The rise of the gig economy has changed the face of the workforce as we know it, with a tidal wave of people supplementing the income from their day jobs with freelance work, or becoming full-time self-employed contractors. While this was previously the domain of freelance writers, photographers, illustrators and graphic designers, changes in the business landscape have seen the rise of web based consumer services like Uber and Air BnB. Often, people draw an income from these services without being fully cognizant of the financial implications.
While it’s great to see such a huge surge in people taking control of their careers and creating opportunities rather than waiting for them to come along, freelancers with an increasing variety of backgrounds and skills are entering the marketplace without a clear idea of their tax obligations.
Heed this advice, and you’ll be free of the tax pitfalls that tend to plague freelancers and ensure that you’re paying the right amount of tax for your fledgling business while making adequate provision for your retirement.
Not recognizing their freelance status
Even if the freelance work you carry out is a “side gig” concurrent with a full-time, salaried job, you have the same tax obligations as a full-time freelancer. This means that you will be expected to pay income tax and self-employment tax and contribute towards your retirement. If you’re lucky enough to make over $200,000 a year, you will also be expected to pay a Medicare surcharge.
However, 50% of your self-employment tax expense is deductible, so it’s vitally important to declare all of your expenditure (more on that later). A report by the accounting software firm Xero revealed that the average self-employed business owner makes approximately $25,000 per year, while those with a side gig tend to make between $2,000 and $10,000 a year in additional freelance income. Those who owe more than $1000 in tax will be expected to make quarterly tax payments of risk facing penalty charges and interest.
Not reaching out for help
It’s a tired phrase but time is money, especially if you’re a freelancer. Whether you freelance full-time or alongside a day job, it’s important to reach out to people who can help you with your taxes. While you absolutely could do it all yourself, you’d be dedicating some serious hours to filling out the forms that could be better spent earning yourself more money. Investing in an attorney to represent your tax case and beat the IRS will likely save you far more than it costs, as will entrusting your accounting and bookkeeping to professionals.
Not deducting their expenses
If you’re a freelancer or an independent contractor, you should be tracking your income month-by-month to estimate your tax liability and avoid frantic deadline calculations. Keeping a separate bank account and credit card for business activities is invaluable in tracking what you earn and spend.
This income, however, needs to be offset with your work-related expenses. Any expenses incurred in the course of your freelance work, or that are necessary for your business should be declared to ensure that you aren’t paying disproportionately high rates of tax. Believe it or not, a staggering 73% of freelancers fail to declare any deductible expenses at all, meaning that they’re almost certainly paying too much in tax.
With this in mind, it’s important to know exactly what qualifies as a tax deductible expense. If for example, you use your car in your day-to-day activities then your vehicle mileage, repairs, and upkeep can qualify as deductible. If you work from home then you can deduct a portion of your rent or mortgage interests, property taxes and utilities as well as computer and office supply purchases, and internet/phone use. Likewise, money spent on advertising and marketing, coaching, licensing and registration are all deductible.
Not saving for their retirement
Not many people are aware that your retirement provision can also legitimately be claimed as a tax deductible. If you’re a freelancer and not paying anything towards your retirement, then it’s strongly recommended that you create a retirement savings account as soon as possible. You may think that you don’t have the head for the paperwork, but it’s surprisingly simple. A Simplified Employee Pension (or SEP IRA) allows you to contribute up to 25% of your net yearly earnings as a tax deductible with a maximum annual contribution of $54,000 this year.
Whether you freelance full time or on the side, there’s no excuse for mismanaging your taxes and incurring unnecessary penalties. By boxing clever and seeking help when you need it, you can save yourself a whole lot of headache with the IRS.