Some tax terms that will aid freelancers to understand taxes for freelancers
Depreciation: Business expenses that are not for services but for some sort of property get divided into two categories. The first generally gets used up in the year that they are bought. These expenses can include computer paper and other office supplies. These expenditures get taken as deductions in the year they are bought and are said to be expensed. The second are assets that typically last for more than a year and are said to be depreciated. These can include office equipment and office buildings. There are various rules that allow deductions over different periods of years as well as one set of rules (Section 179) that allow you to deduct certain of these expenses immediately under certain circumstances.
Estimates or quarterlies: The US tax system is based on a pay as you earn theory. This means that if you’re on a wage, you will have taxes withheld as you earn them. The mechanism that freelancers have to pay as you earn is known as estimates, estimateds or quarterlies. Filed four times a year ( April 15, June 15, September 15 and January 15) on Form 1040-ES, you then file your actual taxes by April 15 following the ending of your tax year, and you have much if not all of the taxes you will owe as a credit against what is owed. The result is that you will not find yourself owing all of your taxes plus a penalty for not filing estimates come filing time.
Expenses: Business expenses are what freelancers pay for items that are used in the course of your business. These may include supplies, professional association memberships, and equipment. Please see the lists of expenses on this web site for your particular specialty. The following are expenses that might be deductible but are not considered business expenses. Expenses like medical insurance may be deducted against your total income on the adjustments section of your 1040 page one. Other expenses may be deductible like medical expenses, contributions, and state and local income taxes on Schedule A subject to various limitations. Many other expenses are purely personal and are not deductible at all.
Home office: Many freelancers work out of your homes. A home office deduction has to do with the part of your home that you use exclusively in their business. A home office deduction only relates to that part of your home which is exclusively used for business. The deduction itself is calculated on Form 8829 and is subject to a variety of requirements. If eligible, the amount able to be deducted is carried over to Schedule C.
Income: Income for a freelancer can mean a number of things rather than one thing. Most freelancers get paid a certain amount for the project that was worked on. This is called the gross income or gross receipts. Sometimes freelancers think this is what you’ve earned. You may not realize that your business expenses must be deducted from this number to get your net income or profit. It is this income that gets taxed. Also if you think of your gross income as what you earned, you might well think you have more to spend in your personal life than you do.
Some people who are called freelancers (particularly in the entertainment industry) get paid on a W-2. In thinking about it, these people say that their income is either the gross amount they receive before taxes are taken out or after or what they actually get paid after withholding. For tax purposes, however, they get taxed on the gross amount.
Also income includes the value of something you may have traded for. For instance if you traded a painting that ordinarily would have sold for $2000 for bookshelves and a table, you must include that $2000 into your income. You may also consider deducting the expenses if they are relevant to your business and used in it.
Itemizing: There is confusion among freelancers about what the term “itemizing” means. It does not mean filing expenses as a sole proprietor on a Schedule C. Itemizing has to do with expenses that are primarily personal on Schedule A. Taxpayers generally can take a standard deduction or itemize their medical, state and local tax and contributions among others on Schedule A. Freelance business expenses are taken on Schedule C.
Schedule C: A freelancer generally files freelance income and expenses on a Schedule C. It’s the tax version of a profit and loss statement. There are specific tax rules about what may be deducted as with meals and entertainment, depreciation, home office, and the rest of what qualifies as business expenses. The net income then gets entered on the Form 1040 for purposes of calculating income and self-employment taxes.
Sole proprietor: A freelancer is by definition in business for yourself. As such you are a sole proprietor. A sole proprietor is by definition self-employed. If you are in business with someone else, you are not a sole proprietor nor are you self-employed. You must determine the kind of entity and filing status you have and file accordingly. A Schedule C is no longer available to you.