The Finances of Freelancing: Tax Tips for Confused Contractors

Michele Lerner, The Motley Fool writes: Freelancers may love their freedom, but they don't always love the financial uncertainty that goes with being an independent contractor.

According to a recent survey by CreditDonkey.com, while 92 percent of those surveyed are happy to be freelancers, 56 percent said their biggest complaint is the uncertainty about their income.While handling a fluctuating income stream can be a challenge, many freelancers and contractors find the complications of paying taxes even more difficult. In fact, 16 percent of the freelancers surveyed by CreditDonkey.com said that at least once during their career, they haven't had the money to pay their taxes.

Watch Out for the IRS

Unlike traditional employees, who have their income taxes deducted from each paycheck, most freelancers and contractors don't have taxes deducted from their paychecks. Instead, they receive a 1099-MISC form from each client that pays them more than $600. The IRS gets copies too, and freelancers need paid estimated taxes quarterly to their state government as well as the federal government if they expect to owe more than $1,000. By the way, even if a client doesn't send you a 1099, you are required by law to report that income.

If you are a freelancer, the IRS Form 1040-ES includes a worksheet to help you estimate your taxes for each quarter based on your income, as well as on deductions and credits for the previous year. You may want to create a dedicated savings account solely for your tax payments.

Even if you have a full-time job but take on an occasional freelance project, you must report net earnings from self-employment of $400 or more on a Schedule SE (Form 1040).

Tax Forms

Most freelancers complete the Schedule C form, which sole proprietors use to report their profit and loss each year. If you are self-employed, have less than $5,000 in business expenses, no net losses, and no employees, you can use the Schedule C-EZ Net Profit From Business form.

Keep track of your business expenses all year and keep your receipts in case you are audited. In the area of deductions, pay close attention to these categories:

• Home office: Many freelancers work out of a home office but are afraid to claim the home office deduction because it's considered a red flag that increases your chances of an audit. However, if you legitimately work at home and are following the IRS guidelines found in Publication 587: Business Use of Your Home, you may want to consider taking the deduction. The main qualification is that the space you call your home office must be used exclusively for work.

Currently, the home office deduction allows you to deduct a percentage of your mortgage interest, homeowner's insurance, utility bills, home repair bills and depreciation. The percentage is based on how much of your home is used as an office, so if your "office" is a couch and a laptop, then you're not likely to qualify or even receive much of a financial benefit from the deduction.

In 2014, when you file your 2013 taxes, taking that home office deduction will get easier. Instead of filling out a long form to take the deduction, you'll be able to use a new optional deduction capped at $1,500. The qualification still holds that your home office must be used "regularly and exclusively for work," but the new form simplifies the process and lets you deduct $5 per square foot for your office on space up to 300 square feet. If your office is bigger than that or you regularly deduct more than $1,500 for it, you can still use the longer form.

• Computer: If you use it for personal business as well as work, you'll have to determine how much time you use it for each function. In other words, if you work on it 20 percent of the time and play with it 80 percent of the time, you can only deduct 20 percent of the cost on your taxes.

• Travel: If you travel for business, you can deduct 100 percent of your airfare and hotel stay and 100 percent of a meal eaten while working with colleagues. You can deduct 50 percent of your costs when entertaining clients.

• Health Care Expenses: As a freelancer, you can deduct your health care insurance premiums, including COBRA costs from your previous job.

IRS Publication 535: Self-Employed Health Insurance Deduction provides the details, but in general you must be reporting a new profit for your business on Schedule C or Schedule C-EZ.

• Retirement Savings: While you don't have the benefit of a 401(k) from an employer, you can open a Simplified Employee Pension (SEP) plan to build retirement savings and protect up to one-quarter of your earnings -- or a maximum of $50,000 -- from taxes. That's much higher than the cap on a traditional IRA.


More Than Anything, Be Prepared

Confused by all these IRS rules? You may want to consider the benefits of hiring a tax preparation expert or an accountant to make sure you are meeting all IRS requirements for freelancers.

The most important thing you need to do as an independent contractor is to sock away cash. Not only do you need to pay lump-sum quarterly taxes, but you need to have a bigger emergency fund than someone who receives a paycheck every two weeks.

Financial experts recommend that most people have three to six months of expenses saved in an emergency fund, but as a freelancer you should probably have six to nine or even 12 months of expenses saved. This is especially important if you are the sole financial provider for yourself or your family. Even the most successful freelancers experience some fluctuations in their income.

On the other hand, freelancers are not as reliant on a single employer. Most have several clients and successful freelancers are consistently marketing their services to bring in new business. So losing one client doesn't necessarily mean you'll need to dip into your emergency fund.

Tax Filing Season opens with official launch and "Ask A Tax Preparer" Mobile App

The "Ask A Tax Preparer" app includes a comprehensive database of answers to more than 2,500 tax questions, and even includes the latest fiscal cliff tax changes recently passed by Congress. Users of the app can simply choose a category and search for the answer to their question in the tax archive. If unable to find the answer to a question, users have the option to type their question and send it to local participating tax preparers whom will answer it for free within 48 hours. The question and its answer will then be added to the robust tax archive for future inquiries. Additionally, those who would like to locate a licensed tax professional can use the app to "Find a Tax Pro" by zip code. "Ask A Tax Preparer" is available for free download and use on the Apple and Android platforms.

Tax season is getting started late this year because of last minute tax law changes made by Congress under the American Taxpayer Relief Act (ATRA). The IRS could not process returns earlier as this fiscal cliff legislation retroactively modified the tax laws for 2012, requiring tax forms and software to be corrected. The most common tax changes enacted under this fiscal cliff legislation that effect 120 million households can be found on the "Ask A Tax Preparer" mobile App. 

"Ask A Tax Preparer" was released by PTINdirectory.com, the first online searchable database of over 700,000 federally PTIN registered tax preparers.  As of 2011, all tax professionals were required to obtain from the IRS a preparer tax identification number (PTIN) and register their "license" annually. PTINdirectory.com was made possible as a direct result of the Freedom of Information Act. Under the Freedom of Information Act the Internal Revenue Service was required to make tax preparer information available to the public. PTINdirectory.com is the only comprehensive directory where you can actually search for a licensed tax preparer by language criteria.

PTINdirectory.com is owned by The National Directory of Registered Tax Return Preparers and Professionals Ltd. The Company currently is focused on providing licensed tax professionals including CPAs, Enrolled Agents, and Registered Tax Return Preparers with the  resources they need to succeed in this rapidly changing and regulated environment. For more information on this free tax resource for your mobile phone go to www.askataxpreparer.com

Crowd funding (like KickStarter) presents a new area of tax planning expertise

Fund recipients, entrepreneurs could use a bit of guidance.  Darla Mercado for Investment News writes:Crowd funding is forecast to grow in popularity this year, leading to an added demand for specialized tax advice.  The latest evolution in “passing the hat,” crowd-funding portals allow people to help back a project or a burgeoning company by providing financial contributions on the web. There's also a philanthropic twist to crowd funding in which individuals and groups can donate to charitable causes or raise money for people who need help covering medical expenses through sites like GoFundMe.com.

Deloitte LLP predicts that this year, crowdfunding portals will raise some $3 billion, up from $1.5 billion in 2011.

But there are potential tax traps for unwary individuals who hope to obtain some funding through the web, and experts warn that the issue of whether a recipient's small windfall is considered a gift or income could be a gray area.

“There are criteria that the [Internal Revenue Service] looks at to see if the funds are a gift or if they're something else,” warned David White, a certified public accountant and member of the American Institute of CPA's Trust, Estate and Gift Tax technical research panel. “You could have an auditor come in and make a determination. Unfortunately, with the IRS, they can assess you and you'll have to defend yourself.”

In the best of all scenarios, the entity soliciting funding on the web is a tax-exempt nonprofit organization or a religious entity which can receive donations that are tax-deductible to the giver.

However, solicitors in crowd funding could also be individuals or other groups that aren't tax-exempt — say, an entrepreneur looking to start a business venture or a starving artist.

When it comes to giving money to an individual, money that's a true gift isn't tax-deductible to the donor. In fact, the giver may have to pay a gift tax if the donation is large enough. This year, donors can make a tax-exempt gift to another individual of up to $14,000.

Funding that exceeds the annual exclusion may still be tax-free up to the lifetime estate basic exclusion amount, which is now $5.25 million, Mr. White said. Alternatively, donors can pay up the gift tax on money that exceeds $14,000 without affecting their lifetime estate basic exclusion amount, but the highest gift tax rate is 40%.

When it comes to recipients, however, entities that aren't tax-exempt can encounter a gray area: Is the money they're receiving considered a gift or income?

Money raised for a family that's recovering from a tragedy is generally viewed as a gift: The person giving the money doesn't get any tax deductibility from it and it's tax-free to the recipient.

“In a situation where there's a fire, and then a fundraiser for the family that's affected, the money is truly a gift,” Mr. White said. “The recipient gets it tax-free, and the donor may be subject to gift tax.”

However, in a situation where a nonexempt small business or an individual seeks funding to help release a product — such as a film — those donations could be considered taxable income, according to David Marlett, executive director of the National Crowdfunding Association.

In those situations, there are ways to offset that income, perhaps by giving donors in those situations a reward — such as a T-shirt — to count as an expense against the income received via the funding, he explained. Such presales allow companies to both raise funds and distribute products to donors. However, businesses may end up on the hook for state sales taxes for these so-called pre-sales, Mr. Marlett said.

Where the picture gets murky as to whether received funds are a gift or income is when an entrepreneur is soliciting donations to supplement his or her livelihood. An auditor for the IRS could very well deem the money to be income.

“Say you're an artist, and these donations are money for you to do your business and sell your art,” Mr. Marlett said. “That's tricky. It's a situational basis.”

Xero Integrates With Harvest for Time-Tracking & Invoicing

Xero, the global leader in online accounting software committed to beautiful design and functionality, continues to deliver a comprehensive platform for managing small business finances in the cloud. Today, the company announced its integration with Harvest, a leader in time tracking and invoicing software designed to be useful, simple and fast. 

"Xero is continuing to partner with industry leaders, like Harvest, who round out our cloud-based offering with tools that make it even easier for small businesses and accounting professionals to manage their finances from anywhere, anytime," said Jamie Sutherland, Xero's president of U.S. operations. "Xero stands out in the market because of its unparalleled focus on design and innovation -- it finally makes accounting software beautiful."

"As a founder and Head of Design at Xero, it's my job to ensure we always apply design thinking to everything we do. Our goal is to make people smile whenever they use Xero," said Philip Fierlinger, Xero's chief designer. "Making people smile while they do their accounting is no small challenge, but it's what sets us apart and why our customers love using our software."

Xero received over ten awards in 2012 and many due to its focus on design, including an IxDA Interaction Award for Optimizing. Xero was also named a finalist for Fast Company's Innovation by Design award and received its fourth Webby nomination in as many years. Top small business and accounting leaders have also recognized Xero for its unmatched expertise and capabilities. For instance, K2 Enterprises awarded Xero the Quality Award for the Best New Mobile App and Small Business Accounting Solution, and CPA Practice Advisor's Readers Choice Award lauded Xero as one of the 2013 top Small Business Accounting [solutions] - Cloud.

"As a web designer, I recognize the many innovations that Xero and Harvest have made in user experience to give me insight and improve the way I work," said Brian Hoff, owner and creative director of Brian Hoff Design, "It's critical our systems run efficiently and effectively. Solutions like Xero and Harvest -- that integrate seamlessly -- are essential to keeping me on top of my workflow and financial picture."

Harvest was born of the same principles as Xero. Before starting Harvest, the founders operated a design firm, but as they grew they could not find quality tools to help them track time and invoices -- so they created one. 

"We've been committed to great design and user experience right from the start. So when we think about partnerships, we focus on others who are committed to the same," said Danny Wen, Harvest co-founder.