The freedom of being a freelancer can be loads of fun. But, when it comes to reporting taxes, that freedom means filing a bit more paperwork than required for the traditional employee.
Independent Contractors and Self-Employment Tax
According to the IRS, people “who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether these people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The earnings of a person who is working as an independent contractor are subject to Self-Employment Tax.”
The self-employment tax typically requires quarterly reporting; however those who contract work part time or carry other positions as an employee of a company can be report annually. The self-employment tax isn't applied only if the income generated that year is less than $400. For those who qualify, self-employment taxes must be paid along with local, state, and federal income taxes. The self-employment taxes cover Social Security and Medicare deducted from the checks of those who are employed by others.
Social Security and Medicare Taxes
Freelancers are not exempt from paying the Social Security or Medicare taxes withheld from the checks of the regularly employed.
In a traditional employment scenario, the employee pays a portion of these taxes while the employer covers another; a freelancer is responsible for the total sum. The Social Security tax rate varies annually; in 2011 employees pay 4.2% of income, while the employer pays 6.2%, thus freelancers devoted 10.4% of their income to Social Security tax in 2011. The Medicare tax rate for freelancers in 2011 was 2.9% percent of income.
Federal, State, and Local Taxes
Freelancers must also pay federal income taxes on all earnings. The amount of income tax for which a freelancer is responsible is determined using earning levels divided into the same tax brackets applied to the traditionally employed. Freelance income is also taxable on the state and local level. Business income generated from freelancing should be reported to the state on the annual return. Freelancers should contact their local municipalities to determine how to pay.
The 1099 form is the umbrella under which freelancers report their income. The form is broken into specific sections to facilitate the different ways of receiving revenue.
1099K — Merchant Card and Third Party Network Payments is new form that covers income generated from those who accept online payments and credit cards. Each card processor (Visa, Amex, Paypal, etc...) sends the
freelancer a 1099K.
The 1099-MISC form is completed by those for whom you've done business that amounts to over $600.
Independent contractors can claim several deductions, which help ease tax liability.
For freelancers on the road, the expenses incurred while having to live elsewhere on assignment can be deducted; up to half of meal expenses can be deducted as well. Vehicular expenses can be deducted using the federal compulsory mileage rate; rental fees for cars or trucks can also apply. However, the expenses can only be deducted if the freelancer did not receive compensation.
Tools and necessary equipment are deductible items for freelancers. Additionally, fees paid for licensure can be deducted. As with most businesses, communication expenses such as phone, fax, and Internet bills can be reported as deductions. Clothing is deductible only if it is suited specifically for the jobs; for instance, scrubs for nurses.
Slightly different than operational costs, professional costs are not related to the nuts-and-bolts of business but rather support the professional aspect of your actual profession. Trade publication subscriptions, organization memberships, and union dues are examples of professional costs.
Being a freelancer can provide a rewarding source of income; however, tax liabilities rest solely on the person. Be sure to appropriately file taxes to reap the most reward.
Katei Cranford is a freelance writer who enjoys the feeling of a properly filed tax return.