Even more than most years, 2020 was tough for media workers. Newsrooms cut some 16,000 jobs, and many of us went from working full-time to striking it out on our own.
Among other changes, working independently means a drastically different tax situation than a full-time employee faces. I’ve found myself confused about this world and spent much of 2020 pushing off thinking about it, reminding myself I’d figure it out by April.
Eventually, I decided to consult an expert about the tax dynamics facing freelancers in 2021. That expert is Greg Geisler, a clinical professor at Indiana University’s Kelley School of Business. Dr. Geisler, a CPA who teaches courses on tax and financial planning, let me pepper him with questions about confronting tax season as an independent worker.
Our conversation below is lightly edited for length and clarity.
I see a lot of tax advice online for people who are “freelance” or “self-employed.” The terms are often used interchangeably. Is there any difference for tax purposes?
The terms “freelance,” “gig worker,” “self-employed,” “independent contractor” — they all mean the exact same thing. You’re either an employee or you’re not.
If you’re an employee, your employer withholds federal income tax, state income tax, local income tax if you have it. Your employer also withholds Medicare tax and Social Security tax. You get a W-2 form that outlines all these different taxes at the end of the year. It’s all very simple and very easy.
But if you’re any of the other terms we just talked about, you are — under the tax law — self-employed, and you have to file what’s called a Schedule C, which is called the sole proprietor’s form. Basically, you’re your own business, and there are advantages and disadvantages to being your own business.
The major advantage is that you can deduct any business-related expenses that the tax law allows. The disadvantage is you have to pay all of the Medicare and Social Security tax — both the employer side and the employee side. You never realized it when you were an employee, but the amount taken out of your paycheck, the employer had to double that. So when you’re self-employed, you pay both sides of that. They don’t call it Medicare and Social Security taxes. They call it “self-employment tax,” but that’s exactly what it is.
You’re on the hook for all of that when you’re self-employed, and that’s what surprises many people who are self-employed. They think, “Oh, if I do something and get a thousand dollars, I’ve got a thousand dollars minus income taxes I have to pay.” That’s only partly correct.
You’ve got to also subtract all the self-employment tax you have to pay, and the rate on that for most people is 15.3 percent, so that’s a lot of tax.
The other surprise for me has been about when I pay my taxes as a freelancer. Of course, Tax Day is April 15, but there’s no withholding throughout the year on a lot of my income as a freelancer. I had previously thought I’d just pay all that tax on April 15, but my accountant tells me that’s not the case. Can you explain how this timeline works?
You have to be attentive to self-employment tax throughout the year, and the way to do that is to make four estimated tax payments. It’s Form 1040-ES. “E” is short for estimated tax payments, and the due dates are April 15, June 15, September 15, and then January 15 of the next year. You’re supposed to pay one quarter of the total tax at a time, which is both self-employment tax and federal income tax, by each of those dates.
And then you do the final accounting of what you owe by April 15, and pay the balance if it's more than you had estimated (or get a refund if you overestimated!). We have a “pay as you go” system. We don’t have a “wait until April 15 next year and pay everything you owe” system.
These estimated tax payments are how as you pay as you go.
Let’s say I lost my full-time media job last year, was slow to get my life together, and did occasional freelance work over the summer but didn’t know to pay estimated tax. Is the IRS coming to break down my door?
You’re not in that much trouble. They will, however, send you a bill after you file your taxes, saying, “You should have paid this much.”
Now, let’s go through the specific scenario you just gave. You were self-employed the whole year, and you did not know about the estimated tax payments. You will owe a relatively small underpayment penalty because you didn’t pay as you go like you were supposed to. They will just send you a bill in the mail after you file your taxes for 2020.
You could figure out that underpayment penalty amount and add it to the amount you pay in taxes all at once, but most people just let the IRS bill them.
What does sound fun to me, as a freelancer, is writing off expenses related to work. My understanding is I can be very aggressive about write-offs. Is that correct?
That is correct. You deduct an expense so it reduces your income — it’s your net profit for the year that’s subject to both income tax and self-employment tax.
What’s the threshold at which something is a business expense? Do I have to use it X percent of the time for work?
That would apply to something like a computer. If you used it exclusively for work, you could deduct 100 percent of the cost. If you game on it half the time and use it for work half the time, then your deduction would be 50%.
On the Schedule C, you list all your self-employment income and then subtract your allowable deductions to get your net profit for the year. That’s exactly where you’d do it: on the Schedule C.
Can I deduct union dues?
If you pay dues, you are usually an employee. Employees cannot deduct any of their business expenses under current tax law. They used to be able to, but they have not been able to since 2018, so that goes back to the big advantage of being a sole proprietor / freelancer / gig worker. You can deduct your business-related expenses.
So if I’m not employed but pay dues into a union, I can deduct those.
Yes. To the extent the union dues were related to your self-employment, you can deduct them on your Schedule C. The union dues back when you were an employee, you cannot deduct.
What about my health insurance premiums? Are they deductible?
You do not deduct your health insurance that you pay out of your own pocket on your Schedule C, sole proprietor tax return. But since you’re the owner of the business, you can deduct those from your total income, so those do end up reducing your income that is subject to income tax.
It does not reduce how much is subject to self-employment tax (that 15.3 percent tax that goes into Medicare and Social Security) on your business tax return, which in the case of a freelancer would be the Schedule C.
Does that extend to anything I might pay out of pocket for healthcare, like a copay?
These are deductible as itemized deductions. That’s a separate category of deductions, and 95 percent of U.S. taxpayers don't have any tax deductions for their copays and deductibles if they’re self-employed.
Because most of us take the standard deduction ($12,400 for a single filer in 2020).
On any of these expenses, what happens if I didn’t rigorously keep all my receipts? Am I out of luck?
Quite simply, you want to go back and do your best to reconstruct them and take any deductions you’re entitled to. But if the IRS ever audited and asked for those receipts and you did not have any, you would lose the deduction, and you would have to pay more tax plus penalty and interest. So the takeaway is: Once you’re not an employee, keep all of your receipts for business-related expenses.
Could I find the prices from a store where I made a purchase, cross-reference that with my credit card statement, and determine an expense that way?
You’re right. Each year, you would do your very best to construct your actual business-related expenditures and include that in your tax file, whether that be a paper file folder or electronically. Yes, calculate all of your expenditures that are allowable as deductions for your business.
I had income from eight or nine sources last year. How do I inform the government and make sure they’re all properly accounted for, other than adding up the money myself?
That is very common in this new economy we’re in. For most of the organizations you have done work for, if you were paid more than $600, they’re supposed to inform you of the annual amount by sending you a Form 1099-NEC and send a copy to the federal government.
So when the IRS gets your tax return, they will have already added up all of the Form 1099s that they have with your Social Security number on them. And if you don’t report at least that much income on your Schedule C of your Form 1040, they’ll send you a letter saying, “Why didn’t you report what appears to be all of your income?”
Do I also need to submit a copy of that 1099?
You’re good simply saying what you made, period. You do not have to include all of your 1099s from your non-employee compensation along with your tax return. You just have to be sure your accounting matches what those employers reported to the IRS.
The thing that kicked off my weird tax year is that I lost my job and then got a union-negotiated severance payment. Some colleagues of mine are under the impression that severance is taxed differently than other income. I have not found anything that substantiates this notion. Can you clear up for me how severance is taxed?
The reason you did not find anything is because you are right: Severance is not treated any differently than any other income. It’s all regular, or as the lax law calls it, “ordinary income.”
A few colleagues of mine have created one-person LLCs through which they handle their business income. What is the practical benefit of that for a freelancer, other than perhaps creating a shield from liability?
Generally, there’s no tax benefit. It’s for legal liability purposes that you incorporate under state law or set up an LLC under state law. You report all of your income and all of your allowable business expenses whether you’re a sole proprietor and don’t formally organize under state law, or you do – as an LLC or a corporation.
What is the biggest tax mistake you see people in this bucket – freelance, self-employed, sole proprietor – make? And how do you recommend not making it?
You want to deduct business use of your automobile. So, you want to use an app that keeps track of every time you have business use of your automobile. And then, generally, you’ll save the most tax if you just take the standard mileage deduction, which varies every year but is approximately 57 or 58 cents per business-related mile. So if you’re going to the grocery store, that’s personal use. You cannot deduct that. If you have an office and you drive to the office and back, you cannot deduct that. But if you’re doing any use of your automobile related to writing articles or driving to meet a client or whatever the self-employed person does, that is deductible.
What if I drive to the grocery store, and on my way back, I stop for a business meeting?
The drive from the grocery store to the business meeting is deductible. The drive from where you live to the grocery store is not deductible.