Does the thought of doing your taxes make you want to cry? For many in the design industry, including myself, the answer is a resounding yes. But a solid grasp of figures and finances is the equivalent to building the strong foundation to a building. If you can shore up the money part of your business, you can spend more time doing what you really love—the creative part of the job.
For those workers issued a W2 form, managing taxes is a relatively smooth process. Your employer does much of the heavy lifting and your income stream is typically more straightforward. However, taxes can be a beast for freelancers. I experienced this when I freelanced for six years before joining 99U. There are all sorts of nooks and crannies, rules and methods that apply to self-employed workers that I had no idea about, but needed to quickly learn to ensure I abided by the IRS rules and paid my fair share of taxes.
What follows is a dive into some of the muddier parts of the freelancer taxation waters. With the help of certified financial planner Susan Lee and accountant Amy Northard—both specialists in preparing taxes for creative souls—we debunk some widespread myths freelancers might stumble across while doing their taxes.
Myth: Everyone pays taxes annually every April.
Wait a second, you say, what’s wrong with paying your taxes annually? Let’s break it down into two buckets. If you’re a full-time employee, your taxes, along with your contributions to Medicare and Social Security, are taken our of your paychecks throughout the year. But if you’re freelance, you need to take the tax equivalents out of your paychecks. Northard recommends setting aside 25%-30% of your net profit on every job to account for your taxes on the payment.
Then, rather than waiting to pay your taxes annually every April, set up quarterly tax estimate payments where you project your total earnings for the quarter and pay the corresponding taxes every three months. “This is beneficial so that when you do get to tax time, you are not draining your account,” says Northard. This two-part approach allows you to have money at the ready when it’s time to pay taxes and helps to better manage cash flow evenly over 52 weeks.
Myth: You bring home the same amount of money as a W2 employee that makes your same wage.
For many of us, our Social Security and Medicare contributions are a blip on our taxes—the contribution percentages seem nominal and it feels like eons until we can collect on them. But, if you’re a freelancer, you’re at a disadvantage in this department. That’s because companies split paying these amounts of 12.4% (Social Security) and Medicare (2.9%) with their employees, whereas you have to pay the entire amounts. You’re paying 7.65% more than your W2 peers, something to take into consideration when you bill for jobs. (Maybe you should add 8% to your rates to cover your Social Security and Medicare costs.) The good news, though? Your net self-employment earnings are reduced by half the amount of your total Social Security tax, and you can deduct half of your Social Security tax.
Myth: If you’re 1099 doesn’t arrive, you don’t need to pay taxes on the income.
“No, no, no, no, no,” says Lee. “What it means is that the 1099 hasn’t come.” It’s still your responsibility to track it down and submit it with your tax documents.
Myth: You can travel anywhere for “research” and write off that expense.
“Someone going somewhere for research, when it looks like a vacation spot, is one of the most common things I see,” says Lee. “Don’t try to do it. It’s not going to work.” What then is defined as a legitimate business travel expense? “If you are in another country, be sure to get work there,” says Lee. “Have records of contacts and some money that you were paid. And if you’re going for a two-day assignment and you spend three weeks there, the IRS is not going underwrite that.”
Myth: If you work from home, you can write off your home office, even if it’s in the kitchen/living room of your apartment.
“For the home office deduction it’s got to be exclusive office space,” says Lee. “If you’re working on your kitchen table, by definition, that’s not exclusive space.” If you do have separate office space, measure its size to deduct that percentage of your home from applicable expenses, such as mortgage interest, insurance, utilities, repairs, and depreciation. “There is something else about home office,” adds Lee. “For those taking losses in your business, you can’t take a home office deduction that year because you can’t take a home office without a profit.” One last note to add: Though you can’t take most home office expenses with a loss, you can take your portion of mortgage interest and taxes.
Myth: Bank statements are adequate documentation.
“It’s a common misconception that you can just provide your bank statements to show proof of your expenses,” says Northard. “The IRS actually wants to see receipts for things.” These can be digital receipts or paper ones. “The big point is that bank statements won’t be enough,” says Northard.
Myth: Side hustles aren’t taxable.
If you earn more than $400 gross annually, you need to pay taxes on the amount. “A lot of creatives start out doing things on the side and they don’t really treat their work as a business,” says Northard. “They’ve got expenses and income going into their personal checking account or they’re using their personal credit card. And when it gets to tax time, it’s hard to go back through all of your personal transactions and remember the business events.” This leads to expenses or income being left out or forgotten. Northard recommends having a different bank account for anything craft-related so you don’t mix it up with your personal transactions.
Myth: An audit means you’re in real trouble.
“An audit is a request for information and it’s not necessarily the most pleasant thing,” says Lee. “It may be the only time many of us are put into a quasi-adversarial position. You feel strange about it.” Something didn’t look right to the IRS on your forms and they want to probe deeper to find out why. “Try to have back up records showing both a receipt and method of payment for every deduction,” says Lee. “If you don’t have every single thing, bring what you have. If you’ve made a mistake, tell them you made a mistake.”