Working as a freelancer means more complicated tax calculations from the typical. Paying self-employment tax is also no fun, but you still have ways to save. What type of entity are you as a freelancer (LLC or a Corporation) to make this happen?
Not every freelancer realizes many of the pitfalls they can avoid at tax time. It's far too easy to overlook things if you are in a hurry to file your return. This could lead to major penalties if doing your taxes on your own.
Take a look at our list of 14 things freelancers often do that put them in hot water, and how to avoid trouble.
1. Assuming You Don't Have to Pay Anything
Remember, you have to start paying self-employment tax once you earn $400 or more as a freelancer. Some people starting out as self-employed individuals make the mistake that if they hardly generated substantial income in a tax year, they owe nothing.
Just keep that $400 figure burned in your brain.
2. Assuming Cash Doesn't Count
Some of your self-employment may involve being paid in cash to avoid any official record you were paid. Being paid this way might be more convenient for you if you don't use credit or debit cards.
Never try to hide cash payments from the IRS or state taxes. Word could get out, forcing you to pay penalties for willingly hiding under-the-table income.
3. Not Paying Your Estimated Taxes
As a freelancer, you're supposed to pay your quarterly estimated taxes, due in January, April, June, and September. Based on income and expenses, some freelancers can't afford to pay them. While it's always possible to make time payments to the IRS and state, this can be a debt burden for many years.
It's best to set aside 30% of your monthly income to pay your quarterlies. Maybe it's difficult to pay them during the year, yet it's better to pay ahead than pay on tax debt into retirement.
4. Never Worrying About Being Audited
Just because you're a freelancer doesn't mean the IRS counts you out in potentially being audited. It can happen to anyone if the IRS suspects you're fudging facts about your income.
Always keep your bank statements from the previous year (or two), plus all receipts for business expenses. Your accountant can probably take on an audit for you, but hand over all evidence of what you make and pay in expenses.
5. Throwing Away Business Expense Receipts
Something seemingly unimportant as meals and travel expenses might be looked at as unnecessary in saving records. When traveling in a freelance job, those expenses can add up fast. It's a good idea to save receipts from all those expenses so you have a paper trail to write them off.
You're supposed to save meal and travel receipts if they go over $2,500. Having receipts available is good backup, even if you have credit or debit card transactions saved in the cloud. You might have paid cash for some of those meals. Plus, receipts have printed info to better prove them as true expenses for business rather than off-time.
6. Not Understanding Difference Between Gross and Personal Income
Some freelancers assume gross income is the amount you earn for yourself. Always remember gross income is your personal income after you deduct expenses. The final figure might look very different for your personal income, depending on how many expenses you had.
7. Not Filing a Tax Return, Despite Paying Estimated Taxes
This freelance faux pas is easy to happen with assumption you paid your quarterlies successfully all year. You still need to fill out a tax return to the IRS to prove you paid taxes through the year. If you don't, the IRS will sock you with a failure to file penalty.
8. Not Reporting Income Not Listed On Your 1099
Sometimes you may have additional income that a 1099 doesn't report. For instance, you may do freelance work for one company that sent you a 1099. On the side, you may have had private clients who paid you for your services, yet not enough to warrant a 1099 being sent.
You need to report that additional income to avoid penalties and interest charges.
9. Not Reporting On Your Schedule C Additional Money Paid to You
Filing a Schedule C requires you to state your entire income. Some freelancers don't include alternative payments there, leading to possible audits. Even if you were paid in alternative currency (including Bitcoin), you need to report it on your Schedule C. Again, it's always risky not to report cash earnings.
10. Not Keeping Receipts for Business Purchases
Working as a freelancer may require you to buy certain items to keep your business thriving. One of the most common is buying a new computer or mobile device, especially if a freelance writer. You can write this off on your taxes, despite requiring a receipt.
Don't throw out any receipts for these purchases since they might not be available online as part of your business records.
11. Not Reporting Reimbursed Expenses
Place this in the unreported extra income category. Too many freelancers who get expenses reimbursed for doing side favors or jobs don't report this extra money.
Some of this could add up during the year, no matter if paid secretly in cash. You have to include this on your Schedule C as much as any added income.
12. Relying Too Much On Bank Statements for Proof of Purchases
Sure, your bank statements can show you spent a certain amount of money on an important business item. Don't rely on these statements alone, though, since they don't provide all the details on what the purchase entailed.
As outdated as paper receipts might look in the digital age, they still come in handy to back up details on where and when you purchased something.
13. Feeling Too Confident in Doing Your Taxes On Your Own
You may think your freelance career is simple enough where you can figure taxes yourself. Based on the above complexities of freelance work, you're better off hiring a professional to help sort through your expenses.
14. Not Roughly Calculating What You'll Make During the Year
Rather just wait to worry about what you'll owe next tax season, keep a running expense sheet on what you have to pay out in expenses. Do the same with what you generally expect to make.
Doing this leads to fewer surprises when your accountant adds up the total.