Debunking 3 Common Freelance Tax MisconceptionsBy Somya Munjal November 18th, 2014
Freelancing definitely has its perks. One perk that often jumps out at aspiring freelancers is the ability to get paid without having taxes taken directly out of your checks. However, while you may be able to avoid taxes in the interim, Uncle Sam will still come and find you.
I find that some freelancers often pay more taxes than necessary because they never learned the complexities of tax planning. In advance of Contently’s Twitter Tax Chat (#ContentlyTaxChat) I’m hosting at 3 p.m. EST on November 19, I decided to explain how freelancers can overcome three common tax misconceptions.
Misconception #1: Big deductions are only for corporations and businesses
Two words are vital to your financial freedom: tax deductions. You know that 10 percent effective tax rate some big corporations are paying? Well, you can significantly decrease your own taxes as a self-employed worker if you know how to use the right deductions.
At a salaried job, employees pay taxes on gross income, so everything they make gets taxed. However, as a freelancer, you can take advantage of useful business deductions. You only pay taxes on your profit—otherwise known as income earned minus common business deductions. So the more you know about the nuances of deductions, the less you pay in taxes.
Below, I’ve listed a few business deductions you may not be aware of:
— Home office: Take the percentage of your apartment’s square footage dedicated to your home office and multiply the number by your total rent for a valuable monthly deduction. For example, if you pay $2,000 rent for a 500-square-foot apartment and use 10 percent of your space for an office, you can deduct $200 per month.
The same ratio can also be applied to your electric, gas, and water bills.
— Insurance: As a freelancer, you may have to pay for your own health and life insurance, which, as many of us know, gets quite expensive. However, insurance premiums are deductible, so stay safe and get insured.
— Communication: Good Internet and phone packages are essential to freelancers who work from home. Luckily, these expenses are also fully deductible.
— Advertising: Searching for new gigs often requires personal marketing. Whether you invest in online ads for a design business or that premium LinkedIn account, your advertising expenses should be deductible.
— Meals and entertainment: If you catch yourself eating with clients or prospective clients, don’t forget to save your receipt. You can deduct 50 percent of your meals and entertainment costs related to your career.
Staying organized is key to taking advantages of these business deductions. Try to allocate a credit or debit card to your freelance expenses. Log how much you are spending each month and calculate your freelance profit. Remember, you only pay income taxes on your profit.
Misconception #2: Freelancers pay annual taxes
If you’re making money, the government wants a piece of it. While salaried employees only make annual tax payments, freelancers are supposed to submit their taxes quarterly. If you don’t, you’ll pay a penalty.
If you’re a savvy investor and would rather see your money grow versus give it up, then by all means go for it. Just do the math when making that decision. Are you better off paying up front, or would you rather just pay your taxes at the end of the year and take the penalty?
Consult an accountant for further assistance.
Misconception #3: It’s okay to put off retirement planning
Yes, one day you’ll get old and won’t want to work. Your friends who hit that office job every day are probably building a 401(k) retirement fund with help from their employers. Freelancers don’t get that luxury. They need to take matters into their own hands and open up a retirement account like an IRA.
There are different types of retirement funds available, but a traditional IRA will allow you to deduct a significant portion on your tax return. The thresholds are always changing, so consult an accountant or wealth advisor. Doing so before December 31 can potentially save you thousands on your next tax return.
Do That Tax Hustle
A freelancer should always be on the hustle, especially when it comes to tax management. Proper tax planning allows you to keep a higher portion of your hard-earned income. This tax season, try your best to get on top of business deductions, retirement planning, and estimated taxes. The more you know, the better off you’ll be.
Somya R. Munjal, CPA, MBA, MAS, is the managing partner of CPA for the People, LLP. She specializes in tax consulting for freelancers. Follow her @somya808 and send her any tax questions with #ContentlyTaxChat.Image by Gunnar Pippel