In my early freelancing days, the only advice I’d retained regarding taxes was “file them” and something about keeping receipts in a shoebox. Granted, I earned less than $20,000 my first couple of years combined, and my husband’s tax return always covered what I owed. But this year, for the first time, after filing my taxes I owed money back and had to pay a penalty for not filing incrementally throughout 2013. This was enough to scare me into reality, make me buckle down and admit it’s time to get my act together. If you’re in the same boat, here’s a little advice to avoid the headache and potentially hefty penalties of putting off your taxes until the last minute.
Paying annually vs. quarterly
There are two ways to pay your dues to Uncle Sam: Annually or incrementally throughout the year. If you owe less than $1,000, there’s no penalty for filing once at the end of the year, says Brittany K. Hopp, CPA of Clayton, York and Hopp CPAs. “However, I do recommend my clients do quarterly estimates so they don’t get stuck with one big bill at the end of the year.” These are due in April, June, September and January, and can be paid online at eftps.gov
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Because freelance income is so erratic, it can be difficult to calculate how much you’re going to owe. William Perez, tax practitioner and freelance writer, says that you can use Publication 505, available on the IRS website, to determine your taxes by hand. “However,” he says, “I prefer using tax software. After building a scenario for next year’s taxes in the software, I capture the data and tax calculations in a spreadsheet. Then I use the tax calculation to create a budget.”
If you’re married filing jointly and your spouse gets a regular paycheck, an alternative option is to take your tax estimation and have a certain amount of money withheld from your spouse’s checks.
This is what writer and communication strategist Meg Maker did earlier in her career, although now that she and her husband are both self-employed, she uses the traditional quarterly filing method.
Keep organized and track deductions
Even if you’re a budding freelancer with nary a paycheck to speak of, it pays to make a habit of getting organized now. Perez recommends familiarizing yourself with the forms 1040, Schedule C and Schedule SE. Print them off, read them and get acquainted with which items are deductible and align your spreadsheets or other bookkeeping tools with its categories.
For example, I have one spreadsheet dedicated solely to potential deductions. Some of the things on my list include my membership to my local networking group, my Mediabistro AvantGuild membership and my coworking group membership. The miles I drive each day to get to my coworking spot are also deductible. Some other common deductions for freelance writers include office equipment, home office expenses, health insurance and retirement plans.
Occasionally, entertainment costs are deductible—say you’re a food or travel writer whose articles depend on spending money on these things—but they’re highly scrutinized by the IRS, so save as much evidence as possible (printed clips, receipts, correspondence with editors) in the event of an audit.
Regarding bookkeeping tools, you should use what works best for you. Maker uses Quicken for analyzing her current financial state and Excel spreadsheets for tracking invoices. I use spreadsheets backed up to the cloud, and I try to keep them as simple as possible: One book for invoices, and one book for income and expenses. Quickbooks is another tool that’s popular with small businesses, although its scope may be too wide if you’re just getting started freelancing.
About the self-employment tax
So, why does the tax bill seem so much higher for freelancers than traditional employees? The answer is the self-employment tax, which is a combination of Social Security tax and Medicare and comes to 15.3 percent as of 2014. If you’re an employee and you get paid through a W2, half of that 15.3 percent is withheld from your paycheck and the other half is paid by your employer.
However, when you’re self-employed, “you have to pay both sides of that, because you’re the employer and the employee,” Hopp says. “Self-employment tax is figured on your net income. So you receive your income, subtract your expenses, and then that amount, that 15.3 percent, is calculated.” From there, you take your net profit and determine your income tax from that. This is where you may see different benefits and drawbacks from filing jointly or separately from your spouse.
Sole proprietorship or LLC?
An important distinction that may impact your taxes is whether you choose to remain a sole proprietor or become an LLC. If you are the only person who owns your LLC, you’ll file a Schedule C (exactly as you would for a sole proprietorship). However, if your LLC is owned by two or more people, you’ll split the net income of the LLC between owners based on their percentage of ownership, says Perez.
Otherwise, becoming an LLC won’t have too much bearing on your taxes — but it could change some aspects of your business for the positive. Maker likes being an LLC for many reasons. Because an EIN (Employer Identification Number) replaces your social security number on legal forms, she states, “it’s nice not having to give out my social security number to everyone I work for.” In addition, it protects her family assets from any kind of business-related lawsuit.
She describes it like this: “If I’m just working as Meg Maker, they can file a lawsuit and go after our personal money. But if I have an LLC, all my client can go after is what I have in the bank for my LLC.” Of course, it’s best to talk to an attorney to see which entity makes more sense for you. If you’re still in startup mode, it may be difficult to justify the initial cost of setting up an LLC, which varies by state.
Tax advice and mistakes to avoid
Hopp recommends that if you’re going to hire a professional to help with your taxes and accounting, choose someone with whom you feel comfortable. “If you know you can’t handle it on your own, call around, get referrals, do interviews for CPAs or tax preparers. They shouldn’t be offended by that. You’re definitely going to be more willing to call someone throughout the year if you feel like you can trust that person.” She also recommends keeping a notebook handy to jot down potential deductions, like mileage, as you go. “I see so many people going back at the end of the year trying to recreate it. Get in the habit of doing it when you’re driving so you don’t miss things.”
The only regret Perez has about his early approach to money management as a freelancer is that he would have re-invested more of his income into business. “Today, I ask myself, where is this money needed, where can it be productive?” He cites the improvement of professional skills, technology upgrades and even ergonomic furniture as great ways to invest in your business—all of which qualify as tax deductions.
A few simple steps is all it takes
You don’t need to get a degree in accounting to be smart about your tax planning as a freelancer. Set small goals for yourself. Schedule a meeting with a CPA (many will do a free consultation), start a free online trial of a business accounting software program that looks good to you—or take a course like Mediabistro’s Develop a Successful Freelance Career, which includes a section on finances.
In the same way that you do a wealth of research before sending out a pitch to Glamour or Sports Illustrated, some advance planning and organization is all you need to pay your dues and get back to what you love: your writing.