If you are brand new to freelancing, you have some basic considerations that will affect you that you must learn about. Tax considerations are enormous for freelancers and if you do not address them early on, you may find yourself in hot water. Here are some things that a freelancer in the United States should review before they accept their first assignment to prepare themselves for the tax liability that they will face:
Get an EIN Number – You may think that because you do not have any employees you are ineligible to apply for an EIN but this is incorrect. An EIN number an be used for opening your bank accounts in your business name, filing your taxes and an entire host of other things as well. Some municipalities may require you to have a business license and you may need an EIN for this purpose as well. Having an EIN also allows you to segregate earnings from personal investments, regular employment and other “personal” income that you would like to keep separated from your self employment income. This is much easier today since you can now apply online for this number.
Understand Tax Responsibilities – Regardless of whether you are freelancing full time or part time, you are still legally bound to file tax forms claiming your self-employment status. In fact, you may find it more beneficial to file quarterly statements with the Internal Revenue Service to avoid potentially be paying penalties at the end of the year for underpayment. You are also required to pay Self Employment tax which is similar to Social Security and Medicare taxes that W9 employees are subject to. You should also check with your individual state or municipality and find out if there are mandatory filings. It is also a good idea to see if the IRS decides your freelance business may qualify as a “hobby” versus a business as there may be times when you may not be required to file as a business.
Determining Tax Year – Most freelancers utilize a calendar year as their tax year, however, there may be cases when it may be more (or less) beneficial to adopt a different tax year for your freelance business. This is best discussed with a tax professional who can help you make that determination.
Record Keeping - One thing that all too often gets overlooked by freelancers is the record keeping requirements. Your records must be in perfect order in the event that the Internal Revenue Service elects to audit you for any reason. Very often, freelancers have multiple sources of income and may not necessarily be aware that they must report income from all sources (even those less than $600 without a 1099) and fail to do so. Additionally, freelancers often miss out on deductions because they do not fully understand which business losses you can deduct. For example, if you are contracted to complete a project you may be able to deduct the loss if you are not paid for the assignment. Verify with your tax preparer the rules for this type of a deduction and remember, that if you later collect on this bad debt, you will have to claim it as new income.
This would fall under this portion of the IRS code for bad debt:
Credit sales. Business bad debts are mainly the result of credit sales to customers. Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt. (note emphasis mine)
This is only a small portion of the tax information that you will need as a small business owner. This is not to be considered tax advice as I am not well versed in tax law. However, these are some basics that you should follow to ensure that you do not find yourself in hot water with the Internal Revenue Service or your state’s Department of Revenue.
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