Ed note: Tax planning can be complicated, especially when you work for yourself. It’s always best to talk about your specific situation with a professional to get advice, however, David Ning has a few helpful tips for things you should start thinking about now.
Are you a freelancer committed to paying less in taxes? Then start thinking about these tactics now in order to reap the rewards next April.
Paying less to the tax man is on just about every freelancer’s wish list. While it may be too late to affect how much you had to pay on your 2014 return, there are many things you can and should be doing now. Here is what you can do for the best tax outcome for this year.
Optimize your expenses.
If you believe higher income next year is likely, then try to delay purchases until the higher tax bracket year because it’s like getting a discount on the purchase. Let’s say you are in the 25% tax bracket this year and the 28% tax bracket next year. If you buy a $1,000 laptop, which is used for business and choose to fully expense it using bonus depreciation, then the laptop really costs $634 after tax savings (taking into account the change in both regular income and self-employment taxes*.) But if you can delay the upgrade until next year, using the same calculation, the net cost of the laptop can be seen as $607, because the amount you owe in taxes (both regular and self-employment) is not being forked over to the tax man. I realize not every purchase can be delayed or pulled in, but consider recurring expenses you can buy earlier or later, such as supplies, stamps or other goods. Each purchase won’t seem to make a big difference, but everything in aggregate will matter over time.
*Takes into account the change in self-employment tax, the change in the ½ of self-employment tax deduction and the change in ordinary income tax.
Take advantage of retirement accounts.
Freelance income can be unpredictable, so why are you wasting precious dollars paying Uncle Sam unnecessarily when you can be putting those dollars in your retirement account? Between 401k plans, traditional IRAs, Roth IRAs and other tax-deferred retirement accounts, some self-employed individuals can contribute as much as $50,000 or more each year. Investments in these tax-deferred accounts will grow tax-free every year on top of the immediate tax savings for contributions. And for those worried about not being able to tap into any pre-tax amounts within these retirement plans without penalty, just remember that you can convert or rollover those pre-tax dollars into a Roth IRA in low-income years. This strategy has two advantages. First, while the pre-tax amount transferred to the Roth IRA is included in income, you still may be able to pay 0% tax if your income that year is low enough, meaning some income will never be taxed. Second, contributions made to a Roth IRA are not taxable when withdrawn, and may not be subject to penalty either, depending on the source of the distribution and the account owner’s age. Additionally, there are workarounds such as taking substantially equal periodic payments from the IRA if you really need the funds before you reach 59 and a half. Just make sure you understand the rules before you take money out to avoid unnecessary penalties.
Start incorporating life into your work.
The IRS only allows deductions for expenses that are both ordinary and necessary to conduct business, but that doesn’t mean you cannot mix business with pleasure. Take a business trip for instance. You can’t deduct a personal vacation, but you can certainly go sightseeing during the nights of all the conferences you attend for work. Just make certain that the trip is actually business related, because there are strict rules on making sure people don’t abuse the rules and deduct a personal trip as a business expense. Or how about your hobbies? Those who like crafting may want to sell some of their creations online. I have a friend who loves crocheting. By selling some of the scarves she crochets, she gets the therapeutic benefits of creating the art while being able to deduct the expenses of the materials. Did I mention she actually gets paid handsomely for her work because people love those scarves and will pay top dollar?
Tax time is when many people drill the tax professionals about deductions, but the time to think about tax deductions is during the tax year when you can actually do something about them. Think ahead now. You can thank me later.
Ed note: Interest is a tricky thing. The difference between a loan with 4% interest and 5% interest sounds so small, but it can mean big dollars over many years. Here are some tips from Credit Karma for making sure you’re able to keep that interest number as low as possible when you buy a house. Leer en Español.
Ready to buy a home? One of the best things you can do is to make sure your credit is in the best shape possible.
Consider two people in similar situations – they both want a $250,000 mortgage and have the same amount saved up for a down payment. The only difference is their credit scores.
One person has a score of 760 and is offered an interest rate of 3.5%*. The other has a score of 620 and is offered an interest rate of over 5%, costing him an extra $83,000.
These numbers paint a stark picture – every fraction you can get off your mortgage’s interest rate can translate into major savings, so it’d be prudent to work on your credit well before you apply. Here are a few steps to take in the months leading to your application:
1. Check your credit score.
It’s best to know what your score is before you apply so you can know what to expect. Many services allow you to check your credit for free, so no excuses!
2. Dispute errors on your credit reports.
In order to ensure that your credit score accurately represents your credit history, look at each credit report and dispute any errors you find.
3. Pay off delinquent accounts.
Outstanding delinquencies could hurt your chances of being approved for a mortgage. Consider paying off any delinquencies before you apply, and if possible, lessen the impact of those delinquencies with months (or years) of timely payments first.
4. Reduce your debt-to-income ratio.
Your mortgage underwriter may question whether you’ll be able to make your payments on time if you’re spending almost as much as you’re making, which is what your debt-to-income ratio measures. If you have any outstanding credit card balances, determine whether you are in position to pay them down or completely pay off the balance. This could help twofold, as it should lower both your debt-to-income ratio and your credit card utilization rate (the amount of available credit you are using), which could in turn improve your credit health.
5. Practice caution when applying for more credit.
When you apply for a credit card or a loan, it produces a hard inquiry that could hurt your score, and a difference of just a few points could raise your interest rate and cost you more money. Try to hold off on applying for new forms of credit until your mortgage is secured.
6. Do your research.
Do you want a 15-year mortgage or 30? Adjustable or fixed? How much can you really afford? Do as much research about the home-buying process as you can, comparing terms, rates and brokers before you commit to anything.
Your home will probably be one of the biggest purchases you’ll ever make. Increase your chances of saving money on interest by proactively preparing your credit history. The time and effort you put into improving your credit health should be well worth the savings!
*Numbers are for illustrative purposes only. Interest rates can vary and are ultimately decided by lenders.
Ed note: H&R Block Expat Tax Services is a highly specialized team of tax attorneys, CPAs and enrolled agents whose singular focus is expat tax preparation for Americans abroad. These tax situations can be very complex, so we are featuring some answers to common questions here. Today’s post focuses on general reporting requirements. Remember that due to the complexity of U.S. tax reporting for expats and its highly fact-specific nature, these responses provide general information. Leer en Español.
Do you have to make a certain amount living abroad before you pay taxes back to the U.S.?
U.S. citizens and residents are taxed on their worldwide income. So regardless of where you work, you must report your income as if you worked within the United States. However, certain rules and benefits are available to expats, such as the foreign earned income exclusion (FEIE) and foreign tax credit (FTC).
The FEIE allows U.S. citizens and residents working abroad to exclude up to $99,200 from their 2014 taxes. But you still need to file a tax return to claim this benefit. Expats can only exclude earned income, which includes salary, and wages. So, retired expats living off of Social Security and pension income most likely will not qualify for the exclusion. There are some tests you must meet before you can claim the exclusion.
The FTC allows you to offset your U.S. tax liability with taxes paid in your country of residence. Often you will owe no tax, but the rules are complex depending on the country where you live and which foreign taxes can be claimed for the foreign tax credit.
The filing threshold requirements are the same for expats as they are for other U.S. taxpayers.
|Filing Status||Age||Gross Income|
|Single||Under age 65||$10,150|
|Single||At least age 65||$11,700|
|Married Filing Jointly||Both under age 65||$20,300|
|Married Filing Jointly||One spouse at least age 65||$21,500|
|Married Filing Jointly||Both at least age 65||$22,700|
|Qualifying Widow(er)||Under age 65||$16,350|
|Qualifying Widow(er)||At least age 65||$17,550|
|Head of Household||Under age 65||$13,050|
|Head of Household||At least age 65||$14,600|
|Married Filing Separately||Any||$3,950|
This Q&A first appeared in an American in Britain magazine article.
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