What You Should Know About Taxes When You Are a Freelancer
Freelancing not only changes the way you work; it also changes the way you manage your money. One area that needs special attention when you are self-employed is your tax return.
This post was originally published on MyBankTracker .
To be successful as a freelancer, you must treat it like a business in terms of marketing yourself and how you treat your clients. The same idea applies to your taxes, as you are solely responsible for ensuring that the IRS receives the correct information. When I first started working as a freelancer, I paid only vague attention to taxes, since from the very beginning I did not earn that much. Over time, I learned more about how freelance taxes work and the following 10 rules every newbie should remember.
You can’t always rely on information 1099
When you work for a company as a paid employee, they are responsible for calculating your income for the year. These are listed along with the taxes you paid on your W-2. As a freelancer, you consider yourself an independent contractor, which means you will be issued 1099 at the end of the year.
If you solely rely on 1099 to find out how much money you have made, you are at great risk. There is always a possibility that the client missed a payment or made a mistake in the calculations. If you are filing your tax return on the basis of incorrect information, you may be in for a nasty surprise if the IRS decides that you really owe more money. Keeping your own records is a smart move to avoid mistakes.
I use a basic spreadsheet to track my income throughout the year. Specifically, I note what it was for the project, which client it was for, the amount, billing and payment date, and my net income after deducting any PayPal or bank fees. It’s a fairly simple system, but it has proven to be effective. I once had a client who sent in 1099, which was several thousand dollars short, and thanks to my spreadsheet, I was able to catch the error right away.
The IRS Will Know If You Don’t Report Income
Understating or missing income on your tax return is a serious prohibition and it would be a mistake to think that the IRS will not understand. First, when a client mails you 1099, they also mails a copy to Uncle Sam, so if you don’t list one at tax time, your records won’t match what the IRS already has.
Even if you have a client who is not trying very hard to keep records, this does not mean that you should take the risk and not report your income. One year I had two different clients who never released 1099, even after I contacted them about it. It made us a decent amount of money, and while it was tempting to just forget about the message, I made sure it shows up on my return.
Separate accounts are the best option
If you’ve worked as a freelancer for a while and haven’t opened separate bank accounts for your business and personal expenses, this should be at the top of your to-do list. First, it makes documentation easier. You can easily see all of your annual income and any expenses you incurred for the business, not excluding what you spent on groceries or meals.
Another reason to keep things separate is to keep yourself safe in the event of an audit. If something about your taxes is confusing to the IRS, having separate bank statements for your business makes it easy to back up your income information.
You may have to pay indicative taxes
When you receive a regular salary, your employer is responsible for withholding the applicable tax amount. As a freelancer, you may need to make settlement payments four times throughout the year, starting in January. These payments are designed to cover your projected tax liabilities, so you won’t receive a large bill by April 15th.
You are generally not required to make estimated payments if you did not owe any taxes in the previous year, you expect your total tax payable for the current year to be less than $ 1,000, or your federal withholding tax from the previous year is 90 percent. about what you think you should. Keep in mind that if you fail to make the estimated payments within a year and end up paying taxes when you apply, you may face an underpayment penalty.
Your tax liability is calculated differently
Freelancers are responsible for paying income tax, but you must also pay self-employment tax. This is an additional tax to cover social security and medical benefits that a traditional employer would normally withhold. For tax year 2015, the self-employment tax rate is 15.3 percent for income up to $ 118,500. The maximum you have to pay in self-employment taxes per year is $ 14,694. This is on top of what you owe at your normal income tax rate.
There are clear rules for deductions
The IRS has very clear rules on what you can and cannot deduct from your taxes. Calling the corner of the living room where your laptop is located is probably not a home office.
Generally, for something to be considered a deductible business expense, it must be reasonable and necessary. This can apply to things like a new laptop, business cards, or travel expenses if they are a direct result of your freelance work. If you are in doubt as to whether some of these are appropriate, it is best to consult with a tax expert, or ignore it at all.
Entries are required
Every time you plan to deduct something from your taxes, you will need a receipt or other documentation to back this up, and this is especially true when you are freelancing. Collecting all of your receipts in a shoebox is a way to keep your physical receipts in one place, but using a program like Quickbooks reduces the clutter.
The software has many features that freelancers love, including the ability to sync it with your bank account, track your expenses, create individual invoices, and pay bills. The most basic version costs $ 13.99 a month, but if you don’t have the money to spare, you can still keep track of your spending with a free app like Expensify.
Your audit risk may increase
The word ” tax audit ” is enough to make someone shudder, and while they usually only affect a small percentage of the population, freelancers may be more receptive. Statistically, completing Table C on your taxes increases the likelihood of being hit by an audit two to four times. The chances of hitting the mark increase depending on how much money you make, so this should be kept in mind when expanding your freelance business.
You have retirement opportunities
Self-employment has many benefits, but unfortunately, a retirement plan is not one of them. Fortunately, there are several options to help you build your nest while earning some tax breaks.
For example, as a member of the Freelancers Union, I am eligible to participate in the Individualized 401 (k) program, which offers higher annual contribution limits than the traditional or Roth IRA, and the ability to deduct money from my income. Technically no match for employer, but I can throw off $ 53,000 in cash as an employer and employee in 2015. Not only can I put it off for the future, but in the meantime, I can get a tax credit by demanding a withholding.
Sometimes it’s worth hiring a professional
Filing tax returns can be tricky if you are dealing with W-2 and standard deductions. When you add business expenses, estimated charges, and self-employment tax, it can be even more challenging. If your freelance business is really picking up steam, or you still don’t have the best documentation, paying a tax expert to take care of you can be a smart investment.