By Maya Kachroo-Levine | Found on Forbes
As a freelancer, I have a front row seat to the true nightmare that tax season can be. I earn almost all of my income via 1099s, and every month, I make a table that reflects exactly how much I earned, who paid me what, and when I received compensation. I also diligently track my receipts for business expenses (which is an entirely different spreadsheet). Between my color-coded Google spreadsheets, my file boxes, and regularly emailing my accountant with questions, I’ve been able to stay on top of things this year, and which will hopefully make for a less chaotic April 15.
For me, preparing for tax season is something that happens all year, but most of the organizational work is concentrated in December and January. These two months are when you can prepare everything you need for your 2016 taxes, and set up your income and receipt-tracking system (have I mentioned I’m a fan of spreadsheets?) for 2017. To help get us all prepared for tax season, I spoke to Richard Lavina, CEO of Taxfyle, and he was able to share some year-end tips for millennials preparing for tax season. Based in Miami, Florida, Lavina is a CPA, who formerly worked at PwC before co-founding Taxfyle in 2015. In the last two years, Lavina has worked with clients ranging from recent college graduates to millionaires.
1. Know exactly how much money you brought in this year, and have the documents to back you up.
What is your exact 2016 income? If you work a salaried job, the answer should be easy to find, but if you side hustle in addition to a full-time job, or you earn any of your income as a freelancer, things can get trickier. You’ll want to track every payment that has come in for the last year, so that it matches what the company reports they paid you. Lavina says, “It’s important to note that the IRS will cross-check your tax return to make sure you reported the correct income based on the tax forms (i.e. W-2, 1099, 1098, etc.) provided to you and the IRS. That’s right, the company that hired you, whether as an employee or independent contractor, is obligated to report your income to the IRS as well.”
2. Learn about the hidden tax breaks and penalties.
Lavina maps out two potential scenarios that he has seen come up:
— “If you loan money to a friend and they don’t repay you, that may be deductible as ‘bad debt’ expense, assuming you attempted to collect. This also works in reverse, you may have to recognize income on your tax return when debt you owed is canceled in your favor.”
— “Selling a capital asset (i.e. assets you own that are not used for business; the best example is stocks and investments). It’s important to consider the holding period so you avoid paying a higher tax rate on any gain realized. The minimum holding period required to recognize favorable rates is more than one year (i.e., a year plus one day).”
And it’s also worth noting that you may receive additional tax breaks because of your retirement account, depending on the type of account you have. If any of these apply to you, it may be worth discussing how they impact your taxes with a professional.
3. Remember that if you’re part of the gig economy, you’re really a small business owner.
“Millennials are receiving 1099s more than ever due to the on-demand economy (i.e. Uber/Lyft drivers, etc.). Whether you realize it or not, freelancing in these fields classifies you as a small business,” says Lavina.
He continues, “Acting as a sole proprietor means you can receive the benefit of several business deductions. It’s important for people to realize they’re entitled to certain deductions and to maximize their benefit from allowable business expenses.”
Lavina also recommends that those who earn the bulk of their income from 1099s consider forming a separate business entity. He says, “The largest benefit is protection from legal liability beyond your business’ assets. That is to say, your personal assets are protected if your business faces legal action. Other benefits include, easier delineation of business and personal expenses, and investor/partner ready expansion opportunities.”
4. Know when you have to start declaring money.
For example, if you’re a college student who made $1,200 interning in the summer of 2016, then yes, you need to file a tax return as an independent contractor. For contractors, Lavina says the income threshold that requires you to file a tax return is $400. “Unlike work as an employee that creates filing obligations at income starting at $10,300 (assuming you are single and under 65), there is a lower threshold for independent contractors. Why is the number $400? While you may not owe any income taxes, as a freelancer, you must pay self-employment taxes in addition to regular income taxes. Self-employment taxes start if you earn $400 or more,” he says.
5. Understand what deductions are applicable to you.
Lavina: “Whether organized as a simple sole proprietorship or a formal corporation, you need to make sure accounting records are adequately recorded and substantiated. Unlike individuals, there is no standard deduction for business income. Regular expenses used for business purposes, (i.e. car, phone, internet, uniform/clothes), if tracked properly, can be deducted as a business expense. In order to minimize the tax bill from business activities, expenses should be properly categorized and receipts should be filed away. Not all expenses are deductible, hence the need for proper categorization.”
6. Maintain your files.
One thing to add to your year-end to-do list: organize or revamp your filing system. If you’ve never been one for keeping tabs on financial paperwork, spend some time over the holidays getting organized, and ensuring that you have a system that will work for you. Not only is this recommend as a best practice, from a tax perspective, but it also allows you to start the new year as a more organized version of yourself. Keeping receipts is especially important in case you are audited. Typically, you’re supposed to save your records, tax documents, and receipts for about seven years.
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