As a freelancer or sole proprietor, you should not only consider your workload and future; you should also have a good handle on what your taxes will look like. Planning now can help you avoid a nasty tax surprise at the beginning of next year.
Here are eight helpful tips when starting out as a freelancer or sole proprietor:
1. The Basics: How are Independent Businesses Taxed?
Just like individuals, your business venture will be taxed on every dollar it makes. Keep close track of your invoices and every penny coming through your door. You must also monitor and maintain documentation of the expenses related to your business. Since freelancers and sole proprietors are not technically separate taxable entities, your business-related taxes will combine with your regular income tax forms each year.
2. Getting a Tax ID Number
As a small business owner, it’s a good idea to get an Employer Identification Number (EIN) for tax purposes. Your EIN is used just like a Social Security number. It can be used in your tax documents, applying for business licenses, and opening a business bank account. If you are unsure as to whether or not you need an EIN, Wicks Emmett can provide you with a handy checklist to help you determine whether or not you actually need an EIN.
3. Working for Clients: Form W-9
Operating as an independent contractor means you will need to fill out a W-9 for your customers. This form provides them with basic information about your tax status including a taxpayer identification number (TIN), which is usually your social security number.
4. Services: Form 1099-MISC
Each client that you have that pays you over $600 for your services should submit a Form 1099-MISC to you directly. The type of profits that you receive will have an effect on how the revenues are displayed on this form. Keep in mind, however, that only expenses related to services will require that your client give you a Form 1099, and you must report the income associated with a particular client even if you did not receive this form.
5. Products: Cost of Goods Sold
If your business is more focused on selling products instead of providing services, you likely will not see many 1099s. Your tracking is going to focus on the cost of your inventory versus how much revenue you bring in for that inventory. It is important to track these expenses because they will be a valuable income tax deduction.
6. Self-Employment Taxes
As an employee, you not only pay income taxes, but you also pay taxes to Social Security and Medicare. You must still make these contributions as a sole proprietor or freelancer as well. These charges are known as “self-employment taxes”. They are separate from your income tax obligations, but they are included on your income tax return. The self-employment tax rate is 15.3%. Of that, 12.4% is usually for Social Security and the other 2.9% will go to Medicare.
7. Schedule C: Income Taxes for Freelancers and Sole Proprietors
All of your income and expenses will end up on Schedule C, which is part of your Form 1040 income tax return. The schedule will indicate your total profit and loss from your business. All of the data you have been collecting all year will end up in this form. Every sole proprietor or freelancer that has income from their business will file a Schedule C. From an income tax standpoint, this is the only additional filing requirement for these types of small businesses.
8. Paying Your Income Taxes: Estimated Tax Payments
One of the most common ways that sole proprietorships and freelancers get tripped up at tax time is by failing to pay their estimated tax payments throughout the year. When you own your own business, there is no one taking out taxes on a regular basis on your behalf. You are obligated to do this on your own by paying estimated taxes. This process involves estimating how much income you have at the end of the year and paying taxes related to that amount.