10 Tax Tips You Can Use Now To Avoid Pitfalls Later
Posted October 8, 2009 in Business, Freelance Stories 34 Comments »
One of the first encounters I had with freelancing involved a very talented co-worker who, sadly, was not very knowledgeable about income tax law. His lack of knowledge ultimately cost him his freelance business.
“Brian” was an extremely gifted graphic designer who worked in the marketing department of the company where I was employed. I’ve always admired those with obvious artistic skill and “Brian” fit the bill perfectly. He was quite open about the fact that he really didn’t like working for our company and that he wished that he still owned his freelance design business.
After several months of working with “Brian,” I worked up the nerve to ask him why he didn’t still own a freelance business. He looked at me in surprise (I guess he thought that everyone already knew his story.)
“Brian’s” Lesson
It turned out that “Brian” hadn’t set enough money aside during the course of his first year in business to pay his income taxes. When tax time came, he couldn’t even begin to pay the huge bill that was due. Sadly, many other first-time freelancers make the same mistake that “Brian” did — especially if they are used to having an employer withhold income taxes from their pay.
Avoid Tax Pitfalls
With proper planning, you can avoid losing your business to a tax pitfall. The time to start getting ready to pay your 2009 income taxes is now, before the tax year ends.
Here are ten tips to help you avoid facing your own tax pitfalls:
- Remember to set money aside for income tax purposes throughout the year. It’s better to save too much money for taxes now, than to be caught without enough money to pay them later on.
- Don’t forget about the “self-employment” tax that freelancers must pay. (This corresponds to the Social Security and Medicare taxes that most employers withhold from employee paychecks.)
- If possible, arrange to pay your income taxes quarterly so that you aren’t faced with a large tax bill all at once.
- Save your receipts for anything business-related. Many business-related expenses ranging from office supplies to new equipment to professional training may be deductible.
- If you use your vehicle for business, make sure that you are keeping accurate mileage records. The standard mileage rate changes each year. You can find the latest rate at the IRS website.
- Keep accurate records of how much you are paid. While some clients will send you a Form 1099-Misc, not all clients will. You are responsible for taxes on income received regardless of whether you receive a Form 1099.
- Make sure that you have accurate records of how much you paid to your own subcontractors. If you paid any individual subcontractor over $600, then you will need to send them a Form 1099-Misc. Start gathering their address and Social Security number information now.
- Contributions to qualified retirement plans such as IRAs may also reduce your tax liability. If you don’t have a qualified retirement plan already, you can still start one.
- If you work from home, decide now if you are going to take the home office deduction. Start gathering the necessary information such as percentage of business usage, size of home office compared to the rest of your home, and utility usage.
- If you sold any equipment or other assets belonging to your business, you will need records of the sale. Likewise, if any of your business equipment or assets were destroyed or stolen during the year you will need those records.
These are just a few steps that you can take now to make the task of paying income taxes next year easier. Don’t let tax pitfalls damage or destroy your freelancing business.
(This list provides general principles to freelancers who live in the United States. The post is not intended as specific tax advice for any particular business situation.)
How Have You Avoided Tax Pitfalls?
How do you get your freelancing business organized for income tax season?
Do you live outside of the U.S.? How do you avoid tax pitfalls?
Share your experiences and ideas in the comments.
About the author: Laura Spencer is a freelance writer from North Central Texas with over 19 years of professional business writing experience. If you liked this post, then you may also enjoy Laura’s blog about her freelance writing experiences, WritingThoughts
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34 Comments
Amber Weinberg
October 8th, 2009 at 4:04 pmDon’t you incur a penalty if you don’t do the quarterly payments? I always wanted to pay a lump sum at the end of the year (so I can earn interest in savings) but thought I read on the IRS website you get a penalty if you do it.
Veign
October 8th, 2009 at 5:41 pm- You need to make Estimated Tax payments (1040-ES) quarterly or you will be penalized
- Get a separate bank account for your corporate income/expenses. Can be a mess, from an IRS standpoint, without one. Lots of banks now have a free business account – get one
- Many can save on taxes by becoming an S-Corp. Look into it. As easy to become as an LLC
- Invest in Quickbooks (or similar) and track everything. The easier is to track all your income / expenses means you will probably save more on taxes and be ready if you’re ever in an audit
- The fees for an account can easily be recouped on the expenses they know you can write off that you probably didn’t think about. Using Quickbooks will reduce their costs as your books will be in a format that can easily work with.
- Best tip is to be honest. Don’t do anything that raises red-flags with the IRS.
Laura Spencer
October 8th, 2009 at 6:16 pmGreat comments!
While most freelancers will need to pay quarterly taxes, some do not realize this (especially if they have never freelanced before).
I believe that it was the tax bill AND the penalties that caused my former coworker’s business to fail. (It probably goes without saying that he wasn’t using an accountant.)
Belinda
October 8th, 2009 at 6:54 pmI’m just starting out, and this sort of information is really useful (and scary). If anyone lives in Australia and knows of anything that has to be done significantly different here, I’d love to hear!
Laura Spencer
October 8th, 2009 at 7:14 pmBelinda,
That’s exactly the point of this post!
Personally, I don’t know much about taxes in Australia – but I bet one of our readers does.
(I think that you’ll find that we have a great community here.)
Can anyone help Belinda here?
Jason
October 8th, 2009 at 8:27 pmHi,
Great article. So, what percentage of all income would any of you recommend to set aside for taxes? I understand that setting aside a little too much is a good thing come tax time, but a general percentage would be good to know.
Thanks!
The Credit Letter
October 8th, 2009 at 8:29 pmThanks for the great list. Although some of this advice is US-centric its advice that is applicable here in Australia for small businesses.
Veign
October 8th, 2009 at 8:30 pmDepends on your income and tax bracket. Anywhere from 18% to 25% is safe. Be sure to look into the requirements of estimated tax payments.
Jason
October 8th, 2009 at 8:33 pmI usually only make around 8 to 9k per year on freelance stuff so it’s pretty low.
Joe
October 8th, 2009 at 8:34 pmFirst year freelancing as a side business. Not a full time gig but hopefully someday! Did all of my invoices in PayPal and recently filed for a sole proprietorship. Luckily I have a dad as an accountant so hopefully he won’t charge too much..haha!
Veign
October 8th, 2009 at 8:44 pm@jason – based on that you’ll be in the lowest tax bracket. I would bet that you can find enough deductions to almost eliminate paying any taxes.
Laura Spencer
October 8th, 2009 at 9:04 pmI just love it when the community comes together and shares tips. . .
Reuven Rubinson
October 9th, 2009 at 2:08 amThe penalty on not paying estimated taxes quarterly is under 10% APR so it’s not onerous unles you don’t pay by April 15.
Be aware that you only need to keep detailed mileage records for 90 consecutive days and can use those percentages for the year’s miles.
And if you mostly drive for business you can record beginning and ending miles and detail non-business miles only.
Any “ordinary and necessary” business expenses can be deducted.
Your business “office” must meet certain criteria to be deducted. It’s not as simple as you state.
Good comments. But you need a qualified person to fill in specifics to each of the items.
And don’t forget about the state. For example in CA you need to send in a report to determine if an individual contractor is a deadbeat parent.
I’d also add get a federal I’D # so you don’t have to give out your social security #.
tim
October 9th, 2009 at 3:01 amI’m from the UK so our laws are a bit different from yours but whenever I get paid I chuck a large percentage straight into an instant savings account so thats it ready and waiting for the tax man and is earning me interest in the meantime.
Luke Jones
October 9th, 2009 at 3:35 amWhen I need to start paying tax, I’m going for the lump sum at the end of the year. That way, I’ve given my account time to start earning more and more interest :).
Lis Sowerbutts
October 9th, 2009 at 8:19 am@Belinda – i am in Australia. Basically its a lot simpler than the US Keep a record of all payments made to your and all your expenses. Almost all of my stuff goes thru my Papal so I just download a spreadsheet each month and annotate it each month so i remember.
if you have a home office you cna claim a % of your rent/ power/Internet etc
If you have Australian clients you will need an ABN (I haven’t bothered don’t have local clients)
If you turnover more than 75k you may need to register for and charge GST (to local clients only)
If you buy an asset before 31 Dec you get a double tax credit (thanks for the new laptop Mr Rudd LOL)
You are not due to pay any tax until after 30 June (assuming you started business after 1 July) – but you might have to pay provisional and what you owe from this tax year if you earn a substantial amount.
In the end I used a Sydney accountant to file my return she only charged me $350 inc all the currency conversions – contact me via my blog if you want her details
Elena
October 9th, 2009 at 8:39 amGood article, I was very worried about taxes at the beginning of my freelance business. Read a lot of articles, bought some books, but the best thing I did was to call a CPA just to make things clear (everyone knows you don’t want to mess with IRS).
Another tip: Outright (www.outright.com) – it’s free.
You can keep track of your income, expenses, they remind you about quarterly taxes and the best thing – they estimate the taxes you would have to pay based on your income. Easy!
Melek
October 9th, 2009 at 8:56 ami take 30% out of all my deposits (to my business account) and put it into a ‘tax savings’ account….an account that accrues interest. I leave it in there until my taxes are due. that way, i know it’s set aside for payments, and it’s gaining interest.
for keeping track of what you earn and what you owe, definitely use something like QuickBooks.
for vehicle records, you can’t just guesstimate how many miles you drove the car, you actually have to have accurate records of what day you drove it, to where, why, and how many miles. i keep mine in an excel spread sheet labeled with date, which client i was visiting (or working for), and however many miles i incurred.
as for keeping receipts, every January, I go to an office supply store and buy one of those accordion file folders. i label them all as to what type of expense (software, books, home office, etc), and put my receipts in accordingly. That way, they’re organized and categorized. After my taxes are done, i bundle up all those documents with that year’s accordion and keep it all together.
great article. wish I’d had this kind of resource when i was starting out.
Belinda
October 9th, 2009 at 10:11 am@Lis Sowerbutts – Thanks so much for that! It’s so helpful to see things clearly laid out in laymans terms! I tend to feel a little confused when I’m trying to make sense of whats on the Au Govt website. You’re a champion :-)
@Laura Spencer – Thank you too! You’re right – a very helpful and friendly community :-) Looking forward to getting to know you all more.
Cheryl
October 9th, 2009 at 10:14 amHolding off until year-end and letting the money accrue interest may sound like a good idea, but at today’s low interest rates, the penalty will almost certainly be more than any interest you earn.
Sean
October 9th, 2009 at 10:18 amThe best rec I can make as a freelancer is in regards your company name. Make sure you not only register your business name with the government but apply for a trademark so you can be fully covered.
Just having your company name registered is not enough you need to have a trademark done as well. Pay the extra couple hundred to have it done so you can protect your self from trademark infringements.
Marie Poulin
October 9th, 2009 at 11:39 amI’m Canadian,
I don’t know all the ins and outs, but I set aside 25%, and we also have to put a small percentage aside for the “Canadian Pension Plan.”
I use http://www.freeagentcentral.com for invoicing and tracking income/expenses and i can basically click on one tab and see what I’ve earned, and what I owe.
The first year I started freelancing on the side I got my income tax bill and was pretty shocked, as I had definitely not put aside enough money. Now that I rely 100% on my freelance income, I have to be more careful and diligent about putting it away. You just have to pretend it’s NOT there!
If you end up putting too much away for taxes, keep it as a nest egg for the next year.
Diane H
October 9th, 2009 at 12:28 pmGreat post! I HIGHLY recommend a book from Nolo Press called “Deduct It” if you freelance in the US. They do a great job of summarizing important tax information in a way that is digestible for the non-financial expert. It’s very readable.
Beth
October 9th, 2009 at 1:32 pmI just started freelance writing this year, and I feel like I’ll be in the same tax bracket as Jason. Is there any website I can go to about the penalties I might be looking at for only paying once a year? Also, does anyone know about specific documentation needed for deducting a home office?
Laura Spencer
October 9th, 2009 at 2:40 pmGreat discussion!
There’s a wealth of knowledge here in the comments. Thanks to everyone for sharing and participating.
Keep it coming. . .
Veign
October 9th, 2009 at 2:44 pmHere’s a blog post I did a while back on helpful stuff for small business (includes freelancers):
http://www.veign.com/blog/2005/12/small-business-help.html
I think it will be of interest to your readers.
Andrew Kelsall
October 10th, 2009 at 4:36 pmI freelance here in the UK, and our Tax system is fairly simple. We fill out a self-assessment form out once per year, and get billed for the tax when Her Majesty Revenue and Customs (HMR&C) department work out the Tax you owe, which is fairly easy to do yourself. Although, my wife is a HMR&C manager, so I would say that ;)
Basically, say I get paid £500 for a job, and £100 was expenses (from printing, etc), I would just take £100 from £500 = £400. 22% is standard tax, so I would then just put aside £88 into my Business Saving account (separate to my everyday business account).
It works for me, although I’m planning to be VAT registered soon, and that’s a whole new ball game…
Laura Tamayo
October 13th, 2009 at 9:57 pmGreat tips. Veign, the link you left isn’t working. I found another that also compares LLC’s and S-Corps that looks pretty good, though.
http://www.powerhomebiz.com/vol136/structure.htm
Veign
October 14th, 2009 at 9:05 am@Laura – Thanx. I fixed the link.
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