Thursday, January 30, 2014

7 Small Business Tax Deductions You Can Take as a Freelancer

Abby Hayes for Career Attraction writes: It’s just about that time of year: tax time.  Although you don’t have to file your 2013 taxes until April, many freelancers like to get a head start. I’m one of them. (Not the least because I leave all my recordkeeping until the last minute, and don’t want to wait until April to figure out this year’s total income and expenses!)
As you’re preparing to file your taxes as a freelancer (the technical tax term is “sole proprietor”), you may not be aware that you’re allowed to take many small-business-related tax deductions. (Click here to tweet this thought.) So gather up that paperwork, and see if any of these small business deductions apply to you:

1. Basic Business Expenses

Many freelancers — particularly the writing type — run relatively lightweight businesses, as far as expenses go. Give us a laptop, a bit of stationary and the ubiquitous cup of coffee, and we’re good to go.
But even if you don’t spend hundreds of dollars a month on your business, chances are you have some business expenses.
If you buy filing cabinets, printer paper, postage stamps, pens, letterhead or other business-related items, all these things can be written off on your taxes as a business expense. However, you do need to earmark those items that you write off as “business use only,” so make sure the kids don’t use your business printer paper as paper airplane fodder.
Also, be sure you’re keeping accurate records of these expenses, as it can be difficult to remember just how much you spend on them over the year.

2. Your Work Equipment

One of the most common business expenses for freelancers is probably the laptop or computer. If you’re in the design field, you may have other very expensive equipment that you use for your business.
These types of items are considered capital expenses. They’re basically investments in your business. As long as this equipment is necessary and normal for your line of work, you’re good to go.
There are a couple of different ways to write off the expense of equipment like computers. You can either write off the total expense in the year you buy the equipment, or you can deduct a depreciation amount over five years.
I’ve always done the latter because the laptop I use for work, unfortunately, predates my writing business. Since I already owned it when it started filing taxes as a freelancer, I had to take the depreciation deduction. You’ll need to do the same if you already owned your equipment going into business.
However, one of these days when I actually buy a new laptop (or a tablet!), I’ll write off that entire expense in one year.
Note that you can only write off the entire cost of this equipment if it’s only ever used for work. If you use your laptop to work and cruise Facebook or play games or catch up on your favorite shows on Netflix, you’ll only be able to write off a percentage of the equipment.
It’s OK to use a rough estimate here, but try to be as accurate as you can. If 80% of the time you’re on your tablet, you’re working, you can write off 80% of the cost/depreciation. If you only use it 40% of the time for work, you can only write of 40% of the cost/depreciation.

3. Business Services

If you use certain business services, you can write off those expenses, too.
My biggest expense each year is actually in money transfer fees. Since much of my business is conducted through PayPal (and, formerly, Elance), it costs me money out of what my clients pay me to get my income to my bank account.
In my line of work, these services are quite reasonable, but they add up to a really big expense each year. So if you’re using services like these, be sure to deduct their fees as a business expense.
Other services to consider writing off include your Internet service and an extra phone line for your business.
For the Internet, write off the percentage of your bill that matches the percentage of your Internet that you use for business. In other words, if your Internet use is 50% work-related, you can write off 50% of the bill for the months you were freelancing.

4. A Home Office

The home office deduction is a tricky one, because to qualify as a home office, your office needs to be just that — a work space, and a work space only. So if you work from the dining room table on a regular basis, you can’t write off your dining room as a home office, since it gets used for other, personal purposes as well.
However, if you’re lucky enough to have a separate room that you use regularly and exclusively as a home office, you may qualify for the home office deduction.
As a freelancer, here’s what you need to qualify for this deduction:
  • You must use your office space just for business. (So a “home office” in the guest room that still gets used as a guest room occasionally doesn’t count.)
  • You must use the office regularly, and it must be your principle place of business. Even if you work from your local coffee shop sometimes, you must be able to prove that you work mainly from the office.
If you have a space in your home that meets these qualifications, congratulations! You can write off part of your rent or mortgage — as well as part of your utilities — on your taxes.
The typical way to take the home office deduction is to calculate the square footage of your office as a percentage of the overall square footage of your home. So if you have a 2,000 square foot home with a 10’x10’ office room, your office is 5% of your home. That means you could write off 5% of your mortgage/rent and certain utilities.
This is a tricky deduction, so check out the actual IRS publication on it here.

5. Travel Expenses

Even if you didn’t make it to any swanky conferences this year, you may be able to write off some travel expenses on your taxes. For instance, if you drive somewhere to conduct an interview for an assignment or to meet a client in person, you can take mileage for the trip.
(Here are the mileage rates for this year, in case you were wondering.)
Also, if you’re wining and dining new clients (or just grabbing them a cup of coffee on you), take that out of your business. The IRS understands that certain forms of entertainment are business-related, so you can deduct those meals as business expenses.
Again, these are tricky deductions, so you’ll want to check out the IRS publication on these business-related expenses, as well.

6. Health Insurance

If you’re a small business owner or sole proprietor and you were unable to participate in an employer-subsidized health insurance plan through a spouse or a day job, you can probably write off your health insurance premiums. If no one else in your family could participate in an employer-sponsored health plan, then you can write off premiums for everyone’s healthcare.

7. Retirement

One excellent way to reduce your tax liability as a sole proprietor is to contribute to a tax-advantaged retirement fund, like a SEP IRA or a Solo 401(k). As long as you set up a plan by December 31st of 2013, you can make 2013 contributions to the plan up to April 15th, 2014.
So if you get to filing your taxes and find that you owe a ton of money, consider kicking some extra money into your retirement account. (You can contribute up to $17,500 yourself, plus an extra employer match of up to 20% of your salary.)
You’ll take money out of your bank account either way, but at least when you contribute to your retirement account, you’re not giving it all away to the IRS!

Be Smart

Many business owners try to cheat the system by taking tax deductions they shouldn’t, but this will only set you up for trouble in the long run. Instead, take the deductions you’re allowed to take, and no more.
As long as you keep good records, you’ll find that you can get some serious tax write-offs for your freelance business!
Posted on 5:39 PM | Categories:

Start Paying Attention To Tax Efficiency (investing)

Larry Swedroe for Seeking Alpha writes:  Much attention has been paid to expense ratios of mutual funds. Yet, despite the fact that taxes have a substantial impact on the long-term performance of taxable mutual fund investors, far less attention has been paid to the impact of taxes on after-tax returns. And while the evidence is clear that it's difficult for active fund managers to create superior investment performance by picking stocks or by timing markets, it's relatively easy to avoid destroying value for taxable fund investors by managing investment taxes. For example, tax-aware funds might attempt to reduce the tax burden by avoiding the intentional realization of any short-term gains and by accelerating the realization of capital losses. Tax management strategies might not only reduce the tax burden, they might also generate lower trading costs. For example, tax-efficient investment strategies exhibit relatively low turnover, generating lower trading costs. In addition, liquidating stock positions with embedded capital losses and holding on to positions with capital gains might generate superior before-tax returns due to the momentum effect.

ReMuch attention has been paid to expense ratios of mutual funds. Yet, despite the fact that taxes have a substantial impact on the long-term performance of taxable mutual fund investors, far less attention has been paid to the impact of taxes on after-tax returns. And while the evidence is clear that it's difficult for active fund managers to create superior investment performance by picking stocks or by timing markets, it's relatively easy to avoid destroying value for taxable fund investors by managing investment taxes. For example, tax-aware funds might attempt to reduce the tax burden by avoiding the intentional realization of any short-term gains and by accelerating the realization of capital losses. Tax management strategies might not only reduce the tax burden, they might also generate lower trading costs. For example, tax-efficient investment strategies exhibit relatively low turnover, generating lower trading costs. In addition, liquidating stock positions with embedded capital losses and holding on to positions with capital gains might generate superior before-tax returns due to the momentum effect.
Clemens Sialm and Hanjiang Zhang, authors of the 2013 study "Tax Efficient Asset Management: Evidence from Equity Mutual Funds," investigated the costs and benefits of tax-efficient asset management on U.S. equity mutual funds for the period 1990-2012. The following is a summary of their findings:
  • On average, taxable fund shareholders are estimated to pay investment taxes of 1.12 percent value per year, similar in size to the average expense of a fund.
  • The standard deviation of the annual tax burden is 1.58 percent, more than three times the standard deviation for expenses.
  • Large cross-sectional differences in tax burdens can have substantial impact on investment performance.
  • Mutual funds that follow tax-efficient strategies generate superior after-tax returns.
  • Passively-managed funds tend to exhibit lower tax burdens than actively-managed funds, despite their higher dividend yields.
  • Tax burdens are especially low for exchange-traded funds, which exhibit very low capital gains distributions.
  • There's no evidence that high tax burden funds exhibit superior selectivity or timing abilities.
  • Tax burdens are highly persistent - funds in the highest tax burden group continue to exhibit significantly higher tax burdens than funds in the lowest tax burden group until five years after the portfolio formation.
  • Tax burdens on mutual funds tend to be higher for funds that focus on small-cap and value stocks, as these investment styles trigger relatively higher capital gains distributions as a result of stocks that perform well exiting their asset class. The tax cost for small-cap funds was 1.43 percent versus 1.28 percent for large-cap funds. For value and growth funds, the tax costs were 1.53 percent and 1.25 percent, respectively.
  • Momentum funds that hold stocks with superior recent stock market performance also exhibit higher tax burdens.
  • Tax burdens also increase with the turnover, the age, and the capital gains overhang of the fund.
  • Funds that experience negative or volatile new money growth over the prior year tend to distribute higher capital gains over the subsequent year, since these funds are more likely to sell shares and recognize capital gains.
  • There's a strong inverse relation between prior tax burdens and subsequent after-tax performance regardless of the time horizon and the performance measures. For example, funds with the lowest tax burdens during the prior three years underperform the market by 0.19 percent per year after taxes. On the other hand, funds with the highest tax burdens during the prior three years underperform the market by 2.29 percent after tax. The difference in after-tax performance of 2.10 percent is statistically and economically highly significant.
The authors concluded: "Due to the persistence of the tax burden, fund investors can increase their future after-tax performance by avoiding funds with high prior tax burdens." They found that funds in the lowest tax burden quintile over the previous three years exhibit excess returns of -0.19 percent over the subsequent year after taxes, whereas funds in the highest tax burden quintile exhibit excess returns of -2.29 percent after taxes.
The authors also found that mutual funds that generate lower taxable distributions don't underperform other funds before taxes, indicating that the constraints imposed by tax-efficient asset management don't have significant performance consequences.
To highlight the impact of taxes on after-tax returns, the authors selected two growth funds with extreme average tax burdens over the period 1990-2012. The tax-efficient fund had an average tax burden of 0.44 percent per year, while the tax-inefficient fund has an average tax burden of 3.77 percent per year. The average before-tax returns were similar: 12.35 percent per year for the tax-efficient fund and 13.13 percent per year for the tax-inefficient fund. However, the distributions of the funds differed significantly. The tax-efficient fund distributed primarily dividends, while the tax-inefficient fund distributed a significant proportion of short-term capital gains. A one-dollar tax-exempt investment in the two funds at the beginning of 1990 would have accumulated in December 2012 to $10.05 for the tax-efficient fund and to $10.82 for the tax-inefficient fund. However, a one-dollar investment would have increased after taxes to $9.12 for the tax-efficient fund and to just $4.08 for the tax-inefficient fund. Thus, the accumulative value of the high-tax fund is less than half the accumulative value of the low-tax fund over this 23-year investment horizon. The difference in the accumulative account values shrinks slightly if liquidation at the end of the period occurred. Since the tax-efficient fund had an embedded capital gain and the tax-inefficient fund had an embedded capital loss, the liquidation tax reduced the value of the tax-efficient investment from $9.12 to $7.74 and increased the value of the tax-inefficient investment from $4.08 to $5.35. The tax-efficient fund produced 45 percent greater ending value.
The authors concluded: "We find that taxes have a significant impact on the performance of taxable fund investors." If you haven't been paying attention to tax efficiency, perhaps the evidence presented here will act as a wake-up call. You can improve your tax efficiency (and after-tax returns) by moving from active to passive strategies. And if you're already using passively managed funds, you can move from non-tax managed funds to tax-managed versions or using ETFs.ad more here: http://www.sacbee.com/2014/01/30/6114416/netsuite-oneworld-brings-agility.html#storylink=cpy
Posted on 2:31 PM | Categories:

Is TurboTax (or something similar) worth the investment?

Over at Reddit we came across the following discussion:
Is TurboTax (or something similar) worth the investment? (self.personalfinance)
submitted  ago by saqneo
Background:
I graduated college last year and it's the first time doing my own taxes (previously done by parents). I tried using the free TurboTax service, but because I earned dividends, it said I would need to buy the premier version ($50) to fill out the Schedule D form.
I am wondering whether this is worth the price or if I am better off filling out the form myself? My income last year was like this:
  • One job and retirement/HSA contributions (all on W-2)
  • ESPP (capital gains/loss and dividends listed on one form)
  • Other holdings in one stock through different broker (capital gains/loss and dividends)
  • Small amount of interest from CD/savings accounts
So, would the paid version of TurboTax make my life easier? Or is it not much more difficult to file these details myself? Thanks!
Edit: Sounds like I'll be checking out TaxAct once I get home and comparing it to TurboTax results since it doesn't require payment upfront. Thanks for the advice, everyone!
all 19 comments

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[–]Xonim 7 points  ago
Have you tried TaxACT? I haven't had any dividend / interest income in the past (though I do this year), but I remember seeing it as an option. Even your situation doesn't seem that complicated, I would assume it should allow you to file for free. Might be worth checking out.
[–]schimdo 2 points  ago
TaxACT is great, i have used it 3 years in a row now.
[–]wolfpackguy 6 points  ago
I find Tax Act to be cheaper and only slightly uglier. But TurboTax is still cheaper than an accountant.
[–]United Stateslukertin 5 points  ago
My dad has been using it for years. He remarked that due to the purchase and sales of stock, not using TurboTax basically requires much more time or getting a tax accountant. Definitely worth the $$.
Your situation is simpler to the point you it might not be that much of a different though.
[–]saqneo[S] 1 point  ago
Do you know if it's simplified at all if I only purchased/sold one stock and earned dividends on two (one is long term)? Thanks!!!
[–]United Stateslukertin 4 points  ago
Yes, the fact that you only dealt with 3 stocks makes it very simple. When you have your own business income stream or over like, $100-200k invested in taxable accounts TurboTax starts to become invaluable.
[–]schlade 4 points  ago
What I liked best about TurboTax was its ability to connect to my Schwab account and download all my transaction data for the year. The free alternative that I tried (TaxAct) allows you to import a CSV file from a brokerage account, but I found that it wasn't really handling my transactions correctly.
For me, TurboTax was well worth it because with the free alternatives, I would have had to manually input 50+ stock and options transactions. The P/L and cost basis numbers from the TurboTax import matched those on my Schwab statements perfectly.
If you don't have many complex transactions, however, I would recommend giving TaxAct a shot.
[–]JonCheddar 1 point  ago
how do you do this?
[–]bobbyk18 2 points  ago
I'm still debating between turbotax and an accountant, but the nice thing with TurboTax is that you do all the work before you pay, so you know about how much your refund should be if you go with another place, as well. I'm kind of upset that I had a $15 gain on one ETF move this year and it forced me to need to upgrade to Deluxe, which is an extra $50.
[–]United Statesplexluthor 3 points  ago
There are other free options.
Even if you end up paying for TT or TaxACT or whatever, only do it for one year. Save all the forms it generates, and work off those when you do your taxes by hand next year using Free Fillable Forms (same link as above). State taxes are also pretty easy to do by hand once the Federal return is complete, so don't pay extra for it, even this year.
[–]saqneo[S] 1 point  ago
I'll definitely check that out!
[–]United Statestoritxtornado 1 point  ago
I make > $58k, so I would have to use the Free File Fillable Forms (that will be available tomorrow). Is this the first year they are doing this?
I can't do the free TT because itemizing gets me a higher refund (I bought a house). I'm just wondering if it's worth paying the $50 for the Basic TT, but I guess I'll try the free one from the IRS when it is available tomorrow.
Sorry, that was a ramble. I don't have any real question other than asking if you had any knowledge of the free fillable forms.
[–]Williamisme 2 points  ago
I use pen and paper. It works pretty well.
[–]marcianitou 0 points  ago
i like TT it's easy 2 use (great if you have no knowledge and want something simple) plus you can get like 8 returns so your cost per use is not bad, way cheaper than paying someone to do it ! I will buy it again this yr
[–]United States13374L 1 point  ago
I got Premier a few years ago for the very reason you mentioned. It was a waste. I did Deluxe last year and it covered everything I needed.
[–]tripshed 1 point  ago
Just do it online at free web file at irs.gov. Don't waste money with these tax software. You can use them to verify your refund but don't use them to file. You case seems pretty straightforward.
[–]nikkiten 1 point  ago
I prepared my taxes on TurboTax last year and it said I owed $200, I did not submit and instead re-did them on TaxACT and i RECEIVED a $200 return. I will never use TurboTax again.
[–]die_civ_scum 1 point  ago
I don't think my free on post tax center would have gotten me the $1000 saver's credit that turbotax got me. Next year I will research everything I can and try to do my own taxes, but then get them checked at the tax center.
[–]nsummy 0 points  ago
I used to use the free options mentioned on the IRS site. They were terrible compared to Turbotax. of course this was about 5 years ago so perhaps tech has improved.
Posted on 2:31 PM | Categories:
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