Freelancing full-time for more than 16 years, I’ve met hundreds of other self-employed scribes. I’ve found that most freelancers share some common attributes. They’re self-motivated. They’re smart. They’re inquisitive. And they’re passionate about making a living from their words.
Yet even the smartest freelancer can make some foolish mistakes when it comes to paying taxes. With tax season upon us, let’s look at nine mistakes even smart freelancers can make – and avoid.
Mistake: Failing to Prove a Profit Motive
The Internal Revenue Service considers the vast majority of writers hobbyists, not business owners. This doesn’t mean that they’re not serious about craft or passionate about pursuing it. Rather, it means that they lack a “profit motive.” A profit motive is the critical primary factor the IRS considers when determining whether a venture is a business, which means you can write off legitimate business-related deductions, or a hobby, which means you cannot.
According to attorney and tax expert Julian Block in Larchmont, N.Y., the IRS considers several factors to determine whether you have a profit motive.
The amount of time you spend on your writing career. Basically, the more time you put into it, the more likely you are to be pursuing a profit, rather than a passion.
The manner in which you conduct your writing. If you write for markets that pay in “exposure,” not money, for example, the IRS may assume you don’t care about making money. Consistently pitching and writing for paying markets provide evidence of a profit motive.
Whether you’ve produced income from writing in the past. If you have, you’re more likely to be considered to be pursuing a profit now as well. (But the fact that you didn’t make a profit one year doesn’t eliminate you from consideration.)
Whether you’ve sought expert advice about your writing. Taking courses, attending conferences or otherwise improving your writing and marketing skills can all support your intention of making money.
If you’re a freelancer, your goal is to be paid for your words, not to give them away. Make sure that intent is clear to an outside observer, and you’ll pass the profit motive test.
Mistake: Failing to File a Schedule C
New writers may think that they must turn a profit every year to be considered a business. Not so. You need a profit motive, as discussed earlier. Or writers may think if they’re only making a few thousand dollars, it’s not worth filing a schedule C, the IRS “Profit or Loss from a Business” form. But that can cost you money.
Consider this: If you gross, say, $8,000 a year as a part-time freelancer, you’ll pay taxes (income and self-employment) on that amount of money. If you’re operating as a business, however, you can deduct “reasonable, ordinary, and necessary” expenses from your taxable income. If you spent $2,000 on a new laptop, printer cartridges, your Internet connection and other related expenses, you’d pay taxes on $6,000, not $8,000. Bottom line? File a schedule C every year you freelance, even if you produce minimal income.
Mistake: Tracking the Wrong Way
Yes, you want to track your business expenses during the year. But simply keeping a running list of all of your business expenses can make more work for you in the long run, says Joseph Anthony, an enrolled agent specializing in tax planning and preparation for creative professionals in Portland, Ore.
“A lot of people who come to me are journalists and writers, and they’re used to organizing their writing work, but they don’t know how to organize their tax records,” says Anthony. “They keep their records on a monthly basis, but they’re not tracking them by category. If you do that – track them on a category basis, whether it’s meals or supplies or entertainment or travel – at the end of the year, all you have to do is add them up, and your life will be a little bit easier.”
Mistake: Going It Alone
You’ve invested in the latest version of TurboTax, so you’ve got nothing to worry about, right? Not quite true, says Anthony. “People think that because a tax software prints out a tax return for them, it’s accurate,” he says. “But that return only reflects what you put into it.”
For example, Anthony had a client who was taking only one-thirtieth of the depreciation deduction he was entitled to – yet his tax software didn’t reveal that. “Writers are intelligent people and good researchers, and they think they can figure out anything,” says Anthony. “But being intelligent and a good researcher have little to do with understanding the tax code. It’s in a foreign language.”
Your best bet if you do your taxes on your own is to ask a tax pro (an enrolled agent or CPA who specializes in taxes) to look over your completed return. Many will do this for much less than they charge to do a complete return. Ask peers for a recommendation or visit the National Association of Enrolled Agents’ website, www.NAEA.org, for a tax pro near you.
Mistake: Failing to Keep Receipts
A lot of freelancers use their credit cards to keep track of their business expenses. That’s a start, but it won’t be enough to satisfy the IRS in the event of an audit. “People tend to think they can rely on their credit card statements, but your card statement only says where you went and what you spent,” says Anthony. “Your receipt may say you spent $100 at Wal-Mart, but it doesn’t say whether you bought groceries or office supplies or a computer printer.”
That’s why you must save your business-related receipts. They’re the gold standard as far as the IRS is concerned.
Mistake: Waiting Too Long
Ever procrastinated on an assignment you didn’t want to write? And then your work wasn’t quite stellar? You may get a similar result if you try to rush filing your taxes.
“Don’t wait until April 14 to start your tax return,” warns Block. “Keep track as you go along, perhaps say once a month. When you get your bank statement and are sorting out the statement, that’s a good time to segregate out which checks represents payments for deductible expenses.” Take the same approach when you receive your credit card statement: Highlight charges that are business-related, and save the statements along with your receipts.
Mistake: Overlooking Deductions
Don’t be afraid to take every deduction you’re entitled to. For example, if you freelance for magazines, you can write off the cost of the magazines you buy – assuming you’re going to pitch them. Same goes for books, courses and supplies that you purchase to further your business. I write off a variety of office expenses, including the cost of thank-you notes (I send personal thank-yous via snail mail), postage and even cool colored gel pens.
“If you feel you genuinely meet the requirements to qualify for the deduction, my advice would be to take it,” says Block. “If you fail to take a deduction you’re otherwise entitled to, particularly with respect to schedule C, you’ll unnecessarily overpay your income taxes and your self-employment tax.”
Mistake: Failing to Take the Home Office Deduction
Do you have a specific area of your home that you use exclusively for your writing business? It doesn’t need to be a separate room, but it must be a “definable area” that you use only for freelancing. Then you should be taking a home office deduction. In fact, the home office deduction can save you money on your travel-related expenses as well.
“If you’re working out of your home, and you don’t qualify for a home office deduction or choose not to take one, when you go from your home and travel to another location for work, you can’t write that mileage off. It’s considered commuting, which isn’t deductible,” explains Block. “On the other hand, if you take a home office deduction, you can write off every business-related trip you take because you’re leaving your office for a business-related purpose.”
That means if you don’t take a home-office deduction, you’ll lose out on some travel deductions, too. And that means you’ll wind up paying more taxes because your net income is higher than it would be if you took a home office deduction.
Mistake: Forgetting to Plan for the Future
I netted a little over $11,000 my first year of full-time freelancing, but I opened a SEP, or self-employment plan, with $1,000 of that income. Since then, every year I deposit about 10 percent of my income to help fund my retirement.
If you forgot about putting money aside for retirement, don’t worry – you have until April 15 to put money into a tax-deductible retirement plan, says Block. While currently you can’t deduct that amount from your self-employment tax, it will reduce the amount of income tax you pay.
Paying less to the government while you save for the future? That’s a smart freelance technique for both the short and long term.
Kelly James-Enger is the author of freelancing books including Writer for Hire: 101 Secrets to Freelance Success.