Working for yourself isn’t always what you expect. And one thing many newbie freelancers are unclear on is how their freelance income will impact their tax situation.
Tax time may be over for 2011, but if you’re a brand new freelancer starting out, your tax time begins now. So here are some basics you should know when it comes to your new relationship with Uncle Sam. Bear in mind these are general tips meant to educate freelancers just starting out; whether you’ve gone full-time with employees or your freelancing is just a side hustle for now, you should consult a CPA for professional advice and guidance in all cases.
Freelance Taxes 101
Get yourself a good CPA. I never thought I’d be fancy enough to warrant needing an accountant. And I know it seems like a big expense when you’re just starting out. But I’m so grateful a self-employed friend convinced me to visit her CPA. I had no idea what I was in store for, and knowing I now have someone knowledgeable looking out for my interests is a huge relief for me in this new territory.
Oh, and did I mention that any accountant’s fees you incur in connection with your freelancing can be deductible as “professional expenses?” So there’s really no reason not to get a CPA.
If you make $600+ from any one client, you need to report it. Each client this applies to should provide you with a 1099-MISC form at the end of the year listing how much they’ve paid you, which you then include with your tax return.
If you net $400+ for the year, you have to pay self-employment tax in addition to income tax. This was a particularly nasty surprise for me. If you work for yourself or as a 1099 contractor, you are essentially double-taxed as both an employer and an employee. (I know; way to encourage entrepreneurship, USA!) In my case, that means a solid one-third of every dollar you bring in will go right back to the government.
So, in the wise words of my CPA, “Don’t take that big project you just got paid for and go on vacation with it.” Start setting aside your tax percentage now—ideally in a separate savings account you won’t be tempted to touch—or else you may be unpleasantly surprised when tax time comes.
You now have to pay quarterly. The good news is that if this is your first year of freelancing, and last year you had no freelance income to report, you don’t need to worry about quarterly payments just yet. (Remember, you only have to report if you’ve made more than $600 for any client. So if you started freelancing mid-2011 and only managed to earn $300 for the year, that doesn’t count as reportable income. Your first freelancing year technically starts now in 2012.)
If this is your first year, you can wait till the end of the tax year to file, at which point you can also get a better idea of what your estimated quarterly payments will be next year. After year one, if you expect to owe the government $1,000+ (after deductions), you will be required to make estimated quarterly tax payments.
These will be due on January 15th, April 15th, June 15th, and September 15th. You don’t have to worry too much about the precision of your estimate; if you estimate too high or too low for any quarter, you can fill out a form to recalculate what you’ll owe the next quarter.
Track your business expenses. The major rules for writing off “home office” and other business expenses (although you’ll want to clear specifics with your CPA) include:
- For a room to be considered a home office, it must be used it solely for business-related activities. (In other words, if you what you have is a home office/kids’ playroom/den, get rid of those slashes.)
- You can deduct things like computers, ink and other office supplies, phone plans, mileage spent driving to a client’s office—anything you need to pay for in order to keep your business running. (Within reason, of course. Getting too deduction-happy can raise red flags you don’t want raised. As always, defer to your CPA’s advice.)
- If you have a dedicated home office, you can also deduct a portion of household expenses like mortgage interest, rent, utilities, and insurance based on what percentage of the square footage of your home is made up by your office.
Solid recordkeeping is so worth your time. Keep a separate insert in your filing cabinet for any potentially deductible expenses so you’re not scrambling at the end of each quarter to track down receipts.
For household expenses like utilities for which you’ll be deducting only a percentage, it’s a good idea to start a running spreadsheet to keep track of what you’re spending over the course of the year. Each month when you pay your heat, electricity and other bills, enter the amounts on the spreadsheet so that come tax time, everything is all there for you to calculate your percentages. It’s a few extra minutes each payday to save you a ton of hassle later on.
Are you just starting out as a freelancer? Tell us about it!
Kelly Gurnett, a.k.a. “Cordelia,” runs the blog Cordelia Calls It Quits, where she documents her attempts to rid her life of the things that don’t matter and focus more on the things that do. You can follow her on Twitter and Facebook.