Let’s rewind to April 2016. To be honest, I often put off filing my taxes, because my go-to accountant lived in my hometown, and I had to travel a long way to get there. I’d wait until I needed to visit home to celebrate my mother’s birthday, and that’s when I tackled all the paperwork. Two birds, one stone. But this year, right as we were going out to celebrate with her, I got slammed with a bill thousands more than I expected.
I’d been saving money for taxes, but that was four solid figures I needed to come up with ASAP, so I could pay up and avoid getting fined by Uncle Sam. Needless to say, it was hard to be cheerful when we went out later that night, and I felt horrible about it. I couldn’t stop running over how I was going to come up with that money so quickly, why my accountant didn’t give me fair warning and how I should really focus on the celebration at hand instead.
I was okay in the end, but I learned some hard lessons about how to not let taxes blindside me again. Here’s what I started doing in 2016 to better prepare myself for the next yearly tax bill:
1. Find an Accountant
Why was I so financially unprepared for such a huge tax bill? When meeting with my previous accountant, she kept trying to “soften the blow” for me. She’d tell me how much income tax I owed for different tax brackets, but failed to discuss the additional self-employment tax and state taxes I needed to tack onto my total percentage.
She felt guilty being the one to tell me I couldn’t keep a large chunk of what I earned. While that’s a sweet personality trait in some instances, it leaves a lot to be desired in any form of financial advisor. When you set out to hire an accountant, you’ll want to look for one who understands the freelancing or self-employed lifestyle and isn’t afraid to tell it like it is.
2. Pay Quarterly
Your quarterly taxes are based on your previous year’s income, and you must pay them. It amounts to the taxes you owed the previous year divided by four. If you earn more than last year, you can still pay the minimums and not face a fine when it comes time to file your taxes, as long as you pay the balance in time.
But if you get to tax-filing season and haven’t paid your minimums, it will result in a fine. Put your tax-paying dates in the calendar, and make sure you send off your checks.
3. Up Your Rates
Let’s do the math. A six-figure freelancer is in the 28 percent tax bracket. Add 15.3 percent to that for self employment tax (which employers typically pay half or most of) and 5 percent for state taxes, and you’ve got 48.3 percent of your income you should set aside after the $91,150 mark going directly to taxes. (Note: State taxes vary.)
I know, it’s a painful figure — 48.3 percent is nearly half your income. That’s a ton of money. But I’m not the kind of person who’s bitter about paying taxes. I actually like seeing how we can use the tax system to make our country and the world a better place. But if you didn’t count that 12.5 percent employers usually pay, it’d be 33 percent (or 39.2 percent if the employer just paid half of the social security tax), which is a third instead of half. A significant difference.
I thought I’d made an impressive income for myself in 2015, and as someone who spent most of the year traveling, I’m still pretty proud of it. But it was a huge lesson moving forward. I had to learn ways to make more money … way more money than my peers. Not only am I responsible for any and all business expenses, but I also need to pay more in taxes. For me to earn more and keep more of my money, I must make more of it.
In 2016, I increased my 2015 income by a little over 50 percent. With that extra money, I felt a lot better about my financial situation. Plus, I’ve been saving money for taxes at the end of every single month with a separate savings account. I know I’m not the only one who’s learned some harsh freelancer lessons at tax time. Reach out to the other indys in your life; you can both commiserate and help each other better plan for the next tax season.