Tax Advice For Freelance Workers,
Independent Contractors, Self-Employed People, Sole Proprietors
If you've left your traditional salaried job to be a freelance consultant, you probably have lots of tax-related questions. Here are the ones I hear most often:
- What records do I need to keep for taxes?
- What expenses are tax-deductible?
- How & when do I pay my taxes?
Records You Need to Keep for Taxes
The best way to pay the lowest possible tax is very low-tech: keep track of all of your expenses! If you avoid paying with cash, and use one checking account and one credit card for all of your business activity, you won't miss any of your tax deductions. Here is more information on setting up a bookkeeping system.
You need to keep your bank & credit card statements, and other business records for at least 5 years. Here is more information about document retention.
You also need to keep track of the business-related miles you drive your car. In 2010, the standard tax deduction is 50 cents per mile, which can add up to a huge tax deduction. You may be able to claim more based on your actual car expenses. You can keep your mileage records in whatever format you choose: on your smart phone, on your desk top, in a little calendar book in the car. The important thing is to keep it up as the year goes along. The IRS regulations state that your car mileage records must be kept "contemporaneously" but doesn't define that term.
Tax-Deductible Expenses
There is no real list of tax deductions, only suggestions. The test question is this: Is the expense "ordinary" and is it "necessary"? "Ordinary" means that other people who do what you do also have this expense. "Necessary" means that this expense is important for the successful operation of your business. If your expense is both ordinary and necessary, it's a tax deduction. I encourage my clients to tell me about all of their expenses so that we can discuss any borderline items. Here is a list of common business expenses (called a "chart of accounts.")
How Do I Pay My Taxes?
When you were working for a paycheck, things were simple. Taxes were deducted from your pay before you received the check. And you split the cost of social security with your employer; they paid half and you paid half. Now that you're self-employed, you will pay 100% of the social security contribution, or "self-employment tax". For many people just starting their consulting careers, the self-employment tax is much more than the income tax and comes as a shock. It works out to about 13% of your net profit! So it's even more important to capture all of your business deductions.
The income tax and the self-employment tax are paid together. The quarterly tax payments are due on April 15, June 15, September 15, and January 15. There is a penalty for waiting until the end of the year to pay all the tax. You have 3 options to avoid penalties:
- Pay based on last year's tax (the safe harbor option)
- Pay based on what you think this year's total tax will be (the crystal ball option)
- Pay based on what you've made so far this year (the annualized option)
For those last 2 options, you will need to consider not only this year's profit from your business, but also the other income & deductions on your tax return. There will be tax calculations involved. So here's the shameless plug for my tax service.
Bess Kane, CPA
August, 2010
