For many new freelancers, tax time can be a rude awakening. For one, you may be used to receiving a big refund of all of the tax your employer withheld from your paycheck. Or maybe you’re shocked to find out how much more complicated it is to file a return when you’re self-employed.
Whether you plan on preparing your tax return solo or seeking professional help, there are some things you should know about filing business taxes—especially if this is your first try at it.
Tax law is complex and ever-changing. Despite talk of tax code simplification in recent years, very little changes have been made that make Internal Revenue Code easier for a layperson to decipher. Despite that, here are the mere basics every freelancer should understand about business taxes.
Generally, individuals are only required to file a return if their gross income is $10,300 or more for a single taxpayer or $20,600 for married couples filing jointly. But, for freelancers, the filing threshold is much lower—just $400. That’s because, while you may not owe any tax, you may have to pay self-employment taxes.
Sole proprietors and members of single-member LLCs report business income and expenses on a Schedule C attached to their individual return, Form 1040. Other business entities, including partnerships, multi-member LLCs, and S-Corporations file their own returns on Form 1120S or Form 1065 and income and deductions are “passed-through” to the owners on a Schedule K-1. Business income reported on the K-1 is then used to complete the owner’s individual tax return and appears on Page 2 of Schedule E. All of this sounds very complex, but your tax prep software or accountant will ask questions and walk you through exactly which forms need to be completed.
However, one thing to keep in mind is due dates if your business needs to file a separate return. If you are in a partnership or multi-member LLC and need to file Form 1065, or if you set your business up as an S Corporation and need to file Form 1120S, the due date of your business return will be March 15, rather than the typical April 15th due date for individual tax returns. Make sure your return is filed—or request an extension before March 15th—or you’ll face penalties.
Did you outsource the design of your website, hire a virtual assistant or pay anyone $600 or more for services in the past year? If so, you may need to issue a 1099-MISC.
The deadline to file Form 1099-MISC is January 31 if you are reporting amounts in Box 7: Nonemployee Compensation. (The majority of 1099-MISC filers report information in Box 7.) Previously, the deadline for filing Forms 1099 was February 28 for paper filing or March 31 for electronic filing.
Whatever you do, don’t ignore this filing obligation. Recently, legislation doubled the penalties for late and non-filers, increasing the penalty from $100 to $250 per return. Since the increased penalties apply to both the copy filed with the IRS and the copy filed with the payee, you could end up paying $500 for every 1099 you fail to issue. If the IRS believes you intentionally disregarded your filing obligation, you could pay combined penalties of $1,000 per form.
Yearli offers a very inexpensive and easy solution for filing 1099s. For a small fee per 1099, they will electronically file federal and state copies and mail the payee copy to the recipient.
When you work for someone else, federal and state income taxes and FICA (Social Security and Medicare) taxes are withheld on your behalf by your employer. When you freelance, it’s up to you to estimate and pay taxes quarterly. Don’t wait for the end of the year and hope for the best or you could end up owing a bunch of money, plus interest and penalties.
If you’re having trouble coming up with a good estimate of your tax liabilities, the safest option to avoid underpayment penalties is to aim for 100% of your previous year’s taxes. Pull up your tax return from last year. If your total tax liability (before accounting for withholding or estimated payments) was $5,000, you should pay in at least $5,000 to avoid an underpayment penalty.
Higher-income taxpayers must meet a higher threshold. If last year’s adjusted gross income was more than $150,000, you’d have to pay 110% of last year’s taxes to avoid penalties.
The IRS does not provide a comprehensive list of deductible business expenses. Instead, they simply say deductible business expenses are those that are “ordinary and necessary” expenses of carrying on a trade or business.
Ordinary expenses are things that are commonly accepted in your industry. Necessary expenses are those that are helpful and appropriate in running your trade or business. For example, ordinary and necessary expenses for a freelance writer might include a computer or laptop, internet service, some office supplies and website hosting fees, just to name a few. Renting a sky villa at the Palms Casino in Las Vegas to use as my office and a private jet to travel there would be neither ordinary or necessary for a freelance writer—but a girl can dream, can’t she?
Unless you have a good understanding of tax law and how a business tax return should look, it’s wise to hire a professional who specializes in preparing taxes for freelancers. Hiring a professional does cost money, but it’s often worth it as a professional can help you maximize deductions and recommend other tax-saving strategies. Here’s a list of a few of the professionals you want on your team.
Freelancers face different financial planning considerations than people with full-time, permanent employment with an employer. Retirement saving, health, disability and life insurance, budgeting and saving are vastly different for self-employed people than they are for people who receive benefits through their employer.
A financial advisor with experience working with freelancers can help you understand your options, think through big decisions and make sure you are on track to meet your goals.
Many freelancers don’t consult with a tax preparer until several years into starting their business. However, the tax elections you make in your first year of business can impact your business’s tax filings in future years, so it pays to start things on the right foot rather than try to fix them later on.
If terms like depreciation, capitalization and accrual sound like a foreign language, you might want to consider hiring a professional to handle tax preparation.
New freelancers often save money by handling bookkeeping on their own. That’s often fine when you are starting out, but if you find yourself putting off the task, you might consider outsourcing or adding a cloud-based tool, like FreshBooks, to help manage your books.
Bookkeeping is not just about entering invoices and paying bills. It might include processing payroll, reporting sales tax, reconciling bank statements, monitoring cash balances, tracking inventory, accounts receivable and accounts payable. If you are already working long hours on your business, you may want to focus your efforts on building your business instead of spending hours on bookkeeping tasks.
The great thing about outsourced bookkeeping is you can receive as little or as much support as you need as your business grows. You might just want someone to reconcile your bank accounts each month and make sure to make sure you haven’t missed any transactions, or you may want to turn it all over elsewhere, so you don’t have to think about it.