Freelance Tax Tips

Freelance Tax Tips – by Lela Davidson

If it helps you, feel free to repay me by visiting my blog and leaving lots of comments!

 

 

Deb and Friends,

 

 

 

Thank you so much for allowing me the opportunity to answer your tax questions. I want to let you all know that as a former CPA, who has let my license lapse, the laws of my state prohibit me from preparing tax returns or from offering specific tax advice. That said, I’m going to offer you some education.

 

Why can’t I just tell you the answers? There are two main reasons. First, it really is true that in order to answers tax questions, competent professionals need to know about your overall tax position. Everything affects everything else. Or, as my favorite professor used to say, push a little here, and something squeezes out over there. Second, tax law is ever changing. As a CPA, I spent over 60 hours each and every year keeping up with these changes. What I’m saying is, go see a tax accountant. I hope that you’ll take this advice to heart knowing that I’m not in the business anymore and therefore not here to plug anything.

There was a lot of repetition in the questions, but in general they fell in to three basic categories: 1) income, 2) deductions, and 3) paying taxes. But first…

 

 

 

The Big Picture

Our system is political. That’s why it’s so complicated and also the reason it changes all the time. Tax code is written by consensus. Sometimes things get convoluted in the process, and other times whole sections of the system get overhauled. That’s why it’s important to retain the services of a competent professional, preferably one who has experience in advising clients in similar tax situations as your own.

 

 

Our system is a business. Well, not exactly, but think about it – what does the IRS do? They collect the money that our government runs on. Like a business they operate on limited resources, and they need to get the most bang for their buck. It’s pretty common knowledge that if you file a Schedule C, which is how most freelance writers will report income, you have a slightly higher chance of being audited. They are out to make money so they need to focus their efforts accordingly, which means they don’t spend and inordinate amount of time torturing the little guy. You don’t need to fear the IRS, just follow the rules.

 

Our system is pay-as-you-go. Other than overstating deductions, this is the area I used to see most people get into trouble. The average person, it seems, does not grasp the concept that in this country, we pay our taxes as we earn our money. We’re not allowed to wait until the end of the year to pay what you owe. If you work for someone else, it is your employer’s responsibility to take the appropriate amount out of your compensation and remit it to the government. That’s why you fill out Form W-4 to tell your employer your best estimate of what you owe. When you’re self-employed, you have the same responsibility to pay-as-you-go, but you don’t have an employer to take care of it for you. That’s why people who make a substantial amount of self-employment income have to make estimated tax payments.

 

 

Our system is subjective. Tax law is made up of code, which is what your legislators hammer out behind closed doors, but also by the results of court cases. Things are not always black and white. The same facts in one set of circumstances can produce a totally different right answer when applied to a different set of circumstances.

No wonder we need help.

What is Income?

There is a lot of confusion about just what income is. Basically, the IRS considers anything you are paid as compensation to be income. Even if you barter services you are supposed to report this as income on your tax return. If I help my graphic artist friend Julie turn her mundane annual list of family achievements into a witty Christmas letter, and in exchange she designs a logo for me, we are each supposed to report the monetary value of the services we received as payment for what we provided. In other words, everything is income. Everything.

So how does the IRS know how much self-employed people are earning? Before larger companies pay you, they probably ask you to submit your social security number right? That’s because they are required to report to the IRS when they pay individuals over a certain dollar amount ($600 last I checked, but the numbers are always changing). At the end of the year, they send you a 1099 telling you the amount they paid you throughout the year. They report the same information to the IRS. If nobody tells the IRS they paid you? You are supposed to report ALL income.

What about Paypal? There is a lot of money going through Paypal that is probably not getting declared. So does that mean you shouldn’t declare your income? Just because no one’s reporting this income, doesn’t mean the IRS can’t find out. Say you make a lot of money under the table. When the IRS decides to audit you, really audit you, they look at what you spend and also at your bank account. Nice house, Mr. Jenkins – what did you pay for it? By the way, how is it that you received in excess of $5,000 a month electronically deposited into your bank account and yet declared no income? If you get paid, report it. Just because you don’t have a 1099, doesn’t mean you don’t report income.

If you got paid to do something, you’re self-employed. It’s not Other Income, and it’s not Wages. And yes, if you hit the threshold, you’ll be responsible for self-employment taxes. Huh? What’s self-employment taxes? Ha! You thought you just paid income taxes didn’t you? Don’t forget about Social Security and Medicare, aka FICA. These are separate from income taxes. When you work for someone else, they pay a portion of Medicare for you, but when you work for yourself, you’re on your own. The term self-employment taxes refers to these taxes.

 

 

 

What is a Business?

People always want to know when a hobby becomes a business. First of all, why would you want to be considered as a business instead of a hobby? For the deductions! The rule of thumb is that an activity needs to produce income in three of the last five years to be considered a business and therefore convert its expenses into deductions. However, this is a general rule and there are exceptions. Put it this way, your Aunt Ruby can’t write off oils and canvases year after year without ever selling a painting and you can’t continue to deduct ink cartridges and new computers every year without selling a few articles. (Computers are actually assets and I’ll touch on those later.)

What is a business? Remember that it doesn’t matter to the IRS. You get money, you pay taxes. That said, a business is a distinct activity. Each Schedule C requires a code that corresponds to the type of business. You can’t simply lump all your money-making activities into one. Some forms of income, such as rental properties and income from partnerships, are reported on Schedule E. Unless… you incorporate.

A lot of self-employed people incorporate, or create an S-Corporation. One big advantage of doing this for a lot of people is that the owner of the business can pay herself a salary and take additional money out of the business as a dividend, which is taxed at a lower rate. However, the salary must be reasonable. You can’t pay yourself, and therefore pay the higher income tax rate on only $10 a month and take the rest out in dividends. As a writer it would be pretty difficult to make the case that your salary should be less than what you’re bringing in. There are other reasons to incorporate, but most of them don’t have to do with deductions, and you’ll have to ask that CPA you’re going to hire.

 

 

 

Can I Write If Off?

As a writer, you have very few expenses. Ink, paper, postage, some magazines, maybe some travel and mileage, and frankly not much else. You’ve got the home office issue, and then there’s your computer.

 

 

Basically, if you’re in business as a writer and you incur and expense in the course of conducting that business, it’s deductible. There are different opinions among tax professionals about many deductions. Some CPAs are conservative, others very aggressive. Remember, it’s a subjective system. If you have a good argument for something being a deduction within the parameters of the rules, then go for it. Use your common sense, and again, consult a professional. And keep track of everything, regardless of when in the year you embark on your freelance activities.

Deadbeat clients stink. What stinks even worse is that as a service provider, you can’t write off the value of your time. If someone doesn’t pay, you don’t include anything in income, but you can’t include an expense for this either. Although you’ve lost your time, in money terms, there’s nothing to write off.

If you pay people to help you in the course of your business, they are self-employed and thus responsible for reporting their own income. This is an expense. You aren’t required to report the details every little thing to the IRS, but if you pay the same person on a regular basis, you want to consult with a CPA or a good bookkeeper.

 

The home office deduction is mired in muck. Do you really qualify? Just because you work from home doesn’t mean you can write everything off. In order to take any deduction for your home office you need to meet some tests. First, the office must be exclusively and regularly used for business. Most of us fail on the exclusivity test. But hey, if you never pay bills, help kids with homework, or read your horoscope in your office, fine. Read on.

 

 

In addition to the first tests, your office must be the main place you work, the place you meet clients, or a separate structure. My position is conservative. I don’t like to mess with this deduction. It’s usually not that much, and you need to keep track of all kinds of expenses to justify the deduction. Also, you know that nifty rule that allows you to basically ignore the gain you make when you sell a house? Did you know the home office deduction affects that exclusion?

 

 

 

While we’re on the subject, beware of any so-called advisor who tries to sell you a trust to make all your personal expenses deductible. Ain’t gonna happen.

Computers are not expenses. There, I said it. Don’t kill the messenger. Computers, and other equipment, like printers and faxes, are considered assets. Assets must be expensed over time, or depreciated. The good news is that there are some wonderful rules in place that let us accelerate that depreciation so that most of us are perfectly within our rights to write off an entire computer in one tax year. But a new laptop the next year? You may be pushing it. It depends on your situation, and as long as you’re not doing this year after year and you have a good reason and a receipt, you may be fine.

While writers don’t have a ton of deductions, there are other ways to improve your financial situation. Consult with a CPA to find out how you can set aside money in a tax-deferred account.

 

 

Paying Taxes

 

 

 

Remember ours is a pay-as-you-go system. If you’re making a certain amount of money, you’ll need to pay your taxes quarterly. A good tax preparer can create an estimate for you and print out coupons with the amount and date printed right on them. All you have to do is write a check and send it to the IRS. If you’re just starting out and you previously worked or are still working for someone else, chances are you’re fine for the first year. As a general rule, if throughout the year you pay in the same or more as what you paid in the prior year, you won’t owe penalties even if you owe taxes at the end of the year.

While everyone’s circumstances are slightly different, it’s a good idea to put away at least 25% – 30% to pay income taxes, whether or not you are required to make estimated payments.

 

 

How to Choose a Tax Preparer

If you were a farmer, you wouldn’t go to the CPA who specializes in shoe stores. Find someone who works with writers and artists, or at least people who are self-employed from home. Ask around. I can tell you from experience that if you call up a CPA firm and ask if they’ve got someone who specializes in freelance writers, they’ll say yes. That’s not such a bad thing. A good CPA will do the research it takes to give you the best advice. However, the more familiar the CPA is with your circumstances, the more efficient the work and in some cases, the lower your fee.

 

 

Always work with someone who is open year round. You will pay more for a CPA than the outfit at the strip mall who pays their preparers $7 an hour and shuts down on April 16^th, but you get what you pay for. Try to find an accountant who will provide a comprehensive analysis at some point during the year because can’t plan for the year after it’s passed.

 

 

Resources

 

 

The IRS creates tons of publications to explain our tax laws. Some are easier than others to read, but if you’re looking for something specific and you don’t want to pay someone to tell you the answer try going to the source!

http://www.irs.gov/ – Main page

http://www.irs.gov/businesses/small/index.html – Small business page