ComproTax Talks!

If you’re anything like me, the very thought of taxes makes your eyes cross and sends you running for cover under the nearest desk. Take heart! About.com’s very own tax guru, William Perez, is here to help us — in this first of a four-part series, offering freelance writers online help with taxes. What are some user-friendly articles, books, or websites you recommend to explain the basics of preparing taxes?

Freelance writers will want to get a basic overview of their tax situation in an article I wrote, called Tax Tips for Freelance Professionals. In addition, they may want to start thinking about what to do when their freelance career starts to really take off and make some serious money. It’s never too early to plan ahead for financial success.

t some point, a writer may want to consider forming a legal business entity around their writing. I provide a basic overview of the issues and questions to consider in my article on Incorporating, Choosing a Form of Business Organization. Freelance professionals should also bookmark IRS Publication 334, Tax Guide for Small Business, which is found on the IRS Web site. Pub 334 covers the very basic information that every freelancer needs to know about keeping records, recording income, allowable business expenses, determining if they can deduct the cost of their home office, and planning ahead for their tax liabilities.

What is the main difference between filing taxes when working for a company, and when working for oneself?

Freelance professionals have a completely different tax burden than employees. Your clients will not deduct taxes from your paycheck and mail it into the IRS on your behalf. Your clients will not pay half of your payroll taxes. And your clients will not be sending you a Form W-2. This means freelancers have to be very good about keeping a record of their income and their expenses.

The biggest difference is that you are in business for yourself as a freelancer. You are responsible for paying both the regular income tax and payroll tax liabilities. Both taxes will be based on your profits — that is, on the net income after subtracting all business expenses. The key to managing both taxes is keeping excellent records of your freelance income and related business expenses. Generally, I recommend you make your record-keeping system as simple as possible.

For freelancers, payroll taxes are called the “self-employment tax.” This is a flat 15.3% of your business profits. Employees don’t pay the self-employment tax. Instead they pay FICA taxes, also known as the Social Security and Medicate tax. Employees pay half the FICA tax (7.65%), and employers pay the other half (another 7.65%). As a self-employed person, freelancers pay both the employee’s and employer’s share of the tax, for a total tax rate of 15.3%.

Employers are allowed to deduct payroll taxes as a legitimate business expense, but not so for freelancers. Instead, the IRS has come up with a discount factor so that takes this business deduction into account. Self-employment taxes are calculated on Schedule SE. Freelancers who file a Schedule C must also file a Schedule SE. These two tax forms almost always go together. Additionally, freelancers can take half their self-employment tax as a deduction against their regular income tax. This deduction is found page one of the Form 1040 in the “adjustments to income” section of the tax form. You do not need to itemize in order to claim this deduction.

Freelancers with substantial income might want to consider incorporating their business, as I mentioned above. One benefit of incorporating is that you can lower your payroll taxes, sometimes significantly, by structuring your business appropriately. As a general rule of thumb, freelancers who earn or expect to earn $100,000 or more per year in gross revenues should definitely start thinking about incorporating. Incorporating a business does not require that you hire an accountant or a lawyer. However, consulting with a tax consultant or attorney is highly advisable. That’s because there are several different types of business structures you can choose from, each with their own tax and legal consequences. It’s often well worth the time to make the right decision from the start, instead of struggling with the consequences of an ill-formed decision.

Does a freelance writer file taxes as an individual, as a small business, or something else?

Freelance writers should file their tax returns as individuals. They will not need to file any business tax returns unless they choose to incorporate their business as a separate legal entity. Husband and wife teams may file separate Schedule C forms, or may file a partnership tax return. This is a special situation, however, and should be discussed with an experienced tax professional prior to making the decision.

Taxes Tips for Freelance Writers

What tax forms does a freelance writer need to fill out and submit to the IRS? At minimum, freelancers will be reporting their freelance income and related expenses on Form 1040 Schedule C. Schedule SE is used to figure the self-employment tax. If the writer has a home office, then Form 8829, Expenses for Business Use of Your Home, will be filed with the tax return as well.

What are some good step-by-step guides a writer can follow in filling out these tax forms?

Generally speaking, I recommend that writers try to follow the instructions published by the IRS. To prepare a basic tax return, a freelance writer will need the instructions for the forms mentioned previously, which again include Form 1040, Schedule C, Schedule SE, and Form 8829. If someone gets stuck or needs help with a tax question, they can contact me by email or submit a tax question through a Web-based form.

Although a bit out of date, Eva Rosenberg’s Small Business Taxes Made Easy covers all the basics of running a small business.

For more up to date information, consider purchasing JK Lasser’s Your Income Tax. This annual book covers all the basics of filing a tax return, and has an excellent chapter on business income (chapter 40). I am not aware of any tax-related videos or workshops. There are, however, classes for learning how to become a tax preparer. In fact, taking such a class might not be such a bad idea. The big tax franchises offer low-cost “tax schools” that cover the basics of Form 1040. You might even find out you have a penchant for preparing taxes, and you could supplement your freelance income during the busy tax season. If you are super serious about taxes, Eva Rosenberg offers, on occasion, a “tax boot camp” for small business owners through her web site.

What information does a freelance writer need to collect during the year, to be well-prepared for taxes?

You will need to keep track of all your freelance income and your related business expenses. Some of your clients will send you Form 1099-MISC to report your “non-employee compensation,” but some clients will not be sending you a 1099 at all. Clients are required to issue a Form 1099-MISC if they paid you $600 or more during the year. Copies of Form 1099-MISC are sent to you and to the IRS. Some clients issue 1099 forms even if they paid you less than $600. And some clients fail to issue 1099s even if they paid you $600 or more. As a result, you must keep an accurate record of all income you earn as a freelancer. You simply cannot rely on your clients to do your accounting for you.

In general, clients will not withhold any money from your payments for taxes. In fact, you must certify that you are exempt from backup withholding by providing each client with a signed Form W-9. Most freelancers are familiar with paycheck withholding for various taxes. As a freelancer, you are in full control of every aspect of your taxes. That means you should get in the habit of setting aside money from every project for your estimated taxes.

Keeping track of your business expenses is essential. You will be taxed twice — both the regular tax and the self-employment tax — on your business profits. This is your net income after you have subtracted all your allowable business expenses from your freelance income. What’s a legitimate business expense? That’s a question I hear all the time from clients and readers. There’s no hard and fast rule. The general definition is that an expense must be “ordinary and necessary,” given your trade or profession. That definition comes straight out of the tax law, so don’t blame me for being vague! This topic is so huge, the IRS has devoted an entire publication to the topic of business expenses (Pub 535).

Generally speaking, a business expense has a legitimate business purpose. Buying a copy of TurboTax so I can review it for taxes.about.com is a legitimate expense. Even An IRS auditor can see how having a copy of this tax software directly relates to my job. Taking my friends out for dinner, however, is not a business expense. Problems arise when an expense might be partly personal and partly business related. A common example for writers is personal projects that turn into published articles. You might be repairing your house, and end up writing some tips that gets published in a magazine. Would your home repair expenses be legitimate expenses? Or would they be entirely disallowed in an IRS audit? Or is this a middle of the road answer?

As a general rule, the IRS will allow you to allocate the expense to personal and business use, and deduct the business portion on your tax return. See Pub 535, Personal versus Business Expenses. Always keep track of all your expenses, even if you have doubts. It will be easier for you to ask your accountant about expenses if you keep track of everything.

And at least once a quarter, you will want to sit down with your accounting records and get a rough idea of what your tax obligations are, and pay any estimated tax liabilities you have. You don’t need to file tax returns every quarter; this is a common misperception. Simply mail payments of your estimated liability every quarter. That way you’ll avoid a huge tax bill at the end of the year, and you’ll also avoid the underpayment penalty.

Taxes Tips for Freelance Writers

What are some tips for how to organize that information during the year, so that it’s as easy as possible to file during tax time? Personally, I use a full-featured accounting software to track my income and expenses. But then again, I’m an accountant and feel comfortable using software such as Quickbooks, Peachtree, and Microsoft Office Accounting. I generally do not recommend these programs to freelancers, as they take a while to get used to; and it’s easy to get frustrated with all the features. Instead, I recommend using personal finance software such as Intuit’s Quicken or Microsoft Money.

These programs are very easy to get used to and can track all of your finances, not just your business. As an added bonus, the better tax software programs allow you to import data from Quicken or Money. So spending some time making sure your expense categories are set up can go a long way to reducing the amount of time you spend preparing your taxes.

All the accounting programs I mentioned can generate profit and loss reports (called income statements by accountants). These reports help you analyze how your freelance business is doing, whether you are profitable, and how you are spending your money. If you decide to hire a tax accountant, having these reports to greatly expedite the preparation of your tax returns.

Anything else you’d like to share with freelance writers about filing taxes?

A recent study found that Americans spend about 40% of their income on taxes. This includes income, payroll, and sales taxes. With a tax burden like that, it pays to take some time to learn about the tax system and how we can keep our tax bill as low as possible.