In this article, we will discuss year-end tax planning strategies and income deferral for freelancers. You can defer or accelerate income and deductions, but this means making some important decisions as the end of the year approaches.
Cash Basis Accounting
Before we dive into year-end tax planning strategies, let’s understand how income is calculated and how it affects the taxes you owe.
The timing of income and deductions depends on the accounting method of freelancers. Most freelancers and small businesses use the cash basis of accounting. This means you should include in your gross income money that you actually received or truly earned during the tax year. “Actual receipt” means that income is counted or made available to you without restrictions or challenges, such as a check you receive in December but don’t deposit until January.
There can be some exceptions in certain cases, but in general, income should be reported on a cash basis.
How to Accelerate and Defer Income
Accelerating income and deferring deductions increases the amount subject to tax in the current year.
These strategies can be helpful if your income falls into a lower tax bracket this year and you expect to be in a higher tax bracket next year. In this scenario, you want as much income as possible to be taxed at the lower tax rates this year.
Accelerating income means trying to bring in more money this year. Identify income that is about to come to you at the end of the year. Deferring income means postponing or delaying the receipt of some revenue until the next year. Again, identify income that is about to come to you at the end of the year that can reasonably be deferred until the next year.
Deferring deductions means postponing spending on deductible expenses until the next year or even future years when that spending is more beneficial to your tax situation.
Strategies for Accelerating Income and Their Benefits and Risks
Accelerating income this year can lead to being taxed on that income at a lower rate if you fall into the 22% tax bracket this year and expect to be in the 24% tax bracket next year. Strategies for accelerating income include:
- Asking clients or customers to pay now.
- Contacting or writing to those who are overdue on your invoices and collecting them earlier.
- Requesting larger upfront payments for projects that will span this year and next year.
Not only do you accelerate income, but you will also help clean up your accounts receivable. However, there is a caveat. Tax brackets depend on the amount of your income, so if you make a large income this year, you may pay higher taxes. You might want to increase your income as much as possible without crossing into a higher tax bracket.
Strategies for Deferring Income and Their Benefits
You may want to push your income into next year to fall into a lower tax bracket if you are in the 24% tax bracket this year and expect to be in the 22% tax bracket next year. Make sure you understand that tax brackets increase slightly each year to keep up with inflation.
Source: https://www.thebalancemoney.com/year-end-tax-planning-self-employed-3193127
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