How to File Freelance Taxes, with Laurel Leckert of Brooklyn Coop

Frequently asked questions about filing taxes from an actual accountant.

Hi Study Hallers! I’m Laurel, your friendly neighborhood accountant. I do tax preparation and bookkeeping both freelance and at a credit union in North Brooklyn, called Brooklyn Coop. I teach a workshop called Tax Tips for Freelancers, and the following is a distillation of that class, based on frequently asked questions.

This FAQ contains answers to the following questions:

• Why are freelancers’ taxes so high?
• How much should I set aside for taxes?
• How can I reduce my tax liability as a freelancer?
• What happens if I take a loss every year?
• Do I have to claim all my income? What about when I get paid in cash? What if they don’t 1099 me?
• What are some common business expenses I can write off?
• What about charitable contributions and medical expenses?
• Do I need to file quarterly?
• New tax law! Ack! What does this mean for me as a freelancer??
• Where can I get my taxes done cheaply?

Why are freelancers’ taxes so high?

There are two main reasons that freelancers pay so much in taxes as compared to folks with “regular” jobs. First of all, employees have taxes withheld from each paycheck, so they’re paying their taxes little by little all year long. By tax time, not only have they already paid most of what they owe, they don’t “feel” it the same way since they never actually had those dollars to begin with. Freelancers, on the other hand, receive all their money and then have to pay a portion of it back in one big chunk (or four smaller chunks, if you pay quarterly).

Additionally, freelancers have to pay what’s called the self-employment tax on top of their income taxes. The self-employment tax is how freelancers pay into the Social Security and Medicare funds, and it’s about 15% of your income! Everyone pays into these funds, but employees get to split the cost with their employer, meaning they only pay about 7.5% of their income into the funds. And these taxes too are withheld, little by little, from each paycheck. Since as a freelancer, you are the company, you’re on the hook for the entire 15%.

How much should I set aside for taxes?

For most people, 25% to 30% of your earnings is a good guideline. So if you make $1000 on a project, you can expect to owe about $250 to $300 of it back to the government. You should take these numbers into consideration when you decide how much to charge for your work.

How can I reduce my tax liability as a freelancer?

You only pay taxes on your PROFIT, meaning the amount of money left over after you’ve subtracted the costs of doing your work. So writing off business expenses is the main way to reduce your tax liability. If your expenses are more than your income, you’ll take a loss for that year and you won’t owe any taxes on your freelance work.

What happens if I take a loss every year?

Here is an unfortunate truth: When it comes to audits, there are literally no guarantees or rules. However, if you take a loss on your freelance business for more than 3 out of any 5 consecutive years, it’s very likely that you’ll get audited. When that happens, you’ll be expected to not only show proof of all your expenses, but you’ll also have to prove to the IRS that you’re in business with the intention of making a profit. If they decide that you’re not really trying to make money, they’ll designate your business a hobby instead, and hobbies cannot take losses. That designation can be retroactive— resulting in new tax liability along with penalties and interest—and it lasts indefinitely. So if you normally have more expenses than income from your freelance work, you need to be strategic about how your report it. This is a case where it would be very beneficial to work with an accountant, so she can help you navigate this.

Do I have to claim all my income? What about when I get paid in cash? What if they don’t 1099 me?

US tax law requires that you declare all your income, regardless of the payment method and regardless of whether or not the person who paid you reports it on a tax form. You’re even required to declare income received in foreign countries and/or in foreign currency. Sorry. :-/

What are some common business expenses I can write off?

Business expenses are any and all amounts spent in connection with your trade, business, or profession. They must be “ordinary and necessary” and they must not be “lavish or extravagant under the circumstances.” Here’s what that means: Write off absolutely everything related to your work. Make sure to keep good records and categorize your expenses so you’ll have annual totals come tax time.

Some common expense categories for writers include:

• advertising (the cost of business cards and website hosting, for example)
• office supplies
• software subscriptions
• new computers
• printing & copying
• postage & shipping
• publishing costs
• books and publications that you use for research and reference
• the cost of admission to a show you write about
• rent at a co-working space

The following types of expenses have special limits and pro-rating rules. Be sure to familiarize yourself with the rules and/or find a tax preparer to help you do so.

• home office (this is how you get to write off a portion of your rent and utilities)
• local transportation
• out-of-town travel
• food (meals consumed with a client or colleague while conducting business)
• business use of your vehicle (bikes too!)
• cell phone bill
• internet bill
• monthly health insurance premiums

What about charitable contributions and medical expenses?

This is important and a bit confusing: Charitable contributions and medical expenses are Personal Itemized Deductions, not business expenses.

Business expenses are written off against business income on a Schedule C to determine the profit or loss from your business.

Personal Itemized Deductions are written off on a Schedule A—but only if they total more than the Standard Deduction. For 2018, the Standard Deduction is $12,000 for single people and $24,000 for married couples. So if your charitable contributions and medical expenses (along with other things like mortgage interest, real estate taxes, and state & city income taxes withheld from your paychecks) don’t add up to more than the Standard Deduction, then they won’t help you. Most people who itemize on a Schedule A have either relatively high income, extremely high medical expenses, or own real estate.

Do I need to file quarterly?

In this country, it’s a pay-as-you-go system. That’s why the IRS requires employers to withhold taxes from every paycheck they issue, submitting the money little by little all year long. They want freelancers to do the same thing by paying at least 4 times per year. If you don’t pay quarterly and you end up with a high tax liability at the end of the year, you may be assessed penalties. The penalties are not huge. For an extreme oversimplification, you can expect to pay about $30 in penalties for every $1000 in taxes owed. The IRS doesn’t assess any penalty if you owe less than $1000 at tax time. New York State begins assessing a penalty if you owe more than $300 at tax time.

Paying quarterly doesn’t mean you have to fill out all the tax forms four times per year. It simply means sending money to the IRS and NYS four times per year. You’ll still only fill out your tax forms once, at the end of the year. That’s when you figure out how much you actually owe for the year, compare it to how much you’ve already paid in, and then either pay more if you still owe more, or receive a refund if it turns out that you’ve overpaid.

To be certain that you’ll avoid the penalty, you should base your quarterly payments on your tax liability from the previous year. The “safe harbor” rule says that as long as you’ve paid in at least 100% of last year’s tax liability toward this year’s tax liability, you won’t owe any penalties, even if it turns out that you owe additional taxes.

Here’s an example. Let’s say you file your 2018 taxes and you owe $4,000 to the IRS and $2,000 to New York. If you want to be sure to avoid the underpayment penalty in 2019, then each quarter you should pay $1,000 to the IRS and $500 to New York. If you do that, you still may owe more taxes, depending on your 2019 income, but you won’t be assessed a penalty.

New tax law! Ack! What does this mean for me as a freelancer??

The new tax law has gone into effect and there are MANY changes. The biggest change specific to freelancers is a new deduction called the Qualified Business Income deduction and it allows most business owners to write off up to 20% of their profit from business. There are a lot of limits and stipulations related to this new deduction so it’s advisable that you work with a professional if you want
to take it. Note that the QBI deduction only applies to your income taxes; your self-employment taxes are still based on your full profit from business.

Another freelancer-specific change is that the cost of entertainment is no longer deductible. It used to be that you could take a client out to a show to woo them into hiring you and you could write off the cost of the ticket. You can’t do that anymore, however food is still deductible so if you’re in the habit of taking clients out to impress them, just take them out for dinner and skip the show.

Some other changes that apply to everyone (not just freelancers) are:

• the standard deduction has doubled
• there are no more exemptions
• the child tax credit has doubled
• there’s a new credit for dependents who are not children
• income tax rates have gone down for most people
• taxes withheld from paychecks have also gone down so lots of people who work W2 jobs are having higher bills / lower refunds at take time than expected

There are major changes to the Schedule A – Personal Itemized Deductions. (If you take the standard deduction then none of this will effect you). Note that New York State has not adopted the below changes so you can still itemize personal deductions on the state side like you always did. But on your federal return:

• you can only write off up to $10K in combined real estate taxes, state and local income tax withholdings, and personal property taxes (there used to be no limit on these)
• you can no longer write off unreimbursed employee expenses (but you can still write off your business expenses)
• you can no longer write off tax prep fees
• you can no longer write off the cost of a safe deposit box.
• you can no longer write off investment expenses

Beginning next year (tax year 2019, for which we’ll file in 2020):

• the penalty for not having health insurance will be waived
• less medical expenses will be deductible than in previous years (remember that medical expenses are personal itemized deductions so if you take the standard deduction, this won’t effect you)

Where can I get my taxes done cheaply?

I work at Brooklyn Coop, which is a community development credit union. We’re a nonprofit, and we work hard to be accessible to everyone in our community, so our prices are a bit lower than you will probably find elsewhere. For most freelancers, the tax prep fee will be $100 or $150 (depending on your income level), and that includes both your federal and state returns. We also offer year-round bookkeeping services for $100/month. If you’re interested, write me at [email protected] for more info.

---