For many first-time freelancers, tax season can be a rude awakening—making them keenly aware of how their self-employed status impacts their tax situation.
If your freelancing business is less than a year old, there’s nothing quite like filing your first tax return as a freelancer to give you a quick (and sometimes painful) education about what you need to do to keep Uncle Sam happy. To help you through the process of figuring out your obligations this tax season and in the future, consider the following tips.
1. Be clear about what kind of return you need to file.
If you established your freelance business as an LLC (or you have yet to establish a business entity because you moonlight as a freelancer and feel you aren’t “big” enough), then you will report your income and make your tax payments on your annual individual return (Form 1040) typically using Schedule C or E if it’s real estate related. However, if your freelance business is structured as a multiple-member LLC, a partnership, or a corporation you will need to file a separate return for your business such as a partnership return (Form 1065) or a C-corp (1120) or S-corp return (Form 1120S), respectively. Don’t forget the corresponding state and local forms as well.
2. Keep your clients on track when it comes to 1099s.
If you make $600 or more from any one client, you must report the income on your personal tax return using the 1099-MISC form that each client should provide to you with a listing of how much they have paid you for the year. If you do not receive a 1099 from a client with billings of more than $600 by February 2 of this year, you need to follow up with them and request one. Don’t forget to file 1099-Misc if you hired other freelancers to work for you.
3. Remember you are responsible for self-employment tax and income tax.
If your freelance business generates over $400 annually, you have to pay self-employment tax in addition to income tax. This often comes as a surprise to many freelancers.
If you work for yourself or as a 1099 contractor, you are essentially double-taxed as both an employer and an employee. Generally, the amount subject to self-employment tax is 92.35 percent of your net earnings from self-employment. You calculate net earnings by subtracting ordinary and necessary trade or business expenses from the gross income you derived from your business.
Note that you can be liable for paying self-employment tax even if you currently receive Social Security benefits. If you didn’t set aside enough tax money to cover this obligation in 2014, start setting aside your 2015 tax money now—ideally in a separate savings account you won’t be tempted to touch—this will eliminate any surprises next tax season.
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4. Keep on top of your quarterly estimated payments.
In addition to putting money aside to cover self-employment tax as noted above, you should also be putting aside money out of every freelance payment you receive so you can pay your quarterly estimated taxes which are due on April 15, June 15, and September 15 and January 15.
If 2014 was your first year in business, you may not have been able to estimate your tax payments accurately because you lacked the income history to do so. However, let this year’s tax return be your guide for how much money you should be setting aside and how much tax you should be paying each quarter for this current year.
5. Itemize and record your business expenses.
Tax write-offs! The very phrase can bring a smile to the lips of even the most stoic freelance professional. While there are available tax deductions, it is important to be aware of the rules regarding them. For example, to qualify for a home office deduction the room you consider a home office, it must be used it solely for business-related activities. If you do have a dedicated home office, you can also deduct a portion of household expenses like mortgage interest, rent, utilities, and insurance based on what percentage of the square footage of your home is made up by your office.
6. Commit to solid recordkeeping.
If you’re scrambling this tax season to put your hands on all of the receipts for your expenses and the records related to your income and tax payments, make a resolution to set up a solid record-keeping system going forward. It will save you time and stress in the long run, whether you continue to do your own taxes, or if your business grows to the point that you need the help of a tax professional.
7. If you’re struggling, enlist help.
While the first year of any business venture can be challenging from a cost perspective, if you’re spending your billable time struggling to calculate your taxes—or you don’t have time to do them—then hiring a CPA (especially one that specializes in freelance businesses) can be well worth the money. A good CPA will be able to ensure that you are taking advantage of all possible tax deductions and credits and give you advice on how to structure your business and personal finances to lower your future tax bills. Plus, a CPA’s professional fees are tax deductible, so the benefit you’ll receive from working with a tax and financial expert will far outweigh the cost.
Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for consultants across the country. His website, www.cpaforfreelancers.com, has a resource section with how-to articles and information for freelancers.