Freelancers and consultants, legally known as “independent contractors,” are defined as people who contract to perform services for others without having the legal status of “employee.” They are in business for themselves providing products and services from a variety of industries.
As a freelancer, you will likely pay lower income taxes than someone doing the same job for a company. On the other, you still need to keep records and pay the IRS.
Organizing Your Tax Files
Thorough organization is your best protection against unintentional tax fraud and the possibility of an audit.
Report all of your income. If you get work through an agency, you may be able to obtain a report from them with all the work you have received through that agency. In addition, keep all the receipts for any and all business deductions. Develop clear explanations of how the item you are deducting is related to your business.
The best way to keep receipts from being lost is to scan them and save them as a digital file. If the originals become damaged or the ink fades, you still have a readable record. There are applications available that can identify and sort your digital files, simplifying your documentation and tax preparation.
You must have a receipt for anything you deduct as a business expense and you may only deduct the portion that relates to your business. That being said, as a freelancer, you can take advantage of deductions not available to an employee.
As long as the expense is necessary and related to your business, you can deduct it provided it is reasonable and normally incurred by businesses of your type. This can include:
- Office expenses
- Travel expenses
- Entertainment and meals
- Marketing expenses
- Some insurance premiums
The IRS also allows a deduction for a home office, but you must be careful. The space you claim as a home office must be used solely in connection with business you conduct frequently. It can be a portion of a room, but that space must only be used for business.
If that space is used for both business and personal reasons, you may not deduct it as a home office.
When Do You File?
If you made more than $400.00 from freelance work for the year, you must pay taxes. You must pay your own Social Security and Medicare tax as well as a self-employment tax, which is the portion normally paid by a company for each employee. Check the tax tables and instructions for the tax year in question to calculate the correct withholding.
If you submitted one or more Forms 1099 for the first time the past tax year, paid more than $1,000.00 in taxes, or expect to make more income this year, you must pay quarterly estimated taxes.
For 2016, the important deadlines are:
- April 18, 2016, for 2015 taxes and for the first quarterly tax payment for 2016. (This includes income from January 1 through March 31 of 2016.)
- June 15, 2016, for income received April 1 through May 31, 2016
- September 15, 2016, for income from June 1 through August 31.
- January 17, 2017, for income from September 1 through December 31, 2016.
Note that the number of months included in each quarter is not equal but you still pay the same amount each quarter.
Always file, even if you cannot pay the full amount. Pay on time and pay as much as you can to limit penalties and interest. Call the IRS and explain your situation; you may be able to obtain an extension or a waiver.
How Will You Pay?
This depends on the profit of the business.
Profit = Total Income – Expenses
You only owe taxes on your profits, not the total income. The total percentage will depend on your overall income, if you work as an employee as well as freelance, or if you are filing jointly with spousal income. You can shelter some profits by opening a SEP-IRA or Keough plan for retirement savings.
A rough estimate to help you save back the proper amount is about 30%. There are penalties for underpayment.
How to File
Use Schedule C to break down business expenses, earnings, and deductions. Use this information for Form 1040. Obtain Form 1099 from each account you do work for, but if one is not available, add up the invoices to report your earnings. Remember, proof of health insurance is required when you file. The penalty for being uninsured will continue to rise.
As Ben Franklin famously quoted, “In this world nothing can be said to be certain, except death and taxes.”
Keep accurate records and file your income taxes on time and in full. IRS auditors tend to focus on small businesses as sources of tax fraud. Protect yourself and your business.
Sam Brotman is a practicing attorney in San Diego and the founder of Brotman Law. His practice primarily centers on all aspects of tax litigation and criminal/civil tax controversies in front of the Internal Revenue Service, Franchise Tax Board, Employment Development Department, Board of Equalization, and various other state/local tax agencies. To learn more about Sam, visit him at his website or follow him Facebook.
Brian is a Dad, husband, and an IT professional by trade. A Personal Finance Blogger since 2013. Who, with his family, has successfully paid off over $100K worth of consumer debt. Now that Brian is debt free, his mission is to help his three children prepare for their financial lives and educate others to achieved financial success. Brian is involved in his local community. As a Financial Committee Chair with the Board of Education of his local school district, he has helped successfully launch a K-12 financial literacy program in a six thousand student district.