2016 is behind us, and now it is time to prepare our taxes so we can help fund our nation’s security, highways, and social programs. Well, okay, maybe it is a bit of a stretch to imagine paying taxes as such a benevolent activity. The truth is, most of us do whatever we can to pay as little taxes as legally possible.
So, how do we do that?
Because freelancers don’t have their taxes taken out of a paycheck automatically, it can be tempting to get excited about earned income through various clients, forgetting how much of a large percentage goes to Uncle Sam.
However, before we step into maximizing our take-home pay, we need to determine just how much that is.
Hopefully you have a separate bank account for your business, that will make a lot of this much easier. If you don’t have a separate business bank account, I highly suggest that you do so. Being able to track your income and expenses automatically with the account’s balance sheet is extremely helpful.
That being said, I don’t always use my business account for business-related purchases. For example, apps from the app store on my phone are paid for by my personal credit card, since that is what is linked to my iTunes account and changing it just for business purposes is a pain. Another consideration is online stores you may shop frequently on like Amazon. If you don’t always change your source of payment, you may have some business expenses in there that can be deducted from your gross pay.
You should also gather your tax documents provided by clients, in America these are in the form of a 1099-MISC. If a client pays you over $600, they will first ask you to complete a W-9 in order to gather your taxpayer id (either social security number or employer id, depending on your business setup). Then, they will fill out a Form 1099-MISC to provide to the government, and send you a copy of the 1099-MISC for your own filing purposes.
Unless you like getting audited and/or fines, I’d suggest that your reported income matches up to these 1099-MISC forms the government is receiving from your clients.
Of course, there may be clients who haven’t sent you a 1099-MISC, and they are required to do so by the end of January. So, if February rolls around, write to them and request your 1099-MISC be filled out and sent to you.
You may also have income from clients that falls under the $600 limit. They can still send you a 1099-MISC if they want to cover their bases, but more often than not you will simply report this as miscellaneous income on your Schedule C.
Now for the fun part: Deductions!
When I first started out as a freelance web designer, I thought that my business had no expenses. I mean, I just used my computer to create code, then handed it off to my clients, right?
As it turns out, I had quite a bit of business expenses that I realized once I realized what I should be tracking:
- The cost of my computer
- The cost of software I use
- The cost of backup and file-sharing services
- The cost of my workstation where I do the coding
- Books that educate me on being a better programmer
- Conference fees and related travel expenses
- A portion of the cost of my cell phone
- A portion of my cell phone bill
- A portion of my home expenses
- A portion of my internet connection
- Lunch meetings with clients, vendors, and partners
- Advertising costs such as hosting a marketing site for my business
The list goes on and on. While I could wait until the end of the year to gather up all of these expenses, it is much easier to simply track them throughout the year using expense-tracking software.
What about mileage?
In the United States, freelancers are not allowed to deduct the cost of driving to and from their office. However, if you are heading out to meet a client, or picking up supplies at the office store, you can include those miles in your calculation for a standard deduction rate per mile ($.54/mile for 2016).
I used to laugh at the idea of tracking miles to and from the office supply store, until I realized the following. If the trip to the store is 10 miles round-trip, that’s $5.40 in income deductions. Once you combine the federal, state, and local taxes you pay on your income, there is going to be about a $2.00 benefit to keeping track of those miles. Now, think about how many times you drive for a business-related purpose, or times when you are driving a longer distance, and you can start so see the benefits adding up, as cash right back into your pocket by simply writing down how many miles you drove.
Note: We’re proud to announce that in 2016 Harpoon added Mileage Tracking as a core part of our platform.
Understanding Self-Employment Tax
Once you have your income and deductions organized, then it is time to start plugging those numbers into your tax form, or tax software, or handing it all over to your accountant.
Unless you are set up for tax purposes as a corporation, your adjusted business income is likely to be passed on to you as personal income. In the United States, you can do this as a sole proprietor (basically, just a person making their own income), or as an LLC filing taxes as a pass-through entity (similar to a sole proprietor, but with more legal protection).
Here’s the bad news: In addition to your federal income tax, you now have to pay another 15.3% for self-employment tax.
What? The government taxes you more because you happen to be smart (or ignorant) enough to run your own business? Well, technically this isn’t an additional charge.
Typically, for an employed individual, around 6.2% is taken out of their paycheck for social security, and 1.45% is taken out for Medicare. This is a total of 7.65% taken from each paycheck. Your employer, in turn, has to pay the same amount for each employee that they have on payroll. Being self-employed, you are both the employer and employee, so 7.65% + 7.65% = 15.3%, your self-employment tax.
Tax-filing time is a great time to figure out whether or not you should be filing as a sole-proprietor or a corporation. While you can figure this out yourself, you really should just see an accountant.
Talk to an accountant about whether a corporation makes sense for you.
Take all of this with a grain of salt
While much of what is in this article can provide guidance, you would do well to seek tax, legal and accounting advice in your own geographic area. The ideas here are just to get you started in the right thinking, but are no substitute for proper professional advice.
And now, a standard legal disclaimer:
Harpoon and it’s affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.