Freelancers experience a lot of freedom in running a business, but when it comes time to do your taxes without the support of an employer, that freedom can feel like a chokehold.
Fortunately, freelance tax preparation doesn’t have to be agony with these simple, yet incredibly handy tips from a certified public accountant.
Gather royalties and other income: Just in case your lack of a boss hasn’t made it clear, freelancers are not employees. Nobody takes the taxes out of your paychecks and it’s up to you to report your income to the IRS. All of it. When you earn $600 or more from any business or individual, you will be issued a 1099 MISC form, which reports how much they paid you for the year.
Old fashioned ledger, online software such as Quickbooks or app-based tracking like Mint, or straightforward Excel spreadsheet. If money entered your hands, (yep, you have to report cold cash, too) your bank, or third party payment accounts like Paypal and Square, it’s on you to report.
Hardcopy expenses: Christina Mercer is a former CPA and author of the forthcoming book Bean Counting for Authors. She recommends that you have a dedicated bank account and/or credit card for your business. “This helps to ensure that all of your business transactions can be tracked using statements from those accounts,” she says. Furthermore, “it helps legitimize a business in the eyes of the IRS, potential lenders, and business clientele.”
After you determine income, and before you panic about how much you think you owe, don’t forget to deduct your expenses, which will help you to determine your net taxable income. While you might think you have a really good memory for expenditures, you don’t want to take your chances in case of an audit.
Mercer recommends you keep receipts, and print all statements from banks, credit cards, or online third-party payment processors that contain business transactions and store them in a folder labeled by tax year. After all, tax returns can be amended or contested for up to three years after filing.
Sales taxes: Mercer wants to make clear that in any business where you re-sell goods (purchased at wholesale, for example, or an author selling her own books), “Depending on the state where a freelance creative does business, re-selling of goods may require Sales and Use Tax reporting.” This is usually done through the state, and each state will have its own rules.
What is a legitimate deduction? How do you determine what a legitimate deduction is for a freelancer, from one that will raise the scolding brow of an IRS agent?
Mercer explains, “Legitimate deductions are for those necessary expenses that are helpful and appropriate for your trade or business.” She gives the example of a freelance writer: “There are a number of common expenses writers in general will incur—pens, paper, software, website upkeep, laptop, etc.—and more specific expenses for each type of writer and/or how a writer is published (writers who serve as their own publishers will also incur the costs of publishing). Most commonly, freelance writers are sole proprietors who will file a Schedule C with their personal tax filings.”
Two overlooked deductions: What tax deductions do freelancers frequently miss out on? Mercer has found that there are two deductions freelancers often don’t know about: auto mileage, and home office deductions. “Miles driven for business purposes, including running to the office supply store, meeting with an editor or critique partner, can be expensed at 57.5 centers per mile for the year of 2015.” The mileage deduction rate is adjusted each year by the IRS.
For your home office, Mercer explains that via the “Simplified Method,” a deduction can be taken “for up to 300 square feet of space dedicated for business purposes in the home.” The square footage of the business space is multiplied by $5 to arrive at a total allowable deduction of up to $1500.
For a more comprehensive deduction, freelancers can use the Regular Method, which allow you to deduct a percentage of rent or mortgage paid, but you must determine the actual expenses of the home office. According to the IRS, “These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. Generally, when using the regular method, deductions for a home office are based on the percentage of your home devoted to business use. So, 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 your business activities.”
In this instance, you must also meet two requirements: 1) Regular and exclusive use of the office for nothing but business, and 2) It is your principal place of business.
Did you pay any independent contractors? Remember those 1099s that you received from people and businesses that paid you? Well now it’s your turn: if you paid any independent contractor $600 or more for the year, you also have to send a 1099 to each person by January 31st.
Mercer says forgetting to send these is one of the biggest tax mistakes she sees creatives and freelancers make. In case you’re not sure which people you might need to send these to, it’s for anyone who works as an independent business, not a corporation: The person who updates your website; your accountant; a lawyer; your graphic designer; an independent fabric supplier; or the friend you pay to lead workshops or retreats with, etc.
You can buy blank forms at office supply stores or download a free template from the IRS. Remember that you must send an individual form to each person you paid.
Retirement funds and donations: Freelancers often forget to think about retirement, but you might be motivated to know that many funds allow you to reduce your taxable income by putting money away each year in Traditional Roth, SEP, or Simple IRAs. Some of them allow you to make a (partially) tax-deductible contribution even after the tax year ends, so long as it happens before you file your taxes.
You can also write off any donations you made to legitimate non-profit organizations. Be sure to confirm that any organizations you donate to is truly non-profit. Online crowdfunding sites like Go Fund Me and Kickstarter are not usually tax deductible; donations there are considered financial gifts.
Should freelancers use Turbo Tax or hire an accountant? For small businesses, particularly sole proprietors, Mercer recommends Turbo Tax, which is user-friendly. For more complex tax returns and/or when a taxpayer is unsure about the accuracy, she recommends hiring an expert. “It’s much better to have done things right the first time, rather than risk having to pay additional taxes and penalties down the road.”
When and should freelancers pay quarterly taxes? If your business is earning a profit of $1000 or more per year, you get the lucky task of paying federal estimated quarterly taxes; which are exactly what they sound like: you estimate what you will owe and make four quarterly payments per the IRS schedule throughout the tax year. Every state has its own rules for these taxes, so you’ll want to research the details or ask an accountant’s help if you’re doing it for the first time. If you miss payments, you may be fined penalties.
If you’re a freelancer and haven’t done these things for the previous tax year, you may want to hire an accountant, and follow these steps for next year to get ahead of the game.
For more financial advice for freelancers and other creatives, check out Personal Finance for Freelancers with Galia Gichon.
If you’re thinking of launching a freelance career for yourself, download our free guide, The Freelancer’s Roadmap today.