Many Americans have been forced to adapt to a change in their work status; now they need to rethink their tax status.
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Come April, some 90,000 freelancers and consultants will file their taxes as a sole proprietor amid the swelling ranks of independent workers nationwide.
But filing taxes as a freelancer is a lot more involved than as a traditional, full-time employee.
Here’s a primer on tackling taxes as a self-employed worker.
1. Tap industry associations to find an accountant.
If you’re an independent worker, be it a financial advisor, consultant, graphic artist or writer, find an accountant via your industry’s professional associations, says Sara Horowitz, founder and executive director of The Freelancers Union. Post an inquiry on their web site asking for accountant recommendations in your state.
2. Set aside 40 percent of your net income.
“A good rule of thumb: Whenever you earn a dollar, put 60 percent in checking, and 40 percent in savings,” says Horowitz.
Set up a business tax account, and deposit that 40 percent into it, adds Stephen Furnari, managing partner of law firm Furnari Scher LLP. Tap into that 40 percent to pay taxes and business expenses.
3. Keep meticulous proof of payment.
“The quick and dirty is you need to keep receipts and proof of payment,” says Howard Samuels, a certified public accountant.
Make sure either your receipt or credit card statement itemizes purchases and reflects its business purpose, be it office supplies or transportation expenses.
4. Pay estimated taxes to prevent government interest charges.
If your business is profitable, you will likely have to pay estimated taxes throughout the year, typically on a quarterly basis.
“Failure to pay quarterly estimated taxes when required could result in interest charges from the government,” Samuels said.
5. Don’t cheat yourself: anything that is business related is tax deductible.
Deductions can be taken on everything from home office and utilities, phone and Internet charges to office supplies and transportation expenses, be it carfare or mileage.
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Once again, it’s crucial to provide proof of payment and an explanation of the business relationship of the expense.
“If you’re deducting travel expenses, have proof of where you went and why,” says Samuels.
Home office deductions, which are often the largest deduction, are typically determined by deducting the square footage of your home office area from the total square footage of your home to calculate what percentage of your mortgage rent and or/maintenance is deductible. You may even be able to deduct a portion of your utilities.
Client meals and entertainment are generally 50-percent deductible, says Samuels.
6. Take advantage of the health insurance filing change.
Effective this year, health insurance is now 100-percent deductible against your freelance income to the extent that your business is profitable.
That’s a change from previous years, when it was a standalone deduction unrelated to your freelance income. “The benefit of this change is that it lowers your self-employment—also known as social security—tax,” says Samuels.
7. Consider a Health Savings Account.
If you have a high deductible health plan—a sensible choice for independent workers who rarely tap their medical coverage, as the monthly premiums are lower—opt for a Health Savings Account from a bank or credit union.
You contribute money that goes towards paying medical expense.
The after-tax contributions you make to your HSA are tax deductible up to the allowable limits. This lowers your taxable income and saves you tax dollars, says Samuels. “You get a deduction for going to the doctor.”
In order to qualify for an HSA, your health plan must have a deductible of at least approximately $1,200 for an individual or $2,350 for a family.
8. Open an IRA or an SEP plan in lieu of a company 401K plan to secure retirement savings.
These retirment-savings plans are generally for people who don’t have a 401(k) plan available to them.
Set up an IRA at a bank or a brokerage firm, which allows a tax-free deduction of up to $5,000 as a contribution to your retirement.
If you think you want to sock away more than $5,000 a year towards your retirement, set up an SEP plan, which allows you to contribute approximately 20 percent.
Your freelance business must be profitable in order in order to contribute any money to a SEP, adds Samuels.
9. Consider incorporating if income exceeds $50,000.
If you’re a freelancer, consultant or independent contractor earning with an annual net profit of $50,000 or more, organize your business as a corporation or LLC, put yourself on payroll and make an S-Corp. tax election, which cold save you $3,000 to $4,000 for every $50,000 in profits, says Furnari.
If you’re operating as a corporation or LLC, set up a separate bank account.
“Keep personal and business affairs very separate for liability reasons,” says Furnari. To that end, set up a bank account that’s separate from your personal checking account.
There are companies specializing in this service and the cost is modest.
10. Take advantage of equipment purchase tax deductions.
Here’s a new tax perk: If you’re considering buying a piece of equipment for your business, such as a computer, fax machine or printer, “if your business is profitable, you can [now] purchase that item and deduct it in the year in which you bought it,” says Samuels.