Year-End Tax-Planning and Deferred Income Tips for the Self-Employed

You Can Defer or Accelerate Both Income and Deductions

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Freelancers and other self-employed taxpayers have several strategies available to them to help mitigate the cost of some taxes and to optimize their tax situations between current and future years.

You can accelerate or defer income, as well as accelerate or defer deductions. But this means making some important decisions as the year draws to a close.

Learn more about tax strategies that can benefit you as a freelancer or self-employed worker.

The Cash Method of Accounting

The timing of income and deductions depends on a self-employed taxpayer's accounting method. The majority of self-employed workers and many small businesses use the cash method of accounting.

This means that you would include in your gross income money that you actually or constructively received during the tax year. "Constructively" means that income is credited or made available to you without restriction, such as a check you receive in December that you don't deposit until January.

You could have deposited it when you received it. But if that check was postdated for January, your control of the money is subject to restriction. 

According to the IRS, income is constructively received if your control of its receipt is not subject to substantial restrictions or limitations.

Deductions are somewhat different. You have no choice but to deduct them when you actually pay them, but you do have some flexibility as to when you pay them.

How Acceleration and Deferral Work

Accelerating income and deferring deductions increases the amount of income that's taxed in the current year.

These can be useful strategies if your income falls into a lower tax bracket this year compared, but you expect you'll be in a higher bracket net year. In that case, you want as much income as possible to be taxed at this year's lower rates.

  • Accelerating income means trying to bring in more money in the current year. Target income that's on the cusp so you might feasibly receive it by year's end.
  • Accelerating deductions means spending money on expenses that will generate a tax deduction now rather than next year. 
  • Deferring income means postponing or delaying the receipt of certain revenues until a future year. Again, target income that's on the cusp so it might reasonably be postponed until next year.
  • Deferring deductions means holding off on spending money on tax-deductible expenses until next year, or even later years when those deductions might be more advantageous to your tax situation.

These four tactics revolve around the proper timing of paid income and the use of deductions for tax-related purposes.

To Increase Income This Year To Decrease Income This Year
 Accelerate Income Defer income
 Defer deductions Accelerate Deductions

Income Acceleration Strategies, Benefits, and Risks

Accelerating income to this year could result in that income being taxed at a lower rate if you're in the 22% tax bracket this year and you expect that you'll be in the 24% bracket next year. Strategies for accelerating income include:

  • Ask clients or customers to pay now.
  • Call or write those who are behind in paying your invoices and collect sooner rather than later.
  • Ask for larger up-front payments for projects that will span this year and next.

Not only does this accelerate income, but it will also clean up your accounts receivable.

But there's a caveat—tax brackets are based on the amount of your income, so taking in too much income this year could possibly push you up into that 24% bracket this year.

You want to increase your income as much as possible without pushing yourself into a higher tax bracket.

Income Deferral Strategies and Benefits

You might want to push your income into a lower tax bracket by deferring income to the following year if you're in the 24% bracket this year but expect to be in the 22% bracket next year.

Keep in mind that tax brackets creep up marginally each year to keep pace with inflation. The difference typically isn't huge, but tax brackets in each subsequent year generally accommodate slightly more income than they did the year before.

This can be another good reason to nudge some business income forward. When you reach the top of your uppermost tax bracket, why go over and pay a higher rate if you can defer that income to the next year and possibly be taxed at the same rate?

Strategies for deferring income include:

  • Avoid trying to collect delinquent accounts until the calendar flips over.
  • Ask for smaller up-front payments for projects that span this year and next.
  • Send out December invoices after Jan. 1.

Deduction Acceleration & Deferral Strategies

To accelerate your deductions, buy equipment and supplies this year instead of next year.

Computers, software, vehicles, furniture, and other types of equipment are either depreciated over multiple years—which in itself is a form of deduction deferral—or they can be written off immediately using the Section 179 deduction.

Section 179 allows businesses to claim up to a $1 million in deduction for qualifying new or used equipment. You must place the equipment in service in the current year if you use the Section 179 tactic. 

Other deduction acceleration strategies include:

  • Stock up on office supplies.
  • Pay bonuses to your employees this year rather than after the first of the year.
  • Pay fourth quarter payroll taxes in December rather than in January.

To defer deductions until next year, you'll want to use the opposite strategies:

  • Put off investments in computers and other equipment until next year
  • Wait to stock up on supplies and other office necessities if possible.
  • Pay bonuses to your employees in January instead of December.

Self-Employment Taxes

You'll also want to keep an eye on the self-employment tax, which consists of two components: Social Security and Medicare. Typically, employers pay one half of these taxes on behalf of their workers, but you must pay both halves yourself if you're self-employed.

According to the IRS, you can deduct the employer-equivalent portion of your self-employment tax in calculating your adjusted gross income.

You need to pay self-employment taxes and file Schedule SE with your tax return if your net earnings from self-employment exceed $400 or your church employee income is $108.28 or more.

The Social Security Tax

The 12.4% Social Security tax stops when a taxpayer's income exceeds $142,800 as of calendar year 2021. For 2022, that t has been set at $147,000. Annual income over this amount isn't subject to the tax, but your earnings start at zero again and the tax kicks back in on Jan. 1.

Consider accelerating income if you're close to this threshold because anything you earn over this amount would be spared this tax whereas it might not be next year.

The Additional Medicare Tax

The Additional Medicare Tax is 0.9% on top of the 2.9% Medicare tax that's included as part of the self-employment tax.

As of 2021, it applies when your income reaches:

  • $200,000 for single filers or head of household filers
  • $250,000 for married couples filing jointly
  • $125,000 for married couples filing separately

This additional tax is assessed on the combined Medicare wages and net self-employment income for both spouses if you file jointly with your spouse.

Avoid accelerating too much income if you're considering an income acceleration strategy, potentially pushing yourself over the threshold to the point where this Additional Medicare Tax would come due.

Self-employed taxpayers whose incomes are near the thresholds for the Additional Medicare Tax might want to consider deferring income if it will keep them below the threshold for both this year and the next. 

Review Your Retirement Plan

Self-employed people have several options when it comes to retirement plans, including SEP-IRAs, SIMPLE IRAs, and 401(k) plans.

SIMPLE plans must be established before Oct. 1, and 401(k) plans must be established by Dec. 31.

Contributions to an IRA can be made up until April 15 of the following year. SEP-IRA contributions can be made until April 15 or till the date of any extension you have sought to file your tax return.

Keep an eye on these dates to want to make tax-deductible contributions at the most opportune time.

Your Choice of Business Entity Matters

Freelancers often work for themselves without any formal business structure. That might be a fine fit for your needs, but there are other possibilities. Consider forming:

  • A corporation
  • A partnership
  • A limited liability company
  • Another formal structure

Entrepreneurs who are working under one type of structure might want to review whether a different business structure could be more advantageous for them tax-wise because each has its own tax advantages and disadvantages. Consulting with a tax professional can help determine what's best for you.

For example, the Tax Cuts and Jobs Act provides for a Section 199A deduction, the Qualified Business Income (QBI) deduction, that allows certain businesses to shave 20% off their annual incomes beginning in 2018 and going forward.

For 2021, the threshold amount for this deduction is $329,800 for married filing joint returns, $164,925 for married filing separate returns, and $164,900 for all other returns.

Many sole proprietorships and partnerships are eligible, as are S corporations and limited liability companies, but C corporations are not eligible—something to keep in mind if you would otherwise qualify for this deduction.

Estimated Tax Payments

You'll also want to set up a plan for tax payments that are due next year because the IRS prefers to be paid as you earn. This includes the fourth estimated tax payment, which is due by Jan. 15.

An extension payment, if any, is typically due by April 15, and the first estimated tax payment for the new year is also due on April 15. Quarterly estimated tax payments are normally due by:

  • April 15, June 15, and Sept. 15 in the current year
  • Jan. 15 of the following year

These dates might be extended by a day or two in some years if the 15th of the month falls on a weekend or a national holiday. 

Get a preliminary idea of what your tax liabilities will be this year so you have an idea of how much you should set aside for this year's and next year's taxes.

Frequently Asked Questions (FAQs)

I am self-employed and pay taxes at year-end. What is my tax form?

When you you file your income tax return you file a Form 1040 or 1040-SR. You will report your business income and expenses on Schedule C of this form. As a self-employed person, you would need also to fill out Schedule SE of Form 1040 if your net earnings from your self employment exceed $400 for the year of if your church employee income is $108.28 or more

Do self-employed pay tax at the end of the year?

The IRS urges tax payers to use a "Pay As You Go" tax strategy, meaning paying most of the taxes through the year rather than paying them at the end of the year. This can be done by correctly withholding taxes from your income and making quarterly estimated tax payments. Estimated tax payments are typically due on April 15, June 15, and Sept. 15 in the current tax year and Jan. 15 of the following year.