something new sunday: doing your freelance taxes 101

06Sep09

The number one thought that goes through my head on this subject?

HELP!!! (accompanied by visuals of panicking, drowning, and a somber suit representing the IRS knocking on my door)

I’ll be honest, I think freelancing is a pretty sweet gig. But there are some things about it that are not so sweet. Taxes/finances probably ranks at the top of this list. With no large company taking your hand, asking you to fill out forms, and reminding you when tax season is, freelancers are completely on their own in navigating a very confusing world of rules, paperwork, and ulsers.

I recently sat down and had a good long conversation with my accountant, and wanted to share with you guys some of the awesome info I got. This post is divided into three sections: the basics, exemptions, and some practical tips.
REMEMBER: this post is only meant to be an introduction/springboard. Don’t take these tips without a grain of salt. Make sure to talk to a tax professional about your individual situation.

Square One

Where do I start?
Do some research and find a tax pro. Seriously, spend the money on an accountant. It is the most worthwhile investment you can make: Firstly, freelance taxes are a mess and a half. You really want someone who does this all day everyday on your side. Secondly, tax laws can change, sometimes even within a few years. Hire an accountant who will keep up with these laws for you. Thirdly, a good accountant can help you compare your exemption options and help you get more money back from the government than you would have on your own. Fourthly, you don’t want to get audited. Really.

How much can I expect to pay?
If you made under XXXXXXXXXX, nothing. If you made more than that, 15% goes to a self-employment tax (aka social security). 15% more is a federal tax. So, in total, you can expect to pay about 30%. Now remember…that’s 30% of what you made AFTER you take out expenses. More info on that below.
How much you owe your state will depend on where you live. California has no specific self-employment tax that applies to me, so I can expect to have to pay a few hundred dollars annually—very little, compared to the federal taxes.

How often should I be paying taxes?

Like everybody else, you’ll file your taxes annually. But, unlike everybody else, you’re not getting taxes taken out of each paycheck, so you should plan to send the IRS an estimated amount of taxes quarterly. These important dates are April 15, June 15, September 15, and January 15. (For January taxes, cut off your income/expenses on December 31).

Um, really?

Yes really. Unless you relish the idea of having to pay thousands of dollars every April. Are you a dedicated enough person to keep all that money on-hand in your bank account, yet not spend a cent of it? Yeah, neither am I. Do yourself a favor and estimate your taxes every quarter.

How do I pay these quarterly taxes?
Go to http://www.irs.gov and download a 1040-EF form. Fill out Voucher 3. Talk to your tax pro, and use some of the suggested exemptions below to estimate how much your income minus expenses amounted to. Calculate 30% of that number, and mail a check in that amount to the IRS. (Photocopy the form and the check for your own records).

Do I hafta?
Yes. Even if you’ve slipped through the cracks and not paid taxes for a while (as it’s sometimes easy for people working independently to do), there’s a VERY good chance that you are eventually going to get royally screwed. Or IRSally screwed. The point of this post is not to shame you or chide you into staying paid up. You should simply know better.

Types of Exemptions

Okay, let’s talk some silver lining here. Because if you’re like me, your head is spinning at the idea of losing 30% of your income. Since you’re self-employed, anything that you spend on your business is deductible. My accountant’s words of wisdom were:

“Every time you take out your wallet, ask yourself how the money you’re spending relates to your business. Get in that habit, and you’ll be amazed at how much money you save. ANYTHING that moves your business forward is deductible.”

Here are some general categories that you should consider:

Supplies and Equipment
There’s the big expenses (new computers, new software, printers, etc), and there’s small expenses (printer ink, paper, pens)…any of these things that you use for your business counts. So let’s say you’re looking to buy a new video camera: if you use it to record a few promotional vlogs, or you get paid to film a friend’s wedding, guess what? Business expense.

Monthly bills
Cell phones. Internet. Use them to run your business? Then heck yes they’re deductible. Some situations even allow you to deduct a portion of your rent and utilities—but these rules can be sticky and you should definitely talk to your tax pro about it first. The basic rule of thumb is that you must have a space used solely for work (ie. not your bedroom or living room), and it must have a closable door. Figure out the portion of your floor plan that this room occupies, and that’s the portion of your utilities/rent you can deduct.

Transportation
Anytime you drive to meet a client, or pick up supplies, write down your mileage! You can take that off too. There are two basic ways that this works:
A. Standard mileage rate: a certain number of cents per mile
or B. Actual expenses: including auto insurance, gas, repairs, etc.
Which one will work best for you? If you’re haven’t purchased a new car, it’s most likely that you’ll get more money back on option A. Talk to your tax pro to be sure.

Research
This one’s quite possibly my favorite: because if I buy something at the grocery store that has good design, it can count as research for my business. I KNOW RIGHT. I’m totally buying more pretty package products. The best way I would suggest to keep track of this is to separate out your products at the check stand into two bills. Otherwise, you’re going to have a mess keeping track of everything. Of course, other things can count as research write-offs: every time your purchase something, ask yourself if this thing is research in any way. My unprofessional advice though is to NOT go overboard. It’s way less of a mess to only claim things you really can prove are research than to get audited in the end. Most sucky.

Self-promotion
The cost of business cards, your website, etc etc. This one’s pretty simple to remember, since it obviously and directly relates to your business.

Outsourcing
If you hire someone else to help you complete a job for your business, the amount you pay them with is deductible. Just make sure that they provide you with an invoice. Make a note of what check number you pay them with (DON’T pay with cash…you always want to have documentation of your payment).

Things that are NOT business deductibles
These are often called personal (or in official tax lingo, itemized) expenses, and my knowledge in this field is quite hazy. But a few basics for freelancers in this category are: charity and tithing, car registration, health/dental/renters insurance. They only count if they add up to more than $5,000 annually. So, keep track of them: but don’t expect to use them to get out of more taxes.

Making it Happen

So, all those deductibles sound pretty awesome, right? Right. But in order to get them, you have to be willing to put in a little work on your own. Okay, it’s kind of a lot of work. But I think you’d agree that the money saved could be well worth the effort.

First step: get organized.
This means a lot of different things for a lot of different people. If many of your expenses are business related, you should really consider having two bank accounts and/or credit cards: one personal and one business. It will help immensely with keeping things straight.

Get a system going.
Figure out your best system for keeping track of your expenses. Excel, Quicken, GoogleDocs, and Mint.com are a few options. Just make sure that there’s a way to denote your expenses, that it’s something you can keep up with on a daily basis, and (especially if it’s electronic) back it up periodically.

Keep your records, and your receipts.
Generally, you only need write-ups of your purchases. But in case the IRS decides to come after you, you will need your receipts to prove that everything is as you claimed it to be. If you don’t already have one, start a binder for 2009 where you can easily drop in pertinent receipts for each month. Get in the habit of printing out records of online transactions. It doesn’t have to be super organized and tediously documented: you most likely won’t need these receipts. But it’s much much MUCH better to be safe than sorry.

Should I charge my clients taxes up front?
Well, you’re responsible for paying taxes in the end. And your clients are accustomed to paying taxes on everything else. It only makes sense to let them know you’re a responsible person to hire.
A seemingly tricky question (as submitted by @iamampersand) is whether you charge your state taxes or your client’s state taxes. Since you are the one responsible for paying the government, it’s necessary to go by your state’s tax laws.

Any more questions?

Feel free to ask in the comments! If possible, I’ll try to pass along your question to my accountant, and get you some feedback. Have any tips for how you stay organized? Please share them too!

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