Make Your Taxes Suck Less in 2016
We're at the start of a new year, a time for new beginnings, and a fresh start on keeping track of your expenses for Uncle Sam.
Disclaimer: I am by no means a tax expert.
I use an accountant to file in case I'm ever audited. (Read one musician's experience with an IRS audit here.) This post is just about what I do, and it's a smorgasbord of advice gathered from other musicians, CPA-types and my self-employed parents.
Self-employed people are at higher risk for being audited in general, so be forewarned that we are often easy targets for the IRS.
W2, W4, W9... WTF
Musicians are often contracted as W9/1099 workers, which means we are employed as independent contractors. We as artists are a business, and our art can have profits, losses, expenses, etc. like any business.
Independent contractors are responsible for paying Self-Employment Tax, which makes our tax burden larger than a salaried W4/W2 employee. This kind of sucks.
However, as self-employed people, we can deduct business expenses from our taxable income to reduce our tax bill. So every time we go to the bar after a gig and talk about music with other musicians, the bill can be deducted from our taxable income, thus decreasing our tax bill. When we buy an album off iTunes, join the International Horn Society, purchase sheet music, get our horn cleaned, or buy a iPad Pro to read music from, we can deduct these expenses. This is kind of awesome.
These are the four most common forms you will see in your working life.
W9 - The form you give a contractor to get paid.
1099 - The form you get in January stating your income from each person/company you worked for.
Excellent comment from Nancy Billman on Facebook:
You may get a 1099 for less than $600. The filing requirement is for $600 and above, but nothing precludes employers sending them for smaller amounts.
**You are responsible for paying taxes and reporting the income even if you don't get a form.**
W4 - The form you give an HR person to get paid.
W2 - The form you get in January stating your income from the job, and how much tax has been paid through payroll.
A W2 employer pays AND deducts taxes for a W2 employee through payroll.
Keeping track of expenses can get overwhelming, because if you're audited the IRS will want to see your receipts. I have found the best way to do this is through an app called QuickBooks Self Employed. I will be writing another post on how to use this app most effectively, so keep an eye out!
Self-employed individuals will often work both W2 and 1099 jobs. For example, one of my private teaching jobs is W2, so I don't have to pay self-employment tax on that income.
An easy way to reduce what you owe from 1099 work is to NOT claim any allowances on your W2 income.
In other words, when you fill out the W4 form, instead of writing "1" on line 5, write "0". This will increase the amount of federal tax that is withheld. You can also add a specific amount to be withheld from your check each pay period on line 6. I personally choose to have an additional amount withheld per pay period.
Why would I want more tax withheld from my check?
This additional withholding creates a safety net. This money that has already been taken out of my income will apply towards my tax bill for other 1099 work. That is why many salaried people get a tax refund in April, because after they file for standard deductions it turns out too much tax has been withheld from their checks.
So by having money taken out of my check automatically, I'm never in possession of that money, and the government is essentially keeping a tax savings account for me. There's arguments as to why this isn't efficient, but personally, I need Uncle Sam to take some of my money automatically and say THIS IS FOR TAXES, NOT NACHOS.
Student Loan Interest is Deductible
Student loans are a fact of life for many of my generation. Make your soul-crushing debt work in your favor for once.
Any interest paid (or just added to a student loan balance) during a given tax year is deductible. The maximum deduction is $2,500, even if you actually paid more. Form 1098-E is sent to you by your student loan servicer, but keep in mind: many companies are making the form appear in your online account without physically mailing it to you.
To Deduct or Not To Deduct: It's Not Really A Question Until You Want To Buy A House
When you maximize your deductions by deducting everything legally possible, you're also bringing your reported annual income down. This will effect many other things, including qualifying for health insurance assistance. For example, in New York State, the new "Essential" plan for $20/month has an income maximum of $23,540/year. I might earn (or "gross") more than $23,540, but I can use business expenses to reduce my taxable income (aka AGI, adjusted gross income), which is the number used by the state to determine eligibility. So if I "make" $40,000, but deductions bring my AGI below $23,540, I can still qualify for the Essential health plan. If I don't track expenses and my AGI is $24,000, I'll end up spending much more than the $460 difference on a standard health plan, so getting below that threshold is very advantageous.
A low AGI will also lower your federal student loan payments if you are on the Income-Based Repayment plan, or any other Income-Driven repayment option. If you have federal loans and are making standard payments, you should definitely investigate these plans.
The downside to maximizing your deductions is if you're interested in obtaining a mortgage or qualifying for an apartment lease in NYC. Many banks/landlords want to see two years of tax returns before approval. If you're grossing $50,000 but deductions take your AGI down to $18,000, they will consider you to be making $18,000 annually. (In New York, applicant(s) for an apartment lease must show AGI of 40x the rent annually, so you'd need $60,000 of income to qualify for a $1500/mo apartment. Once you have a lease in place, it's less important.)
Something new I'm trying this year is paying taxes quarterly. Instead of getting a bill in April, I can pay estimated taxes four times per tax year. This is popular among real estate agents, whose entire income is 1099 (Fun fact: I'm a licensed NYS agent!).
QuickBooks allows you to pay online if you upgrade to a more expensive plan, but it also helps you fill out a 1040-ES voucher to send to the IRS for free. There are other ways to pay online that aren't as expensive, detailed in the official IRS 1040-ES file here.
I'll let you know if this was a good idea next January...
Any Other Ideas?
I've only been at this for a couple tax years, so if you have any other sage advice for the young taxpayers please comment below! I'd love to hear about any other strategies people are using to make their taxes suck less.