Independent contractors and freelancers may have income and expenses that fluctuate wildly over months or years, so financial advisors need to know how to counsel those clients on the best strategies for planning their cash needs for tax purposes.
Employees who have income withheld are less likely to run into problems over timely tax payment, but independent contractors need to plan their estimated installments.
“They should consider their expected tax liability as an expense, and they should budget for it like they budget for anything else,” says Rosemarie Moeller, a certified financial planner and managing director at Freedom Divorce Advisors, a division of AEPG Wealth Strategies in Warren, N.J.
Advisors and accountants must work closely with clients to estimate their expected tax liability for the year, which is 100% or 110% of the previous year’s taxes, depending on earnings.
Accountants advise their clients to take that amount and treat it like a mortgage or any other fixed expense, setting aside the money each month to pay for the quarterly installments to the government.
“You’re estimating, and the government knows that, but they want it evenly distributed, unless you didn’t pay three-quarters of your taxes because you didn’t expect this huge check to arrive in the fourth quarter of the year,” Moeller says.
Large fluctuations in income or deductions should balance out, if the projections are accurate.
“If you keep ending up under or over the projections, then we’ll want to talk about it and do an updated projection,” says Jeffrey M. Mutnik, a certified public accountant and director of taxation and financial services at Berkowitz Pollack Brandt with three offices in Florida.
“It always gets me when people say they’re so happy they are getting a refund they didn’t know they were getting or they’re so upset that they owe money and they didn’t know that they owed it,” he says. “That’s something they should have known at some point during the year; they should have had some type of projected income versus income taxes.”
For independent contractors, that knowledge can be crucial in obtaining tax savings. Especially toward the end of the year, independent contractors may be able to exercise some leeway over when they are paid or when they make payments.
“Maybe they can withhold making a payment until January and get a deduction the next year when they’re expecting to have a larger boom,” Mutnik says.
He warns that clients need to understand that payments are considered received when they are collected, not when they are deposited in the bank.
“If somebody pays you on Dec. 28 by check and you just put it in a drawer and deposit it in the bank on Jan. 3, that’s still a December collection,” Mutnik says. “The fact that you didn’t deposit it doesn’t mean anything.”
Paul Hechinger is a New York-based freelance writer.
This story is part of a 30-day series on tax planning strategies.