Are you a freelance professional? Here are six tax time tips to help you — especially if you are a noob.
When I first started as a freelancer, I didn't think much about the tax implications, and that was a big mistake. From underestimating what I owed in federal taxes to forgetting about my state taxes to my business organization, I didn't “get” taxes and ended up owing more than I should have, and finding myself in difficulty.
As a noob freelance professional, it makes sense to sort out your taxes as soon as possible. Here are five tax time tips that can help you better prepare your finances:
1. Pay taxes quarterly
One of the best things you can do is make your quarterly tax payments. If you base this year's payments on 100 percent of what you owed last year, it's fairly easy to avoid penalties from the IRS for underpayment. If you expect to make more, though, it makes sense to plan ahead for that.
I like to set aside money each month. I figure out how much I will need to pay total in taxes for the whole year (based on my previous year's bill) for federal and state taxes. Then I divide that number by 12. Each month, I pay into a high-yield savings account designed for taxes. Every quarter, when federal taxes are due, I write the check and transfer the money to a checking account. Since my state doesn't require quarterly payments, I let that money sit all year and write the appropriate check on April 15.
You don't have to write checks; the IRS and most states offer electronic payment options. I just like the idea of sending a check at the last possible second, keeping my money for as long as possible.
2. Choose the right business organization
When figuring your taxes as a freelancer, you need to understand the implications of different business organizations. Your self-employment tax, whether or not you pay payroll taxes for employees, and other items depend on your organization.
I have an LLC with my husband, and this setup, thanks to the advice of an accountant, has been helpful to us. Do a little research about business organizations, based on your goals as a freelance professional, and determine what will work best for you.
Also consider whether you want 1099 contractors or W-2 employees working for your freelance business. All of these decisions have tax implications that you need to sort out ahead of time.
3. Know what you can deduct
One of the great things about owning a freelance business is that you have low overhead costs. However, the things you do spend money on might be deductible. Know what items you can deduct as a freelance professional, whether it's the cost of your new computer, web hosting services, or travel to a conference. You should also consider the home office tax deduction and other possibilities.
This isn't just one of the tax time tips you can use, either. Keep your deduction possibilities in mind throughout the year so that you can plan your freelance business spending around deductible costs, from health care to advertising to Internet service.
4. Business loss vs. hobby loss
As a freelance professional, you aren't likely to wind up with a business loss. However, it is possible if you have a bad year. Make sure you understand the difference between a business loss and a hobby loss.
If you have a true business loss, it can be deducted against other income. A hobby loss, though, can only be deducted against the income for that specific hobby. Make sure that you have a bone fide home business as a freelance professional before you attempt to take a business loss.
5. Stay organized
Finally, stay organized with your tax documents. Set up a folder and keep all your receipts together throughout the year. Anytime you have a business expense, file the receipt appropriately.
Most personal finance software allows you to categorize expenses as “business” or flag them for tax purposes. This makes it easier to prepare such items as profit and loss statements, and document deductions you want to take for your freelance business.
When you are organized throughout the year, it makes things easier for everyone involved — especially you.