When I left my comfy full-time job back in 2017, I coincidentally landed my first freelancing client that very same day. I named a price, they said yes, and 24 hours later, a cool stack of cash was digitally piled in my PayPal account.
At first, I was annoyed by the pesky PayPal fees — but the thought of making money on my own, without a big corporate employer, excited me too much to care otherwise. Plus, I was an entrepreneur now, you gotta spend money to make money, right?
I relayed the good news to my three other entrepreneur friends and they each congratulated me in turn. Except for Alex.
“Make sure you set aside at least 35% for taxes next year.”
“What?” I asked. I couldn’t keep all the monies?
“You’re self-employed now,” he continued, “You’re responsible for all the taxes.”
It was as if someone took a hammer to a valuable vase. The news was equally ear-shattering and depressing.
“So I only get to keep a portion of my monies?”
Sure, I knew taxes existed, but I thought that was something big corporations handled, not a lowly self-employed web designer like myself. Uncle Sam couldn’t possibly care about my measly pile of cash.
But as they say, there are only two guarantees in life: death and taxes.
“I have a few ideas that’ll save you money on your taxes,” said Alex. So I booked a call and upgraded Alex to my business accountant.
Here’s what Alex taught me about tax-saving strategies (without opening off-shore bank accounts).
1. Take the S-Corp Election
I’ve recently had a long conversation with Alex about the benefits of taking the S-Corp election. You can listen to our discussion below or read a summary here.
Alex and Declan discuss what financial literacy looks like for new entrepreneurs and freelancers. Together, they discuss how entrepreneurs and freelancers can set themselves up for financial success, understand relevant financial documents, and what habits are essential to business.
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Nothing is simple in Taxland, however, taking the S-Corp election — rather than remaining as a sole proprietor or LLC — is probably the “simplest” means of saving on your taxes year after year without any added paperwork.
How is this possible? Here’s the example I used in my previous article:
Let’s say your business brings in $100,000 after expenses. If you were an LLC, all of this profit would be passed on to you, which means you’d be responsible for the entire 15.3% cut for Social Security and Medicare. $15,300 total.
Now, if you are structured as an S-Corp, you will need to at least assign yourself a salary. Whatever that salary is, that’s up to you. For simplicity’s sake, let’s assume you assign yourself a $50,000 salary. Of that $50,000 salary, you now only pay half of the 15.3% for a total of $3,825 on your W2. The business would be responsible for the other $3,825.
However, now that $3,825 counts as an expense which reduces the other $50,000 to $46,175. That $46,175 of profit is passed through to you as the owner of the S-Corp of which you’re only responsible for Federal and State taxes.
Instead of paying $15,300 in Social Security and Medicare taxes, you and the business only pay an amount dependent on how much salary you take.
In other words, taking the S-Corp election shares the responsibility of Social Security and Medicare tax between you and your business while also avoiding taxing all of your profits.
2. Contribute to retirement
Most tax stuff confuses me (but excites Alex in a nerdy kind of way).
I Google things like “Section 179” and immediately want to throw my computer out the window. But even this strategy is simplest enough for me to understand.
Here’s the gist. If you’ve already gone ahead and set up your S-Corp (and Alex is always happy to help), go ahead and open up your own “Simplified employee pension” or SEP IRA. Most major banks and wealth management companies offer their own SEP IRAs.
Next, designate a percentage of your salary that you would like to contribute to your retirement account each paycheck. Your business will then contribute said amount (before taxes) and use it as an expense on the business, further reducing the taxable profits.
The current contribution limit for 2021 is $58,000 or 25% of compensation, whichever is smaller.
Let’s continue the example from the previous section to demonstrate. Since you took a $50,000 salary, the business can contribute up to $12,500 (25% of salary) to your SEP IRA. That $46,175 of profit you originally had is now reduced by $12,500 to $33,675.
Keep in mind though, a SEP IRA acts as a Traditional IRA which means you can contribute tax-free now but will incur taxes when you withdraw money in the future.
3. Take advantage of your car
I’ve had to call Alex three times to explain to me this nifty little section of tax law. There are a lot of nuances here, so give me some grace as I try to summarize this strategy to the best of my ability.
Option 1: Buy a car through the business
If you buy a car through the business AND it weighs over 6,000 pounds, you can deduct up to 100% of the depreciable basis (car acquisition (purchase) value minus car scrap value) on your taxes next year.
What’s depreciation? According to Investopedia:
“Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Depreciation represents how much of an asset’s value has been used up. Depreciating assets helps companies earn revenue from an asset while expensing a portion of its cost each year the asset is in use. If not taken into account, it can greatly affect profits.”
If you buy a car and it’s less than 6,000 pounds, and it was purchased after December 2017, then you can deduct via straight-line depreciation over the next 5 tax years.
Basically, you’re adding a non-cash expense to your income statement that reduces your taxable income.
Option 2: Expense your personal car through the business
If you personally own your car but use it for work, then you are entitled to pay for expenses through your business. How? Simple, track your usage with an app such as MileIQ.
For every mile driven for your business, you can deduct $0.56 from your taxes next year. If you drive a lot, this really adds up. Don’t forget to save tollbooth tickets and parking payments, those can be deducted too if you can prove they were used for business purposes.
4. Cover your own health insurance
Again, I used to think health insurance was something big corporations handled. Turns out, you can pay for it through your business before taxes and lower your tax burden by doing so.
Now, keep in mind that if you are married and your spouse’s employer offers health insurance, you do not qualify for this strategy.
If that’s not the case for you, then your S-Corp can cover the costs of health insurance premiums for you, your spouse, and any of your dependents under the age of 27. However, the insurance premium cannot exceed the amount of your S-Corp salary.
This is one of those strategies that you should talk to your accountant about.
5. Deduct your home-office expenses
I saved the best for last. However, this one does not apply to those who have taken the S-Corp election. (If you’re still an LLC or sole proprietor then you are good to go.)
If you operate your business from home then your business certainly can pay a portion of your home costs. Let me explain.
Let’s assume your home-office is a 50 sqft corner of my home. It’s where you do all your meetings and consulting work. Your home is 1,500 sqft which means your home-office takes up 3.3% of the entire livable space.
3.3% isn’t a lot to brag about, however, you can tally up all the indirect monthly expenses of home ownership into an “Employee Expense Report” and get reimbursed for 3.3% of the costs. I’m talking about things like:
- real estate taxes
- homeowner’s insurance
- oil heat, gas, and electric
- general repairs and maintenance
- alarm or security service
- water and sewer
- garbage disposal
- mortgage interest
Again, this is money that’ll come to you through your business tax-free, all while lowering the tax burden on the company. Win win.
Call your accountant
Whether you decide to use one or all five of these strategies is up to you. However, I highly recommend getting on the phone with your accountant and asking why they haven’t mentioned these yet.
And if you don’t have an accountant, get one. I happen to know a good one.