While the popularity of gig work has been increasing for years, the pandemic prompted many people to take on side hustles and contract work for the first time. Whether you were a freelancer, contractor, worked through an app, or offered products or services directly to people, it’s all the same in the eyes of the IRS—you’re a business owner.
Doing your taxes when you’re self-employed, even if you also had a job as an employee, can be a little trickier. But it also opens up new possibilities to save money on your overall tax bill.
Preparing for the End of the Year
There isn’t a lot of time to act. But there are some steps you can take to understand where you’re at, and potentially decrease how much you pay in taxes when you file next year.
However, before you get into the tax-related moves, you need to do a little bit of prep work to get a clear picture of your business’s finances. Try to estimate each of the following:
- Business Income: First, you want to estimate how much you earned in business income. If you got work through a platform, such as an online marketplace or delivery app, it might have a record of your income. If not, you may need to go through your bank statements to add up your income.
- Business Expenses: Figuring out your business expenses can be a little more difficult as the options will depend on the type of work you’re doing. As a general rule of thumb, remember that a purchase has to be “ordinary and necessary” to qualify as a deductible business expense. Some platforms, such as a ridesharing app, might add up expenses that were deducted from your pay, including tolls and fees. But you’ll need to figure out the rest of your business expenses on your own.
- Self-Employment Taxes: Once you have your estimated income and expenses for the year, you can figure out your freelance profits. You can then use an online calculator to determine your approximate self-employment tax amount—about 15.3 percent of your self-employment income. Plus, you still have to pay federal state income taxes on the profits.
All of this will be much easier if you’ve been using a tracking system. For example, if you don’t have a lot of income or expenses, a spreadsheet could be a good option. Otherwise, you could look into using accounting software that connects to your bank account and credit cards, similar to budgeting software.
What Can You Do Now to Impact Your Taxes?
With your basic business financial information in hand, you can now make informed decisions. In order to alter how much taxes you’ll pay, you need to increase or decrease your taxable income for 2020. There are two basic ways to do this when you have a side gig.
Rush or defer income
Your federal income tax will be determined by your total income, including income from self-employment, employment, and unemployment benefits.
If you think you’ll make less money next year and be in a lower tax bracket, you might want to try and defer some of your self-employment income. Conversely, if you think your income will increase, you could try to get clients to pay right away, or even prepay you for future projects.
One important note—you must claim the income once you have access to it. For example, if you receive a check on December 20th you have to include it in your 2020 income. You can’t “move” the income to 2021, even if you wait to deposit the check.
Make additional business purchases
You can also decrease your 2020 profits and the resulting taxes by making business purchases before the end of the year.
Supplies, a computer, software subscriptions, and other business-related purchases can all be deductible as a business expense. If you plan on growing your business next year and want to hire a business mentor, accountant, or other professional help, perhaps you could pay a deposit before the end of the year to secure their services.
Even if you’ll primarily use this next year, if you make the purchase in 2020 then you can deduct the expense in that year.
A Few Tax Moves You Can Make After the New Year
Most of the actions that will impact your 2020 taxes must occur within the 2020 calendar year, but there are a few exceptions. Some of these are available to employees and contractors alike. However, they may be more common for people who are self-employed.
One is that if you open or have an individual retirement account (IRA), you can designate contributions that you make through April 15, 2021, as either 2020 or 2021 contributions.
There are IRA annual contribution limits—$6,000 in 2020 and 2021—and tax-deduction limits depending on your income and whether you had a retirement plan from an employer. However, as long as you don’t hit the limits, each dollar you contribute could be one less dollar of income you have to pay taxes on. With the delayed contribution deadline, you have a few months to save up and make contributions to lower your 2020 tax bill.
There are also tax deductions for self-employment retirement accounts, such as SEP-IRAs, SIMPLE IRAs, and solo 401(k)s. Different limits and timelines apply, and you’ll want to look into these options right away, as you may need to open an account before the end of the year.
A health savings account offers another option for making tax-deductible contributions. Similar to IRAs, you can make HSA contributions for the current year up until the next year’s tax filing deadline. However, the accounts are only available to people who have high-deductible health plans.
Plan for Next Year Early
If some of these steps were difficult—and you plan on continuing as a self-employed person next year—the start of a year can also be an opportunity to implement new practices. Opening a separate bank account or credit card for your business is an important step that can make tracking income and expenses much easier.
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