Self Employed Freelancer | A Sole Proprietor
Self Employed Freelancer – The Simplest Way to Organize
So you want to be a self employed freelancer? Are you familiar with the various expenses that you are able to deduct as a cost of doing business?
Most freelancers operate as a sole proprietorship and file their business operations on a Schedule C on their Form 1040 personal tax return.
Some who are going into business with other freelancers, may form a partnership, a corporation, or an LLC. Each form of organization may have certain benefits over the other, so you need to review that carefully.
The sole proprietorship is usually the easiest to organize, but at tax time it can present some unusual and potential tax issues. As a sole proprietor, you don’t pay yourself a salary.
You are taxed on the net profit of the business for federal and state income taxes. In addition, you also pay self-employment taxes (FICA and Medicare) on that same figure.
[bctt tweet=”The most important issue as a self employed freelancer, and for that matter, any business, is to maintain accurate and well organized records.” username=”HBSMoneyTips”] This is not only required by the Internal Revenue Service, but it will help you to know what is going on with your business.
Reporting All Income
You must report all income that you generate as a self employed freelancer in your business. Usually, if you are providing a service to other businesses or individuals, they will issue you a Form 1099-Misc at the end of the year. This form tells the IRS how much they paid you during the year.
If your total services to any one client during the tax year was less than $600.00, they will probably not issue a Form 1099-Misc. Don’t make the mistake of not reporting that income thinking the IRS won’t know.
Schedule C businesses are one of the most audited forms of business for a reason. The IRS knows what many foolish individual business owners do, and in many cases, are able to accurately estimate any under reporting of income.
They also have auditors trained in various types of business and know what to look for. We’re not trying to issue scare tactics. Don’t be foolish and try to hide income, it isn’t worth it.
As a self employed freelancer, sole proprietor, there are many types of business deductions that you are able to deduct. Just remember, the expense must be usual, necessary and customary in generating your income.
There are so many, listing them here is not practical. An example of some are home office expense if properly setup, travel, including use of your personal auto if properly documented.
Meals and entertainment of your clients at 50%, certain dues, office supplies, equipment, and other expenses directly related to production of business income.
Again, keep accurate records, and don’t co-mingle personal expenses with your business. We always recommend that you have a separate checking account for the business, and don’t use it for personal expenses.
Taxes on your business earnings
A word of caution here also. The first two or three years of business operations may reflect a net loss for the year. If you stretch that out for a few more years, don’t be surprised if you’re flagged for an audit by the IRS.
When you reflect a Schedule C loss, you aren’t paying any self-employment tax. Plus the loss also reduces other taxable income, thereby reducing federal and state income taxes.
Let’s assume your Schedule C is showing a profitable year for your freelancing business. The first tax to be calculated is the self-employment tax. This is your share of Social Security and Medicare taxes on your earnings.
If you had been employed by some other business, you would have received a W-2 and one half (7.65%) of these taxes would have been deducted from your wages by your employer. The other matching half would have been paid by that employer. Since you are self-employed, you are required to pay the full amount (15.3%) yourself.
This tax is calculated on Schedule SE and the amount of the tax is shown on page 2 of your 1040 personal return as self-employment tax. You do get a break here however. One half of that amount is carried to Page 1 of your personal tax return and deducted from other taxable income.
Choosing the right type of business organization
As a self-employed freelancer, you get a few other breaks as well. If your business shows a profit, you can deduct the premiums paid for medical insurance established in the business for your family.
You also can deduct contributions to a Self-employed SEP, Simple or other qualified retirement plans, within certain limits. Both of those items are also deducted on the first page of your personal tax return as a reduction of other taxable income.
The net income shown on your Schedule C is carried to Page one of your tax return and included with other taxable income.
As you can see, there are a number of benefits operating as a self-employed freelancer. Many individuals start out that way in their business and over time, often switch to a different type of business organization that may be more beneficial. Personal liability can be a deciding factor for some while taxation is for many others.