What Creative Freelancers & Entrepreneurs Need To Know About Taxes
Today, April 15th, is the tax filing day in the U.S., so for our continued April Financial Literacy Month, I’m going to focus this one on taxes.
When I was studying Financial Planning through UC Berkeley’s certification program, I had to take classes on Investments, Retirement, Estate Planning, Insurance, Fundamentals (which includes Behavioral Finance and Education Planning/Student Loans) and of course, Taxes.
My Tax Professor said something very interesting…
“Remember, the Mafia wasn’t taken down for murder. The Mafia was taken down for tax evasion.”
So, yes…tax evasion is illegal.
In fact, lots of people, especially celebrities have been fined heavily for not paying their taxes. One of my celebrity heroes, Willie Nelson, was one of them.
(Willie is pictured above in a painted mural smoking...what I can only guess is a joint.)
He’s not my celebrity hero because he didn’t pay his taxes. He’s one of my favorite celebrities because of what happened after not paying his taxes.
Willie was caught, or rather, he kinda didn’t care about it and liked thumbing his nose at the government, and it all caught up to him.
So, he was fined a lot of money, which he couldn’t pay off right away, which caused the IRS to seize his assets and auction off many of his prized possessions.
Now I’m sure you can guess that usually the way the music and entertainment industry works is people kick you when you’re down, or at the very least, avoid you.
However, not Willie’s friends.
Instead, they went to the auction, bought up all of his stuff, and then…gave it all back to him!
To me, this shows what kind of person Willie Nelson really is and what kinds of people surround him…
…super loyal ones who stick by him.
However, I don’t want you to have to test your friends’ loyalty to you in this way. So, instead of evading your taxes…why not implement some LEGAL ways of avoiding or minimizing them?
Here are some ways in the U.S. that you can do that (remember that you should check with your accountant about your specific situation. I’m not an accountant, so this is all educational information):
Contribute to a Retirement Account
Certain amounts you put into a 401(k), Traditional IRA, SEP or SIMPLE IRA can be deducted from taxable income in the year you contribute. For example, the max you can contribute in 2023 into a Traditional IRA is $6500 and $7000, if you’re over 50. In 2024, that amount goes up to $7500, if you’re under 50 and $8000 if you’re over 50. If you qualify, you can deduct the amount you contribute from your taxable income, making your income smaller, so less taxes!
Receive income in a tax-exempt form.
You don’t have to pay taxes on what you earn from selling your home (after you’ve lived there for two years), up to $250,000 if you’re single or $500,000 if you’re married, filing jointly. Also, any income you receive from a Roth IRA is tax free! Also…a Health Savings Account or HSA…
Open a Health Savings Account
If your employer or you have a qualified high deductible health insurance plan that gives you an option for an HSA (not an FSA or flexible spending account), take it! It’s the only thing in our system right now where it’s tax deductible in the year you contribute…the money that’s in the account can be invested (and NOT TAXED) into the stock market (or bonds or just earn interest in a cash reserve account), and the money taken out for health-related purposes also will NOT be taxed. Again, money in = deductible (tax free), money held = tax free, money out = tax free! Triple threat.
Business Deductions
Since Trump got rid of most deductions for w-2 employees, if you have a business, you have a greater chance of having more than just the standard deductions, so make sure you keep track of expenses throughout the year and then itemize everything from mileage, shipping, marketing/ads, fees, % of home internet charges, % of square footage of your home office (meaning if your home office is 200 square feet, you get to deduct approximately $200/month), health/dental/long-term care insurance premiums, half of your self employment taxes, professional dues, memberships, office supplies, etc.
Charitable Donations
Cash donations are 100% tax deductible. You can actually avoid capital gains by donating stocks with big gains. If you don’t have a lot in a year, combine a few years.
Tax Credits
This is where having an accountant is preferable over doing your own taxes. Most of us don’t know all of the tax credits each year, so having an accountant (or even something like TurboTax) can alert you to see if you qualify for any tax credits such as energy and energy-efficient home improvements, clean vehicle, adoption, and lifetime learning credits. Remember, credits are even better than deductions. Deductions subtract from your taxable income. Credits actually subtract from what you owe in taxes.
Generate Income that’s Taxed at Capital Gains Rates, rather than Ordinary Income
This one I’m going to let CPA for Small Businesses, Meg Wheeler, explain:
"In order to really save money on taxes, you need to change the type of income you receive.
When it comes to taxes, there are two types of income: ordinary (or earned) and passive (usually referred to as capital income/gains). Here’s how they break down:
Ordinary / Earned Income: This is any income that you earn through providing your labor or owning a business that you actively participate in. This includes wages from a job, payments for services that you receive as a contractor or freelancer and owner’s pay or compensation from a business you own.
Passive / Capital Gains: This is any income from activities in which you do not actively participate. Examples are sales of stocks and other investments, real estate rental income, interest and dividends.
Under our current tax system, capital gains are taxed at a significantly lower rate than ordinary / earned income. In 2023, capital gains tax rates start at 0% and only go as high as 20%, compared to ordinary income tax rates, which start at 10% but go as high as 37%!
You want to know how rich people get rich? It’s not from earned income. Their wealth comes from that second category - capital gains - which allow them to make money off their money AND pay less in tax on that income.
So… if you want to lower your tax bill, don’t just think about the current tax year. Play the long game and work to convert your earned income into activities that will return you capital gains - resulting in more income for you and less tax paid on that income.
This looks like:
Investing in the stock market (and holding those stocks for at least one year before selling - anything less and those gains are taxed at the ordinary tax rates!)
Purchasing investment properties, such as residential or commercial rental properties. Provided you don’t provide significant services in your rentals (think hotel-like services such as housekeeping, turn-down and room service), your income from those properties will be taxed at the lower capital gains rates.
Invest in other businesses. Provided you don’t actively or materially participate in the business (talk to your accountant about the specifics of these rules!), income you earn from your investment is taxed as capital gains."
If you want more ways to save on taxes or find other inspirations to spark your money moves, I want to invite you to join Meg, myself, and 20+ experts in the Financial Spark Series: Experts Drop Their Best Money Moves in 60 Seconds. Sign up below!
With Love & Gratitude,
