Tax Tips for the Freelancer

If you're one of the many freelancers and small-business owners who wait until the last minute to file your taxes, there's good news in 2011: Tax Day is April 18 this year, which gives you three extra days.

Ready for the bad news? That's less than a month away.

I can understand the reluctance to get going. I had most of my documents in one file, but still had to hunt down a couple of receipts and papers. And unlike my days of being a salaried employee, I knew I was going to be the one writing the check to the IRS, not the other way around. Hunting for paperwork, preparing a return, and writing a big, fat check at the end of it? Ugh, I'll do it next weekend.

But Tax Day looms, and if you have freelance income to report, your taxes are going to be more involved than someone who only has a W-2. When my taxes started to get more complicated, I had a lot of questions. I imagine most freelancers have similar concerns, so I've put together some general tax questions for folks who freelance or run a small business. Use them as a jumping off point to get going on your return.

Note: I'm not an accountant or a tax professional. You should seek professional advice for your particular situation.

I made a few hundred dollars on a side project. Do I have to report it?
If you had net earnings from self-employment of $400 or more, you have to report it on a Schedule SE (Form 1040). Also, know that even if a client didn't send you a 1099-MISC (used to report miscellaneous income of $600 or more paid to a non-employee), you're still required to report the income.

Do I need to file a Schedule C?
Schedule C is the tax form filed by most sole proprietors to report profit and loss. Freelancers, self-employed taxpayers with small or start-up businesses, and new business owners who made little or no profit might file a Schedule C. There's also a shorter Schedule C-EZ, Net Profit for Business, for self-employed individuals with less than $5,000 in expenses, no employees, and no net losses.

You can find general instructions for a Schedule C on the IRS website.

If I'm self-employed. Can I deduct my health insurance premiums?
You may be able to deduct medical and dental insurance premiums and long-term care insurance for you, your spouse, and your dependents if you're reporting a net profit reported on Schedule C, Schedule C-EZ (Form 1040), or Schedule F.

The insurance plan must be established under your business, which can be either the name of your business or your name for self-employed individuals. Refer to Publication 535, Self-Employed Health Insurance Deduction for more information.

Can I claim a home-office deduction?
If you use part of your home for business reasons, you may be able to deduct expenses for mortgage interest, insurance, utilities, repairs, and depreciation. This applies to homeowners and renters alike.

Although the home-office deduction is considered one of the Publication 587, Business Use of Your Home.

Can I deduct my laptop?
The rule is that business expenses must be both ordinary (common in your line of work) and necessary (meaning helpful and appropriate, not that the expense must be indispensable).

If your laptop is used for your freelance or small business, it can be deducted; however, if you use it partly for conducting business and partly for personal purposes, you can only deduct the percentage of the expense as a percentage of how much it's used for business. For example, if you bought a laptop that's used 60% of the time for personal reasons and 40% for work, you can only deduct 40% of the value of the computer. Refer to chapter four of Publication 535, Business Expenses, for more details about deducting interest and allocation rules.

Do I need to start filing quarterly estimated tax payments?
If you're filing as a sole proprietor or a self-employed individual, and you expect to owe $1,000 or more when you file, you should be making estimated tax payments.

You can estimate your taxes using your income, deductions, and credits for the prior year, along with worksheet in Form 1040-ES [PDF]. If you estimate too high, you'll complete another Form 1040-ES to recalculate your estimated tax for the next quarter. If you estimate low, you'll do the same thing to reconfigure what you owe next quarter. Visit the IRS's Estimated Taxes guide for more information about how and when to file quarterly payments.

I hired a worker. How do I know if he or she is considered an employee?
In most cases, an employer must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on income earned by an employee. Independent contractors, on the other hand, pay these taxes themselves.

The guidelines to determine if someone is an employee or an independent contractor aren't black and white. Instead, the following factors are used to determine the degree of control and independence of the worker:

  • Does the company determine how, when, and where the work is performed?
  • Does the company determine how a worker is paid, whether or not expenses are reimbursed, and other financial matters?
  • Is there a written contract or employee benefits, such as health care?

If, after examining the relationship with your worker, you're still unsure, use Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding [PDF] to have the IRS determine the status for you.

Here are a few more tips:

  • Be honest about your income.
  • Keep receipts and any supporting documentation to back up your deductions.
  • Use tax preparation software or a tax professional.

And finally, get started today. If you wait until the eleventh hour, it'll only make doing your taxes more stressful!

More about...Taxes

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El Nerdo
El Nerdo
9 years ago

Nice article. For a deeper look at business tax deductions I’d heartily recommend Deduct It!, published by NOLO. Goes into great detail about every aspect of small business deductions. Of course it’s best if you let a CPA handle this but since nobody cares about your money as much as you do it’s good to know these things. Best of all is that it shows you how to stay legal and avoid troubles. PS- I’ve always taken a home office deduction. I even take pictures, measurements & all., just in case. Not sure how much of a red flag is… Read more »

Mike Piper
Mike Piper
9 years ago
Just a quick clarification re: laptops (and other types of equipment that are considered “listed property”).

If you use it less than 50% of the time for business (such as the 40% mentioned above), you can’t deduct that entire 40% in the year of purchase via the Section 179 election. You have to depreciate it over time instead.

El Nerdo
El Nerdo
9 years ago

@ Mike Piper – not necessarily this tax year, I think? Part of the new rules to stimulate small busines is that you can expense purchase of new assets. Of course the “partial use” might change things– which is why a CPA deals best with these questions (and I’m not one, obviously). But otherwise…. 8. New Equipment Some small businesses can write off the full cost of some assets in the year they buy them, rather than capitalizing them — deducting their cost over a number of years. (See Nolo’s article Current vs. Capital Expenses for information on expenses that… Read more »

Crystal @ BFS
Crystal @ BFS
9 years ago

We just did our taxes by hand and the biggest thing we had to remind ourselves is to keep or print out proof of everything we deduct. I rather not be audited in 3 years and have a panic attack because I can’t find proof that I hired technical support for my blog for $50, lol.

Mike Piper
Mike Piper
9 years ago

Hi El Nerdo.

You’re right that there are special Section 179 rules for 2010 and 2012, but they mostly just increase the total dollar limit on the amount of property that you can make the Section 179 election for. They don’t change the requirements for listed property, to the best of my knowledge.

IRS Publication 946 has more info on the topic of listed property: http://www.irs.gov/publications/p946/ch05.html

“If the property is not used predominantly (more than 50%) for qualified business use, you cannot claim the section 179 deduction or a special depreciation allowance.”

Nancy L.
Nancy L.
9 years ago

Another very important thing is the difference between income and royalties. Many freelancers that I knew just lumped together the monies they earned from selling copies of their artwork with their regular income. It’s actually an entirely different beast, and much more complicated to address properly. I’m not an accountant, so I’m not even going to try to explain what needs to be done, but if you receive royalties for artwork that you’ve produced, it’s extremely important to consult with an accountant who is familiar with the proper way to submit them. We actually had to switch accountants after we… Read more »

Joe
Joe
9 years ago

This is a good ‘cheat sheet’ article. It would have been quite helpful when I started working as an independent gov’t contractor a few years ago and had no idea how my taxes would change.

Rene Mayo
Rene Mayo
9 years ago

I did my taxes and I bought my house when they were offering to give us that interest free loan for helping us to buy the houses to simulate the real estate market, I now have to pay it back. I got that extra money from the feds in the first round before they said that the folks in the 2nd round don’t have to pay back the money, it WAS FREE! CRAP! and now I have to pay back the money and as it turns out the IRS computer programs are having problems with this stuff and I will… Read more »

Lindsay
Lindsay
9 years ago

@Rene- I got that first time home buyers tax credit too (we closed on december 18 2008, before we knew that they were extending it and the those closing in 2009 wouldn’t have to pay : ( makes me mad)… Anyway, we just filed our taxes (had our accountant do it (self employed)) and he didn’t say anything about a delay. They are scheduled to take the money from our checking account next month.

Wilson
Wilson
9 years ago

Another reason to get started now is if you end up owing money you may want to start a SEP or traditional IRA, a HSA if you have a high deductible heatlh plan, or top them off to max your deductions and lower your amount owed. If you wait to the very end you might not have time to do so and end up owing that money to the IRS when a percentage of it can go back to you. It looks like I didn’t pay enough in my last estimated payment so I’m depositing more to my HSA and… Read more »

El Nerdo
El Nerdo
9 years ago

Thanks Mike! I appreciate the clarification. It’s always great to learn from the pros.

Ms. K
Ms. K
9 years ago

Good tips. But I’m always curious why the “hire a tax professional or use tax preparation software” is included. That’s basically a tip to spend money…on something you can and should be able to do yourself.

v
v
9 years ago

Hi April, great article. I heard freelancers were supposed to pay taxes quarterly? Is this true? Is there a fine if you dont do so and pay at the end of the year instead?

Thanks…

El Nerdo
El Nerdo
9 years ago

Ms. K–maybe you can do it yourself if you make $1000 a year selling pies at a farmer’s market during the summer, but if freelancing is your main source of income you need a team of pros on your side, and that is no joke. Go to the local SBA and they will tell you who are your 4 basic support people: a lawyer, an accountant, an insurance agent and an IT person. In my case I can do without the IT person (I do the geek work myself, have over 10 years of experience), but I depend on the… Read more »

Adrian
Adrian
9 years ago

Thank You For This Informative Article, April!

Although I Reside North-Of-The-Border (In Canada) This Piece Further Assisted Me In Understanding Your Taxation System And Being Self-Employed, This Provides Me With Much ‘Food For Thought’ In Regards To My Own taxes.

As For My Fellow Canadians, Head On Over To:
http://www.cra-arc.gc.ca/menu-eng.html
The Official Canada Revenue Agency Website In Order To Find Out The Applicability Of Your Own Work-Related Deductions, Expenditures & How You Can Also Benefit From Many Of The Current And Upcoming Tax Credits.

Have A Pleasant Day, Everyone 🙂

Nancy L.
Nancy L.
9 years ago

El Nerdo is exactly correct. Freelancing quickly complicates your finances to a point where DIY is more likely to cost you money than save it. Our accountant is someone who helps us year round, rather than just in “tax season”, and her knowledge of how the tax code applies to our specific industry is worth every penny we pay her.

Kevin M
Kevin M
9 years ago

Pretty good summary of the basics April.

Another nice thing about the home office deduction is the mileage to and from the home office to clients/meeting/etc. are fully deductible rather than considered commuting.

Also, don’t forget you can still start a SEP or SIMPLE IRA and sock away money for retirement if your business is really humming.

Kevin M
Kevin M
9 years ago

v – you can be hit with underpayment/estimated tax penalties unless your total payments equal the lesser of:
a) 90% of your 2010 tax
b) 100% of your 2009 tax (110% if your 2009 AGI was over $150,000)

Basically, if you cover last year’s tax you are safe from penalties. If your tax due with the return is under $1,000 the penalty doesn’t apply.

Deserat
Deserat
9 years ago

I am self-employed as a consultant – my expenses are fairly simple and from simple categories. Therefore I don’t pay someone to do my taxes, I do them by hand. I track all expenses by category, record all of my payments and income and use that on a schedule C. I also live overseas so use the tax laws for that as well, filling out the requisite forms. As for hiring a professional, perhaps–I find that the tax preparation software doesn’t cover all of my situation–and the tax preparers have very different ideas on what to do–gets confusing and contradictory–who… Read more »

20 and Engaged
20 and Engaged
9 years ago

This almost deters me from being self-employed / a small business owner, but if I find the right accountant when that time comes, I should be okay.

sarah
sarah
9 years ago

I’ve found it to be fairly simple to do my own self-employment taxes (using Turbotax though). One thing you mentioned about the laptop though – I thought that with equipment (for me it’s sewing machine, computers) you had to depreciate it over several years. That’s the only part that I find really confusing. But I keep track of all my income and expenses in a spreadsheet that makes it pretty easy to come up with the numbers I need at tax time.

chacha1
chacha1
9 years ago

DH and I had an accountant for the first couple years of marriage, but after watching him work (shuffling papers randomly around his desk, filling in deductions we really weren’t qualifed for, taking phone calls from other clients while we were in his office!) I fired him and started doing it myself. I’d been doing my own for years and I just didn’t trust him. DH is a self-employed fitness professional. He has no employees, no inventories, no company insurance (except professional liability). We take the standard deduction. We file a 1040 with Schedule C and the form SE. The… Read more »

2010 bus. stall
2010 bus. stall
9 years ago

I was doing a tiny bit of freelance work while employed full time, and was just starting out so I didn’t make much but enough to file a schedule C. Then last year I became unemployed and did no freelance work because that would threaten my unemployment benefits. When I’m employed I’ll start freelancing again. Any idea on how I handle the business stall in my tax return? The IRS recommended I submit my schedule C just to confirm made no money. I plan to via Turbotax, unless I get confused enough to hand it to HR block. I’m just… Read more »

Greg Miliates
Greg Miliates
8 years ago

Freelancing/consulting is a business, so treat it that way and act like a business owner–even if that role feels weird at first (you’ll get used to it). Set yourself up as an LLC or s-corp, get a federal tax ID number (FEIN), talk to an accountant, and make sure you’re all legal. All that might sound overwhelming, but trust me, it’s not. Before I started my consulting business, it seemed overwhelming, but as I went through the steps, it was actually really straightforward. Make yourself a checklist of start-up tasks, and work through them–you’ll be done it fairly short order.… Read more »

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