Uncategorized

6 Tax Mistakes Freelancers Should Avoid

 

What’s the deal with you and your taxes?

Are you missing out on refunds? Are you over-paying your taxes? Are you taking risks that could get you slapped with steep penalties?

Take a look at these common freelance tax mistakes and decide if your tax strategy is a good one.

Not filing taxes

Some freelancers haven’t filed tax returns for several years and aren’t planning to file this year either. If you’re one of them, you may want to reconsider.

For starters, you may be screwing yourself out of money. Many people who avoid taxes because they expect to owe actually qualify for refunds. You may think since you’re a freelancer and haven’t had any money withheld you can’t possibly get anything back. But you’re wrong.

Due to credits, such as the Child Tax Credit, many freelancers get checks for thousands of dollars. And if you were eligible for refunds in the past, you can go back and collect that money for up to three years without any penalties. So don’t risk losing because you’re assuming.

Furthermore,  a lot of people think they’re the little fish in a big sea who won’t be caught dodging Uncle Sam. And some don’t get caught. But then there are others who do, and it’s costly. As freelancing grows, the little fish are becoming more important to the economy and therefore to tax authorities. If the IRS discovers you haven’t filed, they can

As freelancing grows, the little fish are becoming more important to the economy and therefore to tax authorities. If the IRS discovers you haven’t filed, they can file a substitute return on your behalf and slap you with a tax bill, interest and penalties.

Under-reporting income

Some freelancers file but they don’t file everything. This is also risky, especially if you’re trying to hide money reported on 1099 forms.

If you received a 1099, the IRS also got a copy. And they have matching software that compares information they receive about you against the information you report. Therefore, they know you should at least be reporting an amount equal to all your 1099s.

When it comes to cash and income that’s not reported on 1099 forms, the IRS has ways to detect that money too. They can do a bank account analysis to look at everything going out and coming in. IRS agents also dig around online. Say you only report income from the three 1099 forms they have on file. If they check your online portfolio and see six clients or see that you have e-books for sale online, that will raise a red flag.

Freelancers often assume their businesses are so small that no one will bother to do too much digging. That’s a gamble and some people lose. And when they do, they pay for it.

The penalty for failing to report income can range from 25% of the underpayment, if the IRS thinks it was an honest oversight, up to 75% if they determine you were trying to get away with fraud. And, in fraud cases, you could also get hit with a fine of up to $250,000 and up to five years in prison.

Not making quarterly payments

“Making late payments, or not making them at all, is a common problem among full-time freelance workers,” Ryan Saltz of the Tax Defense Network told U.S. News.

The U.S. tax system is one where you’re supposed to pay as you go. That’s why employers withhold taxes from their employees. Likewise, freelancers who expect to owe over $1,000 in taxes in a year are generally supposed to make quarterly estimated tax payments (form). But many aren’t doing it.

If you decide to hold off and pay when you file at the end of the year, the IRS may charge you with penalties for paying late.  Furthermore, some freelancers who wait until the end of the year find they have tax bills that they either cannot or do not want to pay. Some decide they won’t file until they can pay or they decide they won’t pay at all.

Not filing and not paying on time can cost you big bucks. The IRS can slap you with penalties for both offenses. Failure to file is either $135 or 100% of your unpaid tax, whichever is smaller. And the penalty for paying taxes late is ½ of 1% of your unpaid taxes. This penalty is charged monthly, and the tab can keep running up to 25% of your unpaid tax.

If you end up in a situation where you can’t afford to pay your taxes, financial advisors say it’s best to file on time and request a payment plan.


Not having health insurance

When Obamacare first took effect the penalty for being uninsured was far cheaper than buying insurance. So, many people chose to pay the penalty. But as it rises, some people may want to rethink that strategy.

For 2016 and 2017, the penalty for being uninsured is $347.50 per child and $695 per adult OR 2.5% of your income. You have to pay the higher of the two. And you don’t get anything for that money.

According to Kaiser Family Foundation, heading into 2016, there were seven million people qualified for premium subsidies. Nearly half of them could get bronze level insurance for free or for less than the penalty. Furthermore, when you’re self-employed, you can deduct your health insurance premiums.

If you plan to forego health insurance, crunch the numbers and check the plans available to you every year to ensure paying the penalty makes sense. And if you do choose to pay the penalty, make sure that you don’t qualify for any of the exemptions that can reduce or eliminate it.

Not maximizing deductions

Savvy business owners claim every possible deduction. They understand that deductions lower their taxable income, and therefore, the amount that they owe Uncle Sam. A lot of freelancers aren’t as hip to this.

Seventy-three percent of freelancers don’t deduct any expenses, according to Xero, an accounting and bookeeping software company. When you don’t claim deductions, you’re shorting yourself, and you’re doing it in a senseless way.

The government doesn’t expect you to pay tax on money you spend running your business. You can deduct anything that’s considered “ordinary and necessary” for your work.  That includes advertising, credit card interest, printing fees, office supplies, utilities, travel costs and expenses to meet with or entertain clients. Keep track of all your expenses all year and claim every cent.

Keep track of all your expenses all year and claim every cent.


Not understanding audit risk

Overall, the risk of getting audited has been going down in recent years. But as a freelance, you should be aware that filing a Schedule C, which is used to claim business income and expenses, triples your odds of being audited, according to Time.

On top of that, certain things boost your chances of raising red flags at the IRS. Claiming a home office deduction and rental expenses, claiming large charity deductions and using lots of whole numbers ($30,000 here. $5,000 there) are some examples.

Excessive itemized deductions is another flag-raiser and it’s a biggie. I know I just urged you to claim all your deductions, and I’m sticking to that. Just understand that if you’re a freelance writer who earns $46,000 and you claim $30,000 worth of deductions, someone at the IRS may think that looks fishy and request a pow-wow with you.

But if you can prove your deduction, it doesn’t matter how it looks. And you should be able to prove them because as a savvy freelancer, you’re going to learn which things elevate your audit risk and you’ll be a good recordkeeper. You’ll have receipts for your purchases, statements for your bills and detailed logs for expenses that don’t have supporting documentation, such as mileage. Right?