A simple 5-step tax strategy for moonlighting freelancers
Are you a freelancer who still holds down a regular job? If so, tax time is of special importance to you. Having a “side business” can make filing your taxes a little more complicated, but if you follow the steps below, you’ll be in good shape when it comes to knowing what to report, how to report it, and how to streamline the handling of your freelance taxes.
1. Report all of your income.
Above all else…if you earned money “on the side” it needs to be front and center on your tax return. It should also be clearly separated from the “regular” income you earn from your employer. Your regular income will be reported on Form 1040. You will need to complete a Schedule C or a Schedule C EZ if your income is $5,000 or less, you don’t have employees, and you don’t plan on claiming the home office deduction, which is covered in step three.
For those new to freelancing in the past year, use the 1099-MISC forms that you received in the mail from your clients to begin calculating your income. A 1099-MISC is what your client sends to the government to report what they paid you, so these forms are important. Keep them and use them to verify your freelancing income. In addition, remember that you have to report all your income, even if your client didn’t send you a 1099 (their mistake if they paid you more than $600).
2. Account for any tax you have already paid—or should have paid.
If you are a regular moonlighting freelancer, you should have a system for tracking, and a plan for paying, your estimated taxes. For those new to freelancing, the requirement for paying estimated taxes is either 90 percent or more of the tax for the current year or 100 percent of the tax shown on the previous year’s return to avoid a penalty.
For those claiming an adjusted gross income in excess of $150,000, the percentage rises to 110. If you didn’t pay estimated taxes on a quarterly basis in 2014, then you may have to pay a penalty when you do file your taxes, courtesy of the IRS.
You are also responsible for paying self-employment tax on your income which includes Social Security and Medicare taxes. This is another obligation that catches many moonlighting freelancers off guard because an employer generally pays 50 percent of these taxes and takes care of making these payments on an employees’ behalf through withholding on each paycheck.
As a freelancer, you should also check to see what the maximum taxable income for social security tax payments is so you can keep this in mind when calculating your estimated tax payments. For the 2014 tax year, the maximum taxable income for social security payments is 117,000. In 2015, this maximum rises to 118,500.
Consider that the Social Security tax rate for a self-employed freelancer is 12.4 percent and the Medicare tax is 2.9 percent of gross income, and you can begin to understand how some freelancers fall behind on their tax payments, especially if their income is variable throughout the year.
Going forward, it may be beneficial to consult with a tax professional to determine whether you should continue waiting until the end of the year to tally up your taxes or make some adjustments to better manage your cash flow so you can afford to make your estimated payments when they are due. Alternatively, if your freelancing income is modest, you may wish to adjust the tax withholding on your full-time paycheck to compensate for your additional income in lieu of making estimated tax payments.
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3. Determine the tax deductions and credits you’re claiming.
Now for the good stuff—claiming any tax deductions or credits to which you might be entitled. Like your freelance income, you need to ensure that you keep all of your freelance expenses separate from those you are claiming on your personal return or for reimbursement from your employer.
Your deductible business expenses will be claimed on Schedule C of your tax return. Examples of deductible business expenses include advertising, insurance, legal and professional services, and office expenses. Check the IRS guidelines, or with your tax professional for a full listing of potential deductions.
You may also wonder if you can claim a home office deduction as a part-time freelancer. The short answer is, yes, you can—as long as you qualify for it. The IRS stipulates that in order to claim the home office deduction, you have to use the space in your home regularly and exclusively for your own business purposes. Keep in mind, too, that 1) your business must be profitable; and 2) your annual tax write-off cannot be greater than your annual business income to be able to claim a home office deduction.
For those that qualify for the deduction, the IRS gives you two options for calculating it: the “regular” method and the simplified method.
The “regular” method requires you to determine the actual expenses of your home office such as mortgage interest, insurance, utilities, repairs, and depreciation. Any potential deduction is also based on the percentage of your home devoted to business use. Therefore, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to business activities.
The simpler option for claiming the home office tax deduction was introduced in 2013 and applies to tax returns filed in 2014 and beyond. This method allows for a standard deduction of $5 per square foot of home used for business to a maximum of 300 square feet.
4. Finalize, file…and file again.
When you have a “regular” job, it is relatively easy to keep track of your earnings and the taxes you have already paid, thanks to the handy W-2 that you receive. When you add moonlighting to the mix, you take on not just additional income, but additional documentation obligations as well.
Once you finalize your tax return and file it for this year, you still have some tax tasks to do. Spend time ensuring that all of your supporting documentation including 1099s, your own accounting records, and receipts for any deductions you have claimed or tax payments you made are filed and easily accessible should you need to refer to them in the future.
For all freelancers, keeping meticulous records is critical. In the event of a tax audit—the likelihood of which dramatically increases for individuals who file a Schedule C with their personal tax return—the burden of proof is on you, so having your records complete and well-organized will make things much easier on you.
5. Plan for the future.
Depending on the direction you want your freelancing activities to take in the future, you may wish to establish a more formal entity for your business. If you plan to gradually transition to a full-time freelancer, you’ll want to consider formally registering your business as an LLC or other type of legal entity, depending on your situation, to reduce your personal liability risk related to your business activities.
If you find filing your taxes as a moonlighting freelancer complex, take a look at refining your ongoing record-keeping system to make it easier to track your income, expenses, and tax payments. For those planning to expand their part-time freelancing into a full-fledged business, outsourcing your bookkeeping to a CPA firm and working with a financial professional to do tax planning throughout the year can be beneficial and save you money in the long run.
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.