Savvy: “Shrewdness and practical knowledge; the ability to make good judgements.”
Navigating the haphazard, seemingly random world of American taxes can feel overwhelming, especially for small business owners and freelancers juggling multiple responsibilities. And yet, learning how to be tax savvy in the system is crucial to avoiding penalties, maximizing savings, and maintaining a healthy financial status over time.
This guide aims to demystify the messy US tax process with actionable steps that will help you stay on top of your tax obligations and even find ways to save money (hopefully without having to hire a professional, as far as that is possible). We may not do your taxes for you, but we can point you towards the right starting line…
The Importance of Being Tax Savvy
For small business owners and freelancers, understanding taxes isn’t just about complying with government regulations. It’s about making informed decisions that can impact the financial health of your business and personal retirement planning goals. Taxes can eat into your profits if you do not manage them properly, but with the right tax strategies, you can minimize this burden and keep more of your hard-earned money over time.
By the end of this introductory guide, we hope you will be equipped with practical tips to manage your taxes efficiently. We will cover everything from understanding your tax obligations and organizing your financial records, to maximizing deductions, planning for tax payments, and knowing when to seek professional help.
Becoming Tax Savvy: (1) Understand Basic Tax Obligations
Different Types of Taxes
Knowing the various types of taxes you are liable for is the first step in becoming tax savvy. Small business owners and freelancers often face multiple tax obligations that those on typical salaried jobs will never have to think about. These include (but are not necessarily limited to) income tax, self-employment tax, sales tax, and employment tax (if you have employees).
Income Tax is based on your freelance and/or personal business earnings and must be reported annually. Unlike salaried employees, entrepreneurs and freelancers need to calculate this themselves using the forms, relevant schedules and official guidance provided by the IRS (e.g. starting with form 1040).
Self-Employment Tax covers Social Security and Medicare contributions, and is mandatory for freelancers and business owners. This tax can eat into a significant portion of your earnings, so it’s essential to set aside funds for it (see Schedule SE). As with income tax, you will need to calculate this tax debt yourself.
Sales Tax applies if you sell products or services as part of your business (or, for that matter, as a side hustle that is not your main business). The rules vary by state, so make sure you understand the specific requirements for your location (e.g. for Pennsylvania, see here).
Lastly (for the purposes of this basic guide), if you have employees, Employment Taxes (including federal income tax withholding, Social Security, Medicare, and unemployment taxes) will also be part of your administrative and tax responsibility.
Becoming Tax Savvy: (2) Organize Your Financial Records
Importance of Record-Keeping
Keeping your financial records organized on a weekly and monthly basis is essential for accurate annual tax filing and can save you from a lot of headaches down the line. Good record-keeping helps you track your income and expenses, ensuring you claim all possible deductions and stay compliant with tax laws. They would also come in handy if ever your business were to be audited by the IRS.
Tips for Effective Record-Keeping
First, separate your personal and business finances. Open a dedicated business bank account and use it for all business transactions. This will make it easier to track your business expenses and income: all you need are your bank statements from your business account.
Second, consider investing in accounting software. Tools like QuickBooks or Xero can simplify the process of tracking your finances. They offer features such as invoicing, expense tracking, and financial reporting, which can be invaluable for simplifying your life when tax season arrives.
Lastly, try to keep digital copies of all receipts and documents. Physical documents can get lost or damaged, but digital records can be easily stored and organized, whether on your computer hard drive or on cloud storage platforms like Google Drive or Dropbox, which are great for easy access and backup.
Becoming Tax Savvy: (3) Maximize Deductions
Commonly Overlooked Deductions
One of the best ways to reduce your tax liability is to take advantage of deductions. However, many small business owners and freelancers miss out on deductions simply because they’re not aware of them.
Home Office Deduction allows you to deduct part of your rent, utilities, and other home expenses if you use a portion of your home exclusively for business (see Form 8829). The form can be a little tricky to understand, especially as you have to file it alongside Schedule C to Form 1040, but the official IRS guidance can help you navigate through the process — and the deduction could be worth a lot after you add up all of your annual home office costs.
Equipment and Supplies can also be deducted. This includes computers, software, office furniture, and even smaller items like pens and paper (again, see Schedule C and the relevant IRS guidance).
Travel Expenses related to your business can be deducted as well. This includes airfare, hotel stays, meals, and even mileage if you use your vehicle for business purposes (see Schedule C).
How to Ensure You Maximize Deductions
To ensure you maximize deductions, keep detailed records of all expenses. When in doubt, consult the IRS guidelines or speak with a tax professional. They can help identify deductible expenses you may have overlooked.
Bear in mind that the IRS exists to maximize your tax burden, and they will do anything they can to make your life more complicated and costly. By keeping detailed records and consulting the right sources, you can be confident that you have claimed the right deductions, for the right amount.
Becoming Tax Savvy: (4) Plan for Tax Payments
Importance of Setting Aside Funds
One common issue freelancers and small business owners face is not having enough money set aside to pay their taxes at the end of the year. This can lead to penalties and interest charges — not exactly the best Christmas/New Year’s present…
Strategies for Effective Planning
So how do you avoid that kind of miserable tax hangover? First, estimate your overall annual tax liability at the beginning of each year. You could use your previous year’s tax return as a starting point, and then adjust for any changes in your projected income or expenses (e.g. based on prospective business deals, conversations with clients addressing contract expectations, etc.).
Second, set aside a portion of your income regularly (e.g. from each paid invoice, or on a time-regulated basis, e.g. monthly). A good rule of thumb is to save 25-30% of your income for taxes. You could set up a separate savings account specifically for tax money to avoid spending it. The IRS’ Tax Withholding Estimator could help, too.
Third, make quarterly estimated tax payments through an official IRS payment partner (see here). This not only helps you manage your cash flow better but also reduces the risk of underpayment penalties at the end of the year.
Becoming Tax Savvy: (5) Fostering a 'Tax Mindset'
Understanding the Relative Cost
Getting the basics sorted can make a world of difference, but applying a “tax mindset” to all parts of your business and personal tax arrangements can take you up another level entirely. Consider this thought from Iron Point Financial’s President, Greg Liszka:
“If there’s something we want to buy [for a client’s investment portfolio], we need to look at the tax treatment of that particular asset to determine where we want to buy it. Taxes over a 25-year investment period (an investment lifetime) are worth paying attention to. They could make a half-million-dollar difference.”
You read that right: half a million dollars. There are tax implications for almost all financial decisions, whether personal or business-related, so it pays to be informed, and to be intentional about how you manage those assets.
Intentionality with Beneficiaries
Without that kind of tax-intentionality, you could end up with less-than-ideal situations that you have to clean up later. Greg has noticed, for example, that a lot of his clients forget to update their beneficiaries after major life changes:
“Say, they got married and their spouse is not their beneficiary — it’s their mother! Or they got divorced and it’s even worse: their ex is the beneficiary! (And I’m assuming they got divorced not because they were madly in love.) So there may be some hard feelings about that, especially with your new partner…
It’s a rudimentary, basic thing that has real-life consequences. If you have no beneficiaries in the State of Pennsylvania, then your spouse will only be a 50% beneficiary; the other 50% goes to your children (though if you have no children, your spouse will inherit everything). That’s designed to maximize the amount of taxes you pay (you can pass assets to your spouse with no inheritance tax).
In other words: it pays to stay informed, and it pays to stay up-to-date — and your spouse will thank you for it too.
IRA Contributions (Long-term Perspective)
Another tax tidbit we would like to offer today is the thought that how you manage your taxes has strong implications for how your enjoy your retirement, especially if you have tax-advantaged retirement accounts.
Knowing how to navigate IRA contributions can keep you tax savvy in two ways:
- When you maximize pre-tax contributions to IRAs and other employer-sponsored accounts, you are reducing your overall taxable income, and in turn your tax liability. The good news about this kind of account is that you can also “catch-up” on years you have missed out on, provided you are over 50 years old.
- IRAs and other tax-advantaged retirement vehicles may also be tax-free when it comes to interest on the account — so you won’t pay any capital gains tax on their growth before retirement. Once you start making withdrawals, those will count towards your regular income, and at that point you will likely be in a lower income tax bracket (saving you lots on your tax bill in the process).
IRA Charitable Contributions: The Importance of Generosity
Finally, if you wanted to save even more on your taxes during your retirement, while remaining generous and other-oriented, you could even funnel your philanthropic endeavors through your IRA — something Greg talks about often with current and prospective clients:
“I just gave an entire presentation to a church in Greenville about charitable donations out of their IRAs. There are a lot of people who, while they are of an age where they are forced to take distributions from their IRA, don’t need the money… but have to pay tax on it. So, if they were going to donate that money anyway, then why not do it directly from the IRA, where there are no taxes?
Easy math: let’s say they were forced to take out $10,000 and they’re in the 25% tax bracket: if they were going to give that money away, they would be $7,500 left over (when funnelled through their checking account). But if they did it directly through the IRA, they could give the full $10,000, tax-free.”
In this way, being ‘tax savvy’ doesn’t just have to be an exercise of personal financial stewardship — it can have considerable knock-on effects for others in your community, too.
Becoming Tax Savvy: (6) Seek Professional Help
When to Consult a Tax Professional
While managing your taxes on your own is possible, there are times when consulting a tax professional is the best course of action. If your tax situation is particularly complex, or if you’re unsure about certain deductions and credits, even after reading through all of the relevant IRS guidance and other free resources (like this one), seeking professional advice could save you money and stress.
Benefits of Professional Guidance
Tax professionals stay updated on the latest tax laws and can provide valuable insights. They can help you plan strategically, ensure you’re taking advantage of all available deductions, and keep you compliant with tax regulations.
Professional help is particularly beneficial during audits or if you receive any notices from the IRS. An expert can represent you and handle any issues that arise, reassuring you with the knowledge that there’s someone fighting fighting on your behalf.
The reality of the US tax system is that, for the most part, it has developed without a comprehensive plan or guiding principle. Instead, different deductions and credits have been added to the foundations of the system over the years, leaving taxpayers with an administrative headache come tax time. The good news? Those willing to find out what those deductions and credits are can make the system work for them.
Parting Thoughts
Being tax savvy is not just about external compliance; it’s about making mindful, smart financial decisions that benefit your business in the long-term.
By understanding your tax obligations, organizing your financial records, maximizing deductions, planning for tax payments, fostering a ‘tax mindset’ and seeking professional help when absolutely necessary, you can manage your taxes efficiently and keep more of your hard-earned cash to use as you think best.
Remember, the key to successful tax management is staying informed and proactive. We hope that if you implement these steps, you’ll not only avoid tax-related stress but also enhance the overall financial health of your business.
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Iron Point Financial is here to empower you to secure a brighter tomorrow. We operate physical offices in Grove City, PA and Greenville, PA.
We primarily serve residents of Pennsylvania, Ohio, West Virginia and Florida but we also have security registrations for 22 other states across the continental USA.
