With unemployment rates at their highest in 15 years, there’s never been a better time to consider becoming a freelancer. Companies may not be hiring the way they once were but there’s still a huge demand for skilled workers. Programmers, web designers, writers and anyone else who can bill their services by the hour are bound to find a receptive audience. But if you’ve never freelanced before you may not be aware of what it takes to run a business. And while you may welcome the thought of setting your own hours, working in your pajamas, and playing your music as loud as you want, make no mistake about it. Freelancing is a business with very specific rules about how you should manage your finances. In this two part article, we’ll tell you what you need to know.
One of the major differences in how you need to handle your finances is how you deal with taxes. As a freelancer, you will have a different tax status than someone who is employed full-time by a corporation. You’ll be responsible for supplying yourself with everything you need to get your work done; perhaps a computer, a phone, Internet access, a desk, and an office. On the plus side, many of these things can be claimed as business expenses and deducted from your taxes.
Depending on your filing status, you may be required to pay quarterly taxes. Estimating your taxes and keeping to a quarterly schedule may be difficult for someone who is used to having the company automatically deduct the tax before their paycheck even hits their bank account.
That’s where a good accountant comes in. When preparing to file your tax return, it is critical to select an accountant that specializes in small businesses and knows how to work with freelancers’ returns. For example, you may have heard that you can deduct a portion of your rent if you work from home, but how much is allowed? And how do you make sure your office is properly delineated from your living space. An accountant that knows what to deduct for you can help you save money and file a more accurate tax return. According to Mark Luscombe JD, CPA Principal Tax Analyst for CCH, which produces the free annual CCH Tax Guide For Journalists, freelancers need to file at a minimum, Form 1040 and Form 1040 Schedule C, depending on their particular situation. If the freelancer estimates that they will owe more than $1,000 in tax beyond any tax paid through withholding, in general they should pay quarterly estimated taxes.
Working as a freelancer essentially means you have your own business. Filing your taxes as a sole proprietor could be a good idea since it will enable you to deduct business expenses. “A sole proprietor attaches a Schedule C to the Form 1040 individual return. Schedule C is the place to set forth the income and expenses of the sole proprietorship.,” says Luscombe.
Deductions and Expenses
Tracking deductions is important, as this will help you be better prepared come tax time. Keep a record of any phone or car expenses you had that were business related. Having a separate phone account that is exclusively for business will provide a better-detailed list of related phone expenses. Make sure you have receipts for everything you plan to deduct and keep track of all expenses. If you have minor expenses under $75 it is less critical.
Use expense tracking software such as Mint.com to automatically sort transactions into categories such as groceries, gas and many others so you see exactly where your money goes and keep a record of your expenses. It’s also a good idea to have a separate credit card and bank account dedicated to business related expenses, that way you can have a documented record at the end of the year. Many credit card companies will send you a year-end summary with purchases neatly categorized so all you have to do is go through it and mark which ones were legitimate business expenses.
Requirements for home office deductions have loosened up in recent years, Luscombe says, “The home office deduction has gotten a little easier to meet - the home office is no longer required to be used by customers or clients as long as it is the principal place of any business carried on by the taxpayer. There is no dollar limit on what can be deducted, but expenses applicable to the overall home such as utilities and depreciation require an allocation between the portion of the home used for business and the portion used for personal purposes. Also, the allocable expense portion of the deduction for a home office cannot create a loss (i.e. cannot exceed business income less other business expenses). Such expenses can, however, be carried forward to future years.” It’s also important to note that any income received should be reported as income. A few examples include money won in a writing contest or funds received from grants.
Some of the common home office deductions include, equipment and office supply purchases such as computers, printers, software, hardware, office furniture, paper, and pens. Deductible business related expenses are a dedicated business telephone line and Internet connection, as well as web domain registrations and hosting fees. Also deductible are entertainment expenses such as meals or drinks for colleagues or interview subjects. Car expenses, travel expenses, and professional journals and dues, research related magazine subscriptions and books, health care and advertising expenses like brochures, business cards and flyers are also deductible.
Figuring out the depreciation value of your office equipment can be a bit more difficult.
According to the tax analyst, “Depreciation can be very complicated to determine. It depends on the depreciable basis of the asset, the depreciation method that applies under the tax law, the depreciable life of the asset, and any special rules such as bonus depreciation or small business expensing elections that may apply.” If you aren’t working with tax professional, you may want to turn to IRS Form 4562 and Publication 946 for help in determining how to depreciate an asset.
When looking for tax assistance, a reputable accountant can be found by talking to organizations, friends and colleagues in the field. Once you find a specialized accountant, interview the person and ask them how much of their time is spent preparing freelancers tax returns, see if you have a good rapport with them and find out what their fee is. These questions will help you determine if this is the right person who will meet your tax needs.
In part two you’ll learn how to deal with health insurance, retirement issues, and clients that refuse to pay.