Feel overwhelmed by the thought of filing your business taxes for the first time? Many freelancers balk at sifting through their receipts, invoices, and 1099 forms for the year. But like so much in life, avoiding it is not the answer. Having an open conversation with a certified public accountant could save you buckets of money and help relieve the anxiety that surrounds tax day. (In case you hadn’t heard, in 2020 the tax filing day was postponed from April 15 to July 15).
For the most part, “Keep it simple, stupid” applies filing taxes. But you aren’t most people. And keeping it simple can cost freelancers – both self-employed individuals and incorporated entities – quite a bit of money. Enrolled Agent Rus Garofalo of Brass Taxes recalls a musician who used a 1040-EZ to make filing as quick as possible, missing out on any possible deductions: “I understand that motivation, but what if it’s costing you $3,000 every year?” And putting your freelance profession on a tax form can come with a little boost to your professional ego, legitimizing your efforts “as a career, and not a hobby,” he adds. If you are worried about the cost of pro tax prep, keep in mind that the fee you pay an accountant to prepare your taxes is one of many deductible business expenses.
Still not sure if you should talk to an accountant? Accountant Jonathan Medows has a rule for freelancers who are wondering if they should file their taxes themselves: “If you feel it’s over your head, it’s over your head.”
We asked experts to explain the basics of how to structure your business, and why you should seek out an accountant who specializes in freelancers. Then, we’ll go over a couple of preliminary steps to take before you meet with a small business accountant.
#1. Decide how to structure your business
Freelancers have three choices for how to structure their businesses: sole proprietorship, limited liability corporation (LLC), and S-corporation. Structuring your business is not a one-size-fits-all solution, and we can’t tell you which is best, since so much depends on your location, chosen field, and business model.
There are some distinct advantages to incorporation, especially when it comes to retirement. Folk encourages freelance writers and photographers to incorporate, not just to have the protection of an entity in case of a lawsuit, but so they can take advantage of putting more money into their retirement savings accounts. For an Individual Retirement Account (IRA), you can only put in $6,000 per year if you’re under 50, while a SEP retirement account for LLCs allows you to put in as much as 25% of your income. So if you make $100,000, you can put $25,000 in your SEP account, and not pay any taxes on that $25,000.
The following are some pros and cons to consider as you decide how you want to structure your business. Keep in mind that these only take into account the federal rules – your state might have its own rules regarding each of these business types.
Pros: No filing incorporation paperwork, which usually comes with a fee and a bit of hassle.
Cons: No protection of assets in case of a lawsuit, no way to save with an SEP retirement account, and self-employment taxes.
Pros: This form of incorporation offers some legal protection, allowing you to distinguish between your assets and liabilities and your business’s assets and liabilities. LLCs also have some tax flexibility, and have the option to file as C-Corps or S-Corps.
Cons: You have to file with your state and pay a fee, although the paperwork for LLCs is relatively straightforward and in most states it’s fairly inexpensive.
Pros: You can also operate as an LLC, with the same legal advantages, and set up your business so you owe less in self-employment taxes.
Cons: In most states, filing as an S-corporation is more expensive than for an LLC. You may also be subject to taxes that only apply to corporations.
Many freelancers have heard that S-Corps are the way to go, to avoid having to pay social security taxes as an individual. Medows works in New York City, where many independent business owners don’t realize: “New York City is its own animal. Lots of people become S-corp, and they think they’re saving money because they don’t have to pay social security,” not realizing they now have to pay the steep New York City business tax.
(Please note: We’re not telling you that forming an S-corp is a bad idea if you live in New York City, only that tax law is quite complicated, and it’s worth diving into it with an experienced accountant or a tax attorney.)
#2. Find an accountant who works with freelancers
Garofalo emphasizes the importance of working with someone who understands your industry, and the feast vs. famine reality of many freelancers: “The lives of creative people are changing all the time. You could have a year where you make $150,000, and then the next year you might make $10,000. There are so many more variables.” In Garafalo’s experience, many accountants have a misanthropic outlook, and approach their clients with a “‘Give me your papers and go away!’” attitude. “You have to work with someone who understands your industry and you need to feel comfortable. If you work with someone who makes you feel like you’re not supposed to talk, it could end up costing you money,” he warns.
You might even meet an accountant who’s in the same boat as you. “I’m also a freelancer, so I’m on the same journey. I’m empathetic to their stresses,” says Medows of his freelance clients. He’s also fond of freelancers because of their “eternal optimism,” and unflagging belief that “next year will be better.”
Bottom line? Turbo Tax is going to ask you a million different questions to find out if you’re a farmer. Sit down and do your taxes with someone who makes you feel like a go-getter, a visionary, and a professional whose creative approach to business deserves to be taken seriously.
#3. Calculate your wages
First things first: Keep a running tally of how much money you made in a year. Employers should send you a 1099 form that reports how much you were paid as a contract employee. As a freelancer, you’ll probably have a client at some point who does not send you a 1099. Any accountant will tell you: You still need to report that income.
Jackie Folk, an Enrolled Agent working with freelancers in Los Angeles, recommends using accounting software to track your income as well as expenses. If you don’t, you might waste your initial appointment – Folk says she isn’t shy about sending clients away and filing for an extension, or charging them an hourly rate to do their tallying for them.
#4. Tally your expenses
Freelancers, especially freelancers in a creative field, have an enviable list of possible deductions — deductions that might seem frivolous for most occupations. “We work with people who have worked hard to make their career something they enjoy,” Garofalo says. “Some things that you enjoy doing are also business expenses.” A traditional accountant might discourage you from deducting your Netflix subscription, but an accountant who works with freelancers would recognize that that’s a necessary expense for a TV writer. No matter what your expenses, remember that it’s your responsibility to save your receipts and provide your accountant with the totals.
Garofalo has met with plenty of freelancers who feel shy about deducting expenses for businesses that are technically losing money. “You’re a business once you’re trying to make a profit,” he says, adding, “If you’re doing normal things that writers do to be writers, from the IRS’s perspective, you’re a writer, and you should be writing those expenses off.” Medows cautions freelancers to be careful with these types of deductions, as the IRS only allows up to $5,000 in deductions for start-up costs, and there are limits to what kind of deductions you can take. If you lose money for too many years, the IRS will eventually classify your business as a hobby, although the rules surrounding this are dense, even for the IRS. Think about your business holistically, and if you have questions about what counts as a business expense, don’t hesitate to ask.
#5. Remember: You got this
Freelancers are by nature creative free-thinkers, and may have a hard time reconciling their professional identity with the doldrums of tax returns. But the money you can save on your taxes is worth some number crunching and pencil pushing. Put on a power suit with oversized shoulder pads if it helps you get in the mood. Or imagine yourself in a montage, punching numbers in a calculator while “Eye of the Tiger,” or any ‘80s power ballad of your choice plays. We’re rooting for you.
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