December 22, 2011, 10:16 AM —
Rumor has it that there's a slight uptick in women in the United States having labor induced in the last week of December, for the most logical of reasons: financial. Every child represents money you can deduct from your taxable income, and even if your baby is born at 11:50 p.m. on December 31, 2011, you still get the full benefit for the 2011 tax year. If you're due around that time anyway, well, you can see where the impulse to cheat a bit would come from.
Of course, if you aren't heavily pregnant right now, gaming the system in this way isn't an option for you. But if, like a growing number of techies in the United States, you make at least part of your income from freelance work, there are some tricks that can help save some tax money that also hinge on working the calendar. But don't delay: some (though not all) of the suggestions here involve figuring out a plan by December 31st.
Why December 31st matters: Our progressive tax system
If you don't know much about taxes -- and let's face it, most people just sort of glance at what gets taken out of their checks every other week, fill out their 1040 with TurboTax, and hope for the best -- then the idea of worrying about when your income happens might seem kind of strange. A dollar you earn this week should cost you the same amount in taxes as a dollar you earn next week, right? Well, not if this week is in 2011 and next week is in 2012.
The U.S. Federal government (along with most states that have income taxes) has what's known as a progressive tax system. Essentially, as your income goes up, you pay not just more in taxes in absolute terms, but a higher percentage of your income. The percentage sort of stair-steps upward. For instance, if you were a single person in 2011, your first $8,500 of taxable income is taxed at 10 percent, the next $26,000 at 15 percent, then next $49,100 at 25 percent ... and it goes on from there. These income bands are called brackets. (The exact numbers can be found on page 6 of this form from the IRS.)
Since the numbers used to calculate annual income are set by your earning within a calendar year, you can pay different amounts of taxes depending on how the same total income is distributed across multiple years. For instance, if you made $33,000 in taxable income in both 2011 and 2012, you'd end up paying $4,525 in federal income tax in both years. But if you made $28,000 in 2011 and $38,000 in 2012, you'd pay $3,775 the first year and $5,625 the next -- owing $350 more over the course of the two years. That's because in 2012 you'd have more income over the line into the 25 percent bracket.
Freelancing puts you in the driver's seat (a little)
Most of this information is pretty academic to someone who works a regular 9 to 5 job; their income comes in identically sized paychecks every other week, with an occasional raise if they're lucky. But if you've struck out on your own as a freelance developer, you don't just get to be in charge of your working hours, the development tools you use, or how late in the afternoon you finally change out of your pajamas: you also have a bit more control over when you get paid. And as you saw above, the year in which you get paid can affect how much you pay in taxes.
The simplest way to manipulate your income timing is via your relationship with your clients. If you're about to cross the threshold into another tax bracket, and you'd like to push off some income until next year, just wait until January to invoice on work you've finished in late in the year. Your clients will be more than glad to wait to pay you. Conversely, if you feel in your bones that next year is going to be quite a bit more lucrative for you than this year was, invoice promptly to get as much income in at the end of the year as you can (though anyone who's freelanced knows that getting paid by clients quickly is no simple matter).
In general, your best bet is to try to make your income as smooth year-over-year as possible, as the progressive tax system will take bigger bites out of high income spikes. But depending on how close you are to the thresholds of different brackets, your mileage may vary, so do a little math to see if how things might work out for you. (Yes, this will involve predicting future income -- always risky business -- but at least give it a shot. Math is fun!)