Freelancing? Self-Employed? Avoid These Tax Mistakes
Ed Note: Whether your paychecks come exclusively from steady contract work or you’re side-hustling on top of your 9-to-5, the IRS treats freelance income differently than employee income. As anyone earning money from more than one source can attest, tax time can get tricky. Luckily, David Weliver. the publisher of MoneyUnder30.com. is here to share the do’s and don’ts of tax filing for freelancers and side-hustlers. Enjoy.
Freelancing can be a rewarding way of life or a savvy way to make money, in addition to a full-time job, to pay down debt or build savings faster. But when it comes to taxes, a dollar earned on your own isn’t the same as a dollar earned from an employer. If you plan on earning money on the side – or if you’re trying to make a living as a freelancer – you should understand how the income you earn will be taxed. You’ll learn how to keep more of your hard-earned money in your pocket and how to avoid surprise tax bills or penalties.
Whether or not you have a full-time job, the IRS considers any money you earn on your own to be self-employment income. And they treat this income differently than income you earn as an employee. The following pointers will help you keep more of the money you earn come tax time.
DON’T spend all that freelance money!
When you get a regular paycheck, your employer has already withheld Uncle Sam’s cut. With freelance income, you’re responsible for setting that money aside to pay taxes. If you’re accustomed to receiving a tax refund, it can come as a big surprise that you might actually owe the government hundreds or thousands of dollars. Avoid getting caught with a big tax bill you can’t pay by making estimated tax payments every quarter. (If you’re not sure how much to pay, setting aside a third of any freelance income is a good rule of thumb.)
DO report all your income.
As you start earning freelance income, it can be tempting to just leave it off your tax return. After all, how will the IRS know? Well, they will. For one, if you earn $600 or more from any one source, that person or company is required
to file form 1099 with the IRS detailing how much they paid you. Later, IRS computers match your tax return to filed 1099s and red flag any discrepancies. If there is one, you’ll get a bill for the difference…plus penalties and interest.
DO keep your business records separate from personal.
As soon as you begin freelancing on a regular basis, it makes sense to open a new bank account that you use only for depositing business income and for expenses. Not only will this make it faster to prepare your tax return each spring, it will provide better evidence of business deductions in the unlikely (but always possible) event of an audit.
DO take advantage of deductions.
If you’re running a legitimate freelance business and not as a hobby, you can deduct ordinary and necessary expenses you incur in the course of doing your work. This includes everything from the office supplies you buy at Staples to miles you log in between visiting clients. (Good records are key!)
Also, be sure to take advantage of other deductions available to the self-employed. These include a deduction for half of the self-employment tax and contributions to a Simplified Employee Pension (SEP-IRA), a kind of tax-deferred retirement account available to anybody with self-employment income.
DON’T try to pass off a hobby as a business.
Let’s say you restore old cars and occasionally sell one you’ve worked on. Still, you end up putting far more money into parts than you ever make back in a sale. You get the genius idea to create a business for your restoration services so you can deduct all that chrome.
Careful. To be considered a business (as opposed to a hobby) in the eyes of the IRS, you must expect to show a profit in three of the next five years. There are some uncommon exceptions, but in general it’s best to avoid taking deductions from mostly non-profit personal pursuits.
DON’T be afraid to ask for help.
Your taxes may have been straightforward for years, but freelance income (and especially deductions) can add several pages to your tax return. Enlisting the help of a tax professional can be a good idea to help you maximize deductions and avoid mistakes that could trigger penalties – and unnecessary headaches – later on.