With tax deadlines on the horizon, we’re shifting our attention—albeit, just slightly—away from type design and smart graphics, and towards money and the IRS. It’s been said that taxes are certain. What’s less certain is how to do them, especially if you’re a freelancer, small studio owner, or just so extremely right-brained you can’t tell a pay stub from a 1099.
Because of the Covid-19 outbreak, the IRS shifted this year’s tax deadline from April 15 to July 15. If you’re all set, you can still proceed with your return as if the April 15 deadline is still in effect; if you need a bit more time, now you’ve got it. Whatever your situation, to guide you in the right direction, we consulted with three seasoned accountants, all of whom have (and love) designer clients. They passed on handy instructions and salient advice for filing annual taxes, as well as planning for them year round. Without further ado, here’s how to not get screwed by the IRS…
First, some general advice:
Are you a freelancer or an employee? If you’re an employee (with no extra side income or mortgages) you get a W2, and can submit it via TurboTax. Because the 2018 tax law eliminated expenses for all employees (except military and teachers), you’re done. Freelancers and side hustlers, read on.
If you go freelance, meet with an accountant. It’s like preventative care: “We see everybody from the inside—we’re like doctors for money,” says New York accountant Ben Sargent. A good accountant can also help you set rates and meet your goals throughout the year.
Set aside 30-35% of your income for taxes in a separate savings account. Employers match Social Security and Medicare payments for employees; freelancers have to match it themselves. *If you take away only one thing from this guide, let it be this.*
And then ask yourself: Is this necessary and reasonable? Scott Hunzinger tells clients to ask this question when assessing expenses. “Yes, you have to rent a car on a work trip, but no, you don’t need a Bentley,” he says. A few more rules of thumb:
- Obvious business-related write-offs include use of cell phone, up-to-date computers and software, and even cultural expenses that dovetail with your practice, like magazines or conferences.
- Travel gets dicey, Sargent says. “The fact that you worked while on vacation does not make it work; you have to set some meetings. Book a trip with more business days than fewer. Ask yourself: Did I get paid, or expect to get paid on this trip?”
- Personal expenses are just that—personal. “I once did taxes for a hairdresser, and she insisted she could write off her manicures, because she was ‘seen in the public eye,’ ” Hunzinger says. That was an incorrect belief. “If she was a hand model, absolutely.”
Make quarterly estimated tax payments (for the following year’s taxes) on the 15th of January, April, June, and October. The U.S. government uses a pay-as-you-go system. “Common misconception here,” Hunzinger says. “People think, ‘Oh, I don’t have to file something?’ You don’t, but it’s your responsibility to make an estimated payment.” If you don’t, expect a penalty based on what you didn’t pay, plus interest. If you overpay, rest easy: You’ll get a refund when you file your return. (If you feel equipped to brave technical jargon on your own, the IRS publishes worksheets online; page 21 covers estimated tax payments.)
If you own a studio and have employees, run payroll through a service like Gusto or Justworks (if your studio keeps growing, get ADP or an accountant), and pay yourself a salary. “The IRS only requires that you pay yourself a fair salary, which is what you would pay someone else to do your job,” Hunzinger says. (If you’re an S Corp, any money left over from your salary can be a distribution, and thus not subject to Social Security and Medicare taxes.)
4 common tax-paying pitfalls you can avoid:
1. An extension only means extra time to file your return (the paperwork). Your estimated taxes (the money) are still due July 15 (or in a regular year, April 15). If you can’t pay, apply for one of the IRS’s payment plans, and be forewarned that it comes with some interest.
2. Working from home ≠ a home office. “Everyone swears up and down they get this deduction,” Sargent says. “To truly meet the requirements, a home office has to be a space you use exclusively for work. Carve out a space, put a desk in the corner with a little file cabinet, and then we can talk about it.”
3. Do not take money out of your 401(k). You will pay income tax on it, and it will be steep.
4. Do not make yourself an S Corp, unless you’re committed to it. “I’ve had this a lot with designers; they want to be an S Corp, and then the next year they take a job at Apple,” Hunzinger says. “You either have to close the S Corp or file an S Corp tax return each year.” The estimated fee for that is between $500 and $2,000.
Ask a Mom: How does one not get screwed by the IRS?
“I don’t think people get screwed by the IRS. I think people don’t understand how the IRS works, and I don’t think they understand their paycheck. When you’re an employee and someone says they’ll pay you $10,000, you don’t get a check for that amount. When you’re freelance you have to adapt your habits to living on the net, not the gross, and that’s where people get in trouble. It’s really $7,000, not $10,000.
It’s a real misconception to focus on getting a refund at tax time. You should focus on what your tax bill is, and your taxes equal X dollars. You either pay in the right amount, or too much, or too little. Your goal is to pay in the correct amount during the year. If you’re self-employed and your income fluctuates, it does require you to do tax estimates with an accountant.
One of the things about creatives that always amuses me is that because they create, they have this idea that they can create what their tax world looks like. But we are driven by regulations and rules that are dictated by the government. There’s not really room for creativity in that structure.” — Deborah Wiley, Austin, Texas accountant (and mom to Eye on Design’s community editor, Margaret Rhodes)
What’s new with taxes in 2020?
“This year, the big thing is crypto,” Hunzinger says. “If you have income on a sale of a cryptocurrency, you have to report that income. But even if you just own cryptocurrency, you have to note that too. There won’t be any taxes due; you’re just stating that you own it.”