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Preparing for Tax Season as a Freelancer

For most standard wage earners, preparing for your tax filing is fairly simple.  You receive a Form W2 in the mail and unless you have other rental properties or other complications, your return is relatively straightforward.  But for the freelancer, things aren’t quite as simple.

When you are a sole proprietor, independent contractor, freelancer, or other self-employed person, you will not receive a paycheck and subsequent W2 from the companies you work for.  Instead, you will receive a Form 1099-Misc for any payments received via check or cash.  If you accept credit cards, these amounts will be reported to you by your processing company on Form 1099-K.  The amounts on these forms will be the gross amounts paid to you, as companies you work for will not deduct taxes from your pay.  The processing company will not indicate their fees on the form.  Both of these forms are also reported to the IRS.  This gross income needs to be reported on your annual tax filings.  It is important to note that you should keep separate records of your payments as well both for verification as well as the fact that companies are not required to report payments to you if they are made by credit card or under $600.  Income tracking is made easier if you keep a set of books and a separated bank account for your business.

After you have tracked and gathered all of your income, you will also need to report your expenses.  These items will help you reduce the income that results in your taxation.  It is important to remember that because expenses reduce your tax, the Internal Revenue Service scrutinizes what you are reporting. But what is a legitimate expense?  Legitimate deductions are ones that are necessary, helpful and appropriate for your trade or business.  Easy ones are things like office supplies, computers, advertising, banking, and credit card fees.  Basically, if you need it to operate your business, then it is most likely a valid expense.  Always keep in mind that the IRS will require receipts for purchases that you are deducting.  For easy referencing at tax time, try to keep your expense by category with an efficient filing system throughout the year.  The standard categories will be broken down into:  accounting and banking, advertising, auto expenses, contract labor, computers and other equipment, meals and entertainment, memberships and dues, education and training, rents, insurance, interest, office expenses, supplies, repairs and maintenance, professional fees, cost of goods sold, and more. 

While some of these fees are straightforward, others are a bit trickier.  Take meals and entertainment for one.  The support of this type of expense could be an entry in a business calendar that you keep with all of your appointments, etc. Be sure to note who was at the event, when was it, what was the purpose, and how much was the cost. You also need to prove you spent the money by a debit card entry in a bank statement or a credit card statement. You get half of the total amount of the expense in this category unless it meets other requirements.

Another area of contention is the home office.  One of the freedoms of being a freelancer is the potential to work from home.  But what makes up a true home office in the eyes of the IRS?  The office that is part of your home ineligible provided you can show that it is your principal place of business and used exclusively for your business.  So, if your office doubles as the kids’ homework center or a guest room, the IRS is not going to allow it.  If your space does qualify, you need to know the space used for your freelance work and the total space in your home.  Things like mortgage interest and real estate taxes or rent, utilities, insurance and repairs related to the space can be reported here.

There are many programs that can assist with tracking and categorizing your expenses.  When things get complicated or you get busy enough, it is advisable to see professional help.  Yes, a good accountant can be expensive, but they can also help you save time, money and a headache.  Often programs such as Turbo Tax ask questions that seem easy on the surface but are actually much more complicated.  For example, many of these self-filing programs will ask, do you have educational expenses?  And if you purchase manuals and other materials to educate yourself or your clients, you may click yes.  But unless you are a K-12 teacher, this deduction is not for you.

If you do not yet have an accountant or are not at the point where you feel you need one, but sure that you understand the tax requirements in your state as well as the federal ones.  Prepayment penalties are the biggest hits that most self-employed individuals take.  Without the withholding you receive from a W2 wage, you will need to pay into taxes throughout the year using estimated tax payments.   The tax rate for Self-Employment Tax is 15.3 percent, which puts 12.4 percent toward social security and 2.9 percent toward Medicare. Just remember, the SE Tax does not include all of your tax liability. You have to pay regular income tax on top of that 15.3 percent.  A good place to start is setting aside thirty percent.  While the actual amount may be higher or lower, this will put you in the ballpark.  If you live in a high-income state, aren’t married, have no other deductions or a variety of things that will give you a high-income amount, you may need to adjust this percentage.  Be sure to make your prepayment quarterly on the required dates.

Even though you made payments to the IRS throughout the year, you haven’t yet filed an annual return. There is a difference between those two actions.  You are still required to file an annual tax return just like a traditionally employed person. You probably also need to file a Schedule C, which reports the income or loss you generated from your business. Your tax return is due the same day as your traditionally employed friends, which for your 2019 tax return is April 15, 2020.

Do you have the support you need to manage your small business bookkeeping? Schedule a 30-minute appointment to speak with a local small business adviser.

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