This post was helpful to me, and I don’t even do my own taxes. The person I hire to do them is great, but she goes through things so quickly I sometimes don’t understand what she’s talking about. Thank you for this basic, helpful guide!
10 Income Tax Terms All U.S. Freelancers Must Learn
Posted February 16, 2011 in Accounting/Bookkeeping
If you’re a freelancer in the U.S., then you’ve probably either just completed your income tax return early, or you (like many of us) are still in the process of completing it before the April deadline.
This post is for those of you who are still working on your tax return.
The income tax return of a freelancer is notably different from the income tax return of a corporate employee. Whether you’ve been freelancing for a long time, or just started freelancing, you should take note of the differences.
In this post, I’ll list and describe ten tax terms that all U.S. freelancers should understand. (This list is mostly specific to freelancers who use Form 1040.)
Tax Terminology for Freelancers
If you’re struggling with your income tax return for the first time, or just need a quick refresher, you’ll need to know the terms on this basic list.
Here’s the list of freelancing tax terms:
- 1099-Misc.–As a freelancer, you will not receive a W-2 form from your clients. U.S. clients who pay you over $600 should send you a 1099-Misc. (You may also be required to send out a 1099-Misc. if you paid an individual more than $600 for their services.) Regardless of whether you receive a 1099-Misc for the year, you are responsible for reporting all income that you receive.
- Asset–An asset is something with a monetary value that you use for your business. If you own a business asset that you will use for several years, check with your accountant to see if you can deduct depreciation expense.
- EIN–The term EIN stands for employer identification number. Many freelancers will not need an EIN. However, if you incorporated your freelance business, operate as a partnership, or if you had employees (not contractors) during the year, you may need an EIN.
- Expenses–These are the costs that are directly related to the running of your business. Examples of business expenses for a freelancer could include advertising, home office expense, supplies, business-related travel, and more. If this is your first year in business, you may also be able to deduct some of your start-up costs.
- Gross Receipts–Gross receipts refers to the total amount of money that your freelancing business received before your expenses are subtracted. If you have a product that you sell, such as a WordPress theme, gross receipts include the amounts received from the sale of your product as well as any amounts received for services you provide.
- Net Loss–If your business-related expenses are greater than your receipts for the year, then you may have a loss for the year.
- Net Profit–If your receipts are greater than your business related expenses, then you may have a profit for the year.
- Schedule C–Profit or loss from an independent contractor, sole proprietor, or a self-employed individual (this includes freelancing businesses) is reported on Schedule C of the Form 1040.
- Self-Employment Tax–Self-employment tax consists of the Social Security and Medicare taxes that employers normally pay for their employees. As a self-employed freelancer, you are responsible for paying these taxes yourself. Use Schedule SE of the Form 1040 to figure out your self-employment tax liability.
Note: This post does not constitute legal or tax advice nor should the Freelance Folder posts referenced here be considered legal or tax advice. For help with your own specific legal or tax issues, please contact a legal or tax professional.
Of course, this is just some of the tax terminology that you may face (and not be familiar with) as a freelancer in the U.S. Your specific situation may require that you understand additional terms as well.
Don’t Forget About the Health Insurance Deduction
A new deduction for freelancers this year is the deduction for health insurance costs for eligible individuals when computing self-employment taxes. This became law under the Small Business Jobs Act of 2010. You can learn more about this deduction from the IRS site.
We’ve written some other posts on Freelance Folder about income taxes that you may find useful. Here are some posts that contain even more information:
- When to Hire an Accountant
- 10 Tax Tips You Can Use Now To Avoid Pitfalls Later
- 10 Things You Should Keep for Tax Purposes
- Seven Benefits of Hiring Your Children
- 5 Tips For Filing Your Taxes Easily
What About You?
Do you do your own taxes, or will you hire a tax professional to do them? What is the biggest difference about income taxes that surprised you as a freelancer? Did I leave any terms out?
Share your answers in the comments.
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February 16th, 2011 at 10:31 am
February 16th, 2011 at 10:37 am
I think a lot of freelancers, particularly new freelancers, are surprised at tax time. I’m glad you found this helpful. :)
February 16th, 2011 at 11:10 am
Regarding #3 above, note that freelancers can get an EIN even if they are a sole proprietor (not incorporated). It is easy, fast and free to get it on the IRS website. It is good to use an EIN instead of your Social Security number when filling out W-9s and other information because that protects your Social Security number from being shared with many people. THe IRS links your EIN to your Social behind the scenes, so it is seamless. I would recommend that freelancers get and use an EIN instead of their Social Security #.
Regarding your question about tax prep (in the US), I have used a CPA to do my taxes since I started freelancing 10+ years ago. It takes too much time (my time could be better used elsewhere) and my CPA knows the tax laws in and out. What I pay him is more than worth it.
February 16th, 2011 at 11:32 am
Thanks for your comments.
Yes, freelancers CAN get an EIN, but in the circumstances I listed the freelancer MUST have an EIN. It is easy and the process is online.
Personally, I’m all for using a CPA. :) It is worth it. However, many CPAs will use this language–so it’s helpful to know the lingo, so to speak. :) (Plus, there are also those who won’t use a CPA for whatever reason.)
February 16th, 2011 at 12:10 pm
Nice summary, Laura. Mind if I add a tax-season pitch that every freelancer should establish a Roth IRA *and* a retirement plan of some kind?
Doesn’t matter if it’s a SEP-IRA, Solo 401k, Keogh…but it’s a way to lower your current tax exposure as well as ensuring that you’re not eating cat food in retirement. As a 40-something, I’m not counting on Social Security to be around.
February 16th, 2011 at 12:38 pm
Thanks for the compliment. :)
Absolutely, add that tip about establishing a retirement plan. That’s a good one! It doesn’t really matter how young you are, you should still do it.
February 16th, 2011 at 1:12 pm
Also self-employment taxes are getting a small break this year too. We won’t be paying as much as in previous years. So technically it’ll be a credit since self-employment tax is already mandatory for freelancers.
And I’ve been itemizing my own taxes for over 15 years now because the tax person who was highly recommended didn’t know how to do taxes properly, so we got audited. And BTW, when you hire someone to do your taxes and you end up getting audited, the tax people say they can represent you but the IRS doesnt allow it. They hold you accountable for everything on your taxes and no tax person or company can get you out of it. So know everything that is on your taxes when you file. .
Another main reason why I do my own taxes, most tax people think an artist can write off the donation of artwork and design, but unfortunately you can’t. For any donation, you can only write off the value of what the artwork is painted on or with (frame or canvas and paints) or the paper that a design is printed on. You cannot deduct the time you took to create something. You can only deduct the time it took to drive to and deliver it. I imagine the donation example is the same for website programmers and writers
I very much feel that even if a designer doesn’t do their own taxes, they should always know the tax laws in their field.
Last but not least, if the new law that they’re looking at passing goes in to effect, it’ll be an accounting nightmare for everyone. It goes something like this: if you pay anyone more than $500 for goods or services, a 1099 will be required. That means that all the $ you spend for office supplies, at print companies, for pretty much anything you purchase for your business, you have to know how much it is and send a 1099 to Staples and all the print companies you get things printed at. Now you say ‘That’s not a big deal if I have all my figures.’ Well you’re right. But if someone accidentally files several 1099s for you for work you didn’t do or supplies you didn’t sell, you are responsible for fixing the error but still filing on time. Also if you don’t file a 1099 for someone because they didn’t give you an EIN or SSAN, you’ll be fined for not filing. It’s all very convaluted and will be scary for those who don’t do their own taxes.
Hope this info helps.
February 16th, 2011 at 4:04 pm
I apologize for my double post….. could you delete the first one Laura? Some kind of glitch happened.
February 16th, 2011 at 4:11 pm
My favorite Tax related word is ” Solo 401-K”, which is an individual 401k account that is great for freelancers or independent contractors. I believe tho, you can only set one up if you’re an LLC or INC. But, once you do, you can contribute as the employee AND as the employer, thus effectively doubling the amount of money you can sock away every year. The total amount you can contribute is a percentage of your total income.
February 16th, 2011 at 5:34 pm
Thanks Christina for an update on that bill. I was aware of it, but didn’t know where it stood. Thanks also for sharing your experiences. I’m sorry that you had a bad experience with an accountant. There are definitely many of them who don’t understand freelancing.
Melissa–Great tip! There are actually a number of good retirement plan options for freelancers.
February 17th, 2011 at 11:21 pm
The above points are most important for tax payers, corporate employee always wants to get the report about the calculations of tax. Government try to update the rules for self employees and many others. Thanks a lot.
February 18th, 2011 at 2:04 am
Thanks a lot for sharing such a nice and informative article, really a very nice and detailed review on it. By the way more information on Itemized Tax Return go through this link http://mytaxfiler.com. It offers the US Visa Tax, leadership, Indian CPA Consultant, US Tax Planning accomplishment greatness and India US Tax, making the final solution an ultimate experience for our stakeholders.
February 18th, 2011 at 6:03 pm
There are some changes to 2011 Estate Planning Taxes that I think freelancers should pay attention to.
NadineFebruary 19th, 2011 at 8:35 am
I hate tax season. I had worked as a contractor for this online company and have since owed taxes for every year. We can’t afford a CPA so we usually do it ourselves with Turbo tax. Now I should say that it is probably my fault for owing because I had not paid my taxes quarterly like I’m supposed to because basically I really couldn’t afford to so expected to owe some. The amount still is way to much unless we are not deducting what we should be. Basically all design work is done on the computer so how many times can you deduct for your computer or related equipment?
February 19th, 2011 at 10:28 am
@Nadine …. You can do a one-time depreciation or a % of depreciation on your equipment for a certain amount of years. It’s in there on TurboTax, you just have to find it. I think it’s easiest to do a one-time and you don’t have to remember about it for subsequent years.
February 19th, 2011 at 10:31 am
And also Nadine, the reason it feels like you owe more is because being self-employed, we do. We pay the self employment tax portion and other things that an employer normally would. We’re our employer so that’s why we pay.
May 6th, 2013 at 5:26 am
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Please stay us informed like this. Thanks for sharing.
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