10 Things Contractors Need To Know Before Their Annual Filing
Drynuary is over and you’ve officially, finally (maybe) kicked the last of that holiday cold. Which means it’s time for your other least favorite time of year: tax season.
This receipts-and-returns ritual is painful enough if you have a full-time job. For freelancers, it’s a whole other level altogether. And whether you’re just starting your career as a card-carrying member of the 1099 crowd or are a seasoned veteran of the gig economy, here are some tips from financial and tax professionals to get you through your season of despair.
Of course we should note that Fair does not provide tax, legal or accounting advice. We’re an app for getting awesome cars—with a flexible contract that fits a freelancer’s needs, no less. Just be aware that this article is for informational purposes only, and that we should NOT be relied on for, tax, legal or accounting advice. Our lawyers also want us to stress that tax laws are complex and that you should consult your own tax, legal and accounting advisors. Because, again, we are not one.
Still, this stuff is pretty solid. Read on!
Part of staying on the right side of the IRS is simply staying organized. This means giving some manner of order to your monthly expenses and maybe even investing in a small desktop scanner to help you manage your receipts.
“When I have receipts, I scan them right in and save them to my desktop,” explains CFA Lou Haverty, founder of Financial Analyst Insider. “It makes a world of difference rather than sorting receipts by hand because your files are labeled with dates, which can be easily found at year end when you need to find it again.”
You can also find no shortage of apps that will help you manage other deductions like your mileage (MileIQ) and other business expenses (Expensify or Smart Receipts).
Filing taxes as a freelancer is a different beast than it is for a full-time W-2 employee, so you’ll have to get used to planning for the future in a whole new way—including paying your taxes differently. For example:
“Make quarterly payments,” advises David Bakke, a freelance personal finance writer at Money Crashers. “If you don't, you face significant penalties and added charges.”
To that end, you’ll also need to think about your future income, especially if it fluctuates, so you can budget accordingly. Also?
“Put a line on your budget for tax payments, just so you don't forget,” Bakke says.
One of the more common mistakes freelancers make with their taxes is to either deduct too much—or not enough. And while the help of a qualified tax professional can help you avoid this pitfall, the onus is still on you to prepare accordingly.
“Become familiar with your local tax laws and make note of any changes that may have occurred since last year,” says Eric McCormick, a Certified Debt Specialist at Liberty Debt Relief. “If it becomes too overwhelming, hire a professional, which is also a deductible expense.”
Financial professionals often advise having a credit card that you use strictly for business, which makes it easier to manage your business-related expenses come tax time. But McCormick suggests taking things one step further.
“Open separate accounts, perhaps even at different banks,” he says. “That way you can account for every penny that is being spent or profited from your business. You can even pay yourself a salary from your business account to your personal one.”
Sometimes freelancers get a little extra financial break, as is the case with those who will be filing for 2018.
“Income that is defined as ‘pass-through,’ which is business income, is eligible for a 20% tax deduction,” says Haverty. “The deduction is targeted toward small business owners to promote hiring and growth, but self-employed workers are eligible as well.”
Haverty says freelancers pick up this benefit even if they claim the standard deduction. However, there’s a cut-off designed to exclude high-earners in professional areas like medical, legal and accounting—and you need to be a true freelancer, not someone working through an agency sending you from gig to gig.
There’s a lot that goes into running your own business—or just being your own boss—so don’t forget to add in all the administrative and supplemental things you pay out throughout the year. For example, your legal and accounting expenses.
“These are fully deductible and are given a reasonable amount of flexibility; it’s just important to keep a copy of the bill,” Haverty advises.
Maintenance and repairs to your home office count, too. But Haverty points out that certain repairs like roof work or other major construction with a multi-year useful life will be partially deducted over the estimated useful life rather than taken in full.
Contributing to a regular IRA is a great way to carve a nice stack of income right out of the taxable category, as you can deduct up to a $5,500 IRA contribution against your income for 2018. If you go hardcore and invest in a SEP-IRA (Simplified Employee Pension), you can potentially turbo this deduction all the way up to $55,000 for 2018 (you may deduct the lesser of $55,000 or 25% of your net earnings from self employment). Just know that if you hire employees, you’ll have to contribute to the SEP-IRAs of all participants who performed services during the year in which contributions are made, pursuant to a written allocation plan.
Moreover, if your adjusted gross income does not exceed a certain threshold, you may be eligible for a tax credit for qualified retirement savings contributions. “A little-known treasure in the tax code is Form 8880, which is designed to help low-income people build their retirement savings,” says Carney Shegerian, lawyer and founder of Shegerian & Associates. “If you meet the requirements, the federal government will match your retirement account contributions at a rate of up to 50 percent, up to a total of $1,000 for single filers, and $2,000 for joint filers.”
As Shegerian explains, this is as close to free money as you're likely to get.
It’s hard to shoulder the cost of healthcare as a freelancer, but the good news is you can deduct up to 100 percent of your premiums for health, dental and long-term care insurance. But that’s not all.
“You can put up to $3,450 completely tax-free for a single freelancer into an HSA (health savings account) each year that you can use at any time for any medical expense,” adds Stacy Caprio of Fiscal Nerd. “This money carries over year-over-year and you can use the tax-free money for any medical expenses.”
From the moment you buy a computer, it starts depreciating in value. You get the one write-off when you purchase it, and that’s it. But if you lease your computer, you can write off that cost every year for the life of your lease—and you can upgrade when you want, without having to shell out the full cost of a new computer. Similarly, using the home office deduction means you can write-off a percentage of your living space for home office use. Owners can deduct mortgage interest, but not the principal. And if you’re a renter?
“You would be able to deduct the full rent,” Haverty says. “This typically represents a higher deduction than just your mortgage interest, which doesn’t include mortgage principal.”
Just remember: the write-off is based on the percentage of your home’s square footage that is devoted to business use, not your entire home.
When calculating your home office deductions, you can take the simplified way (standard deduction of $5 per square foot of home used for business, with a maximum of 300 square feet) or the detailed route. The latter could result in higher deductions, but it does take some work.
“With a simplified deduction, you don’t need to itemize your costs. It’s just a standard $1,500 deduction,” says Lawrence Pereira, President of King Harbor Wealth Management. “But that doesn’t allow you to deduct other household expenses like utilities and insurance. If you choose to spend the time itemizing your costs, you could receive a benefit up to twice the amount of a simple deduction.”
Just remember to keep detailed records of all your expenses just in case they get called into question—and consult with a tax professional if you’re unsure of anything.