Now that we’re in the last quarter of 2015, what should freelancers be doing to prepare for filing taxes next April?
Let’s be honest: a lot of us are probably not thinking too much about April 2016. Some of us may still be breathing a sigh of relief after hitting the October 15 extension deadline for last year’s taxes! But taking the time to think about taxes now will save you a lot of time and trouble next spring—and that’s time you could spend completing client assignments and earning money.
The first big question: should you get a CPA? A lot of freelancers try to do it themselves with TurboTax or TaxSlayer, but once you go from “employee” to “freelancer,” your taxes get a lot more complicated, and it’s very easy to make mistakes.
Shana Bickel, a Sarasota, Florida-based certified public accountant who focuses on small business owners, tells the story of a client who came to her while being audited after having used TurboTax to file. While redoing his tax return, she saw he had taken a deduction for educational expenses up to $250, which teachers take if they buy supplies for their classroom. But he was a personal trainer. When she asked him what that deduction was, “he said, ‘Yeah, I buy a lot of materials that I educate my clients with. I said, ‘Did you realize you just took the K-12 teachers’ expense?’ And he’s like, ‘No, I just answered the question how TurboTax presented it,'” she says. While it was true that he paid for educational materials out of pocket, “only a CPA would understand what that is—that if you’re not a teacher, this line should be blank,” says Bickel.
That’s how I knew it was time to get my own CPA, by the way: I didn’t understand whether the TaxSlayer questions applied to my freelance business, and I didn’t want to guess wrong.
So we’re going to look at freelance taxes under the assumption that you are working with an accountant, even though we know some of you are still going to slug it out with TurboTax—and if you are, plenty of this advice will still apply. With that in mind, here is some advice from CPA Jonathan Medows on how to prepare for the upcoming tax season.
1. Set up a meeting with your accountant
Don’t think of 2015 taxes as something to take care of in 2016. Be proactive, and set up a meeting with your CPA before the year is out.
“I encourage my clients to do a check-in in the last month of 2015 or so, just to see if we have to revise our last quarter estimated taxes,” CPA Jonathan Medows explains. “If you’re itemizing deductions and expenses, state and local taxes should be paid before year-end.”
That’s why you should set up a meeting with a CPA before the end of 2015, whether you’re meeting with someone you’ve worked with for years or whether it’s your first time working with a tax professional.
“Be proactive about it,” Medows says. “Make sure estimated taxes are correct through year-end.”
2. Get your documents in order
This is what Medows would like to see when a freelancer walks into his office:
- A profit and loss statement
- Records of estimated tax payments
- W2s and 1099s
- Royalties statements
- Brokerage statements
- Health coverage 1095 forms
You might not have all of these documents—if you don’t have any investments, you aren’t going to have any brokerage statements, for example—but you should bring the first three items on Medows’ list to any tax meeting with a CPA.
If you’ve never created a profit and loss statement, don’t worry. As long as you’ve been tracking your income and your expenses, it is relatively easy to put one together. You can use a template like the one at Entrepreneur, or you can make your own: list your income, list your expenses, and use these two numbers to calculate your net profit. This is also where you list operating expenses, administrative expenses, processing fees (such as the percentage that PayPal deducts from your client payments), and anything else that turns your gross profit into a net profit.
As for the estimated tax payment records and the W2s/1099s—keep those important tax documents filed for times like this. You won’t get your 2015 W2s and 1099s until next year, but you can still come to your end-of-year CPA meeting prepared to talk about what those numbers might be for 2015. This is particularly important if your income has increased significantly in 2015; you might owe more in estimated taxes than you planned for, so let your CPA know about any rate increases and how much you’ve currently paid in estimated taxes.
3. Understand recent tax changes
It’s your CPA’s job to keep track of all of the tax changes the IRS implements each year, but the more you know about tax changes, the more prepared you’ll be.
According to Medow, these are two of the 2015 tax changes with which you should familiarize yourself:
- Affordable Care Act penalties increase this year. If you do not have health insurance and did not elect to purchase health insurance through the ACA Marketplace, be prepared to pay a little bit more: penalties are increasing to 2 percent of your income if you’re above the tax filing threshold of $10,150, or $325 per person ($162.50 per child under 18) with a maximum household cap of $975.
- FICA tax is also going up this year. This is the tax that funds Social Security and Medicare, and it’s the tax that freelancers have to pay “both halves of”; employers pay part of the FICA tax responsibility for people who are not self-employed. This year you’ll be paying 15.3 percent on your first $118,500 in net income and 2.9 percent on net income above that amount.
Medows also wants freelancers to know about two lesser-known opportunities to save on taxes:
- In 2014, the IRS implemented a new home office deduction which allows freelancers to deduct home office space at a simplified rate of $5 per square foot (up to 300 square feet). If you were previously itemizing your home office deductions and calculating the percentage of rent, utilities, etc. you were using for your business, you might want to consider the simplified rate.
- If you work for per diem rates when you travel, you can deduct the Department of State’s standard travel rates. This might be better for you financially than keeping track of travel receipts—and yes, you are entitled to the full per diem!
4. Talk to your CPA about whether it makes sense to purchase business-related tools before year-end
Medows says that a lot of freelancers ask him whether it’s a good idea to buy a bunch of business tools and supplies before year-end, in the hope that they can be used as tax deductions.
“I’m not into spending money for the sake of spending it,” he says. “But if people need new business tools, now is the time to invest in them.”
In other words: buying business-related items just to rack up potential tax deductions is probably not a wise idea. However, if you’ve got a business purchase you want to make that fits within your budget, it makes sense to buy it before the end of 2015.
Medows reminds freelancers that the last three months of the year are also a good time to test new software that they might want to use on their business in 2016. So if you’re thinking about trying FreshBooks or Apple Pay, remember that you can deduct any software payments you make in 2015.
5. Consider setting up an entity
The last thing you should discuss at your CPA meeting is the pros and cons of becoming an entity for tax purposes.
“An LLC, an S Corporation, a C Corporation; there are pros and cons to all of these things depending upon what you’re doing, where you’re living, and your income,” Medows says.
Medows has an overview of how becoming an entity might ease your tax burden at Freelancers Union, where he lists one of the biggest pros of becoming an LLC:
By setting up an LLC, you also avoid paying both personal and business taxes on your freelance income. As a “pass-through entity” all the income and expenses from your LLC get reported on your personal income tax return as the business operator.
There are also cons to consider, including filing fees. Use Medows’ overview as a starting point for your research, but remember that, like most financial issues, this is probably not the kind of decision you should be making alone.
When it comes to the new tax season, start getting prepared now—and talk with someone informed on how the whole byzantine system works. Your freelancer business will thank you.