax obligations beyond the commonly known deductions for travel, meals, equipment, healthcare, and home office space.
Are You Raising Red Flags for an IRS Audit?
As you look at your tax return, you may see some red flags that can draw extra IRS attention. In and of itself, the fact that you are running a freelance business means that you may be subject to more intense scrutiny, so be sure to claim all of the income that you have made throughout the year, and be prepared to substantiate it with proper records. In addition, taking deductions such as claiming 100 percent business use of a vehicle are also worth a second thought. (From the IRS’ perspective, it is rare for an individual to use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.) Also, writing-off big dollar amounts for business expenses that could also be personal entertainment such as dining out and travel can cause the IRS to take another look at your return, especially if the deduction amounts seem too high for the type of business that is claiming them.
How Healthy is Your Retirement Nest Egg?
You can tell by looking at your tax return whether you made the maximum allowable contribution to tax-advantaged retirement saving options. If you didn’t this year, you may want to consider a setting up a traditional or Roth IRA (Individual Retirement Account) to build retirement savings and protect up to 20% of your earnings from taxes.
Is this Process Too Painful?
While few people would peg tax preparation at the top of their list of fun things to do (unless you are a CPA, of course), ask yourself if you are making things harder for yourself than it really needs to be. If gathering all of the documentation and receipts you need to file your taxes or support the deductions that you are claiming is pushing you to the edge you may want consider overhauling your record-keeping system for the coming tax year and enlisting the help of a CPA specializing in freelance taxes to help you get everything in order, minimize your tax obligations, and make the process considerably less painful and time-consuming.
What is the Best Way to Use Your Refund?
In addition to making sure that you take the appropriate steps to maximize your tax refund, you should also consider what you do with it once you receive it. You could have it deposited directly into a savings or retirement account, effectively reducing the temptation to spend it right away. Another smart use for your refund is to use it to pay down any debts that you may have.
Your tax return provides you with a snapshot of your current financial picture. Use the opportunity that preparing your taxes presents to take control of your finances and ensure that you live comfortably now—and in the future, while still honoring your tax obligations.
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for consultants across the country. His website, www.cpaforfreelancers.com, has a resource section with how-to articles and information for freelancers.