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First, a disclaimer. Everything freelancers need to know about taxes can’t be covered in a chapter. Tax regulations also change over time and differ from state to state. We’ll focus on federal taxes for the sole proprietor in this chapter, covering some important general tax points for sole proprietors, profiling some of the top tax deductions for freelancers, and outlining the basics of estimated taxes and tax issues when subcontracting or hiring. At the end of the chapter is a Selected IRS Tax Resources section listing IRS publications worth checking out. But don’t stop there! The IRS website is packed with useful info that’s surprisingly comprehensible, considering the crazy complexity of the tax code. For state and local tax regulations, check your state tax department. Build your knowledge through reading and talking with qualified pros (your accountant; your attorney) about your situation. Also review Chapter 14 for info on record keeping.
Take this short true-or-false quiz:
1 True or False: Freelancers get hit with a bigger tax bill than staff workers.
Answer: True. Employers share the burden of paying Medicare and Social Security tax. Freelancers, as boss and worker bee, get to pay both, as self-employment tax.
2 True or False: Self-employed workers’ tax returns may get more IRS scrutiny than traditional employees’.
Answer: The ways of the IRS are known only to the IRS. What we do know is that the IRS gets a copy of the W-2 form staff workers receive from employers detailing their income. The IRS can just match this against the staffer’s tax return and say, “Yep, that checks out.”
You, freelancer, aren’t an open-and-shut case. You have income from multiple sources. You’re deducting business expenses. Both fluctuate. This makes you potentially interesting and possibly complicated to someone whose job description is: “Make sure Uncle Sam gets his due.”
3 True or False: Freelancers have to keep more detailed tax records than traditional employees.
Answer: True. For the reasons in Statement 2, whether they do their own bookkeeping or hire someone, it costs freelancers time and sometimes money to document their income and maintain detailed records and files to prove their deductions.
4 True or False: Freelancers have to be more consistent about saving money for taxes than staff workers.
Answer: True. While everyone has to save for taxes, employers help by withholding and paying taxes from employees’ paychecks. Freelancers, lacking that built-in step, often have to save and pay income tax four times a year (estimated tax), keep books on the payments, and often pay an accountant to calculate them.
I’m front-loading the bad news because it helps explain why it pays to get smart about what you can deduct, and why good record keeping and reporting are essential, so you can back up your deductions with confidence. On the upside, there are opportunities not to be missed.
Selling tangible items and even some services can require collecting sales tax from your customers and remitting it to your state by filing sales tax returns. Check with your state or with your accountant beforehand about licensing and procedures, as regulations vary and states take sales tax remittance super-seriously. If you’re selling items to an entity that will sell them to the general public (for example, as a wholesaler), you should register with your state and make sure you get a resale certificate from those clients stating, in essence, that they, not you, are responsible for remitting sales tax.
Unless you’ve selected a different business structure, you’re a sole proprietor for tax purposes. There can be valid tax reasons for choosing a different business structure, so discuss this with your accountant.
Your tax return covers a tax year, generally twelve consecutive months. Depending on the business, it could be a calendar tax year (January 1 through December 31), a fiscal year (twelve consecutive months that end on the last day of a month other than December), or a fifty-two- or fifty-three-week tax year, which doesn’t have the last-day-of-the-month rule. You may have to get IRS approval to change your tax year. With very rare exceptions, a sole proprietor uses the calendar year.
For the “when,” check out IRS Publication 509, Tax Calendars.
The “what” and “which forms” depend on your business structure or organization. Some taxes a sole proprietor may pay include:
• Federal income tax using Form 1040 U.S. Individual Income Tax Return and Schedule C (Form 1040) Profit or Loss From Business (Sole Proprietorship), with separate schedules if there’s more than one business.
• Self-employment tax, filing Schedule SE (Form 1040). This is your contribution to Social Security, which offers retirement and disability benefits among others, and hospital insurance via Medicare.
• Estimated tax using Form 1040-ES, Estimated Tax for Individuals (see Estimated Taxes).
• State and local taxes (including estimated taxes).
Income tax is supposed to be paid as the money is made (hey, even the government doesn’t like waiting for payment!). Thus employees have taxes withheld from their paychecks. If you don’t have withholding (or if you do, but still need to pay more tax), you might have to pay estimated taxes (see Estimated Taxes).
Here’s a highly simplified snapshot:
You keep careful records of all your earnings (gross income) as a sole proprietor. You and the IRS should receive Form 1099-MISC Miscellaneous Income from clients who paid you $600 or more during the tax year, but you must report all income whether or not you received a 1099-MISC. Make sure the amounts on your 1099-MISCs jive with your records. If you spot a discrepancy, alert the sender. If the 1099-MISC is in error, they can file and send you a corrected form.
You also keep careful records of all your business expenses. Some will be “direct expenses”—directly related to the running of your freelance business. Some may be “indirect expenses”—the business-related portion of expenses connected partly with your business and partly with your personal life (more on this is coming up).
You calculate the appropriate tax deductions for your business expenses, based on tax law. Your net income is the difference between your gross income and your deductions. A positive number = a net profit. Negative number? A net loss.
You report all of this truthfully, on time, and pay any tax you owe, because penalties, interest charges, audits, or worse are no way to spend your time and hard-earned money.
Some people really get into the nitty-gritty of taxes and swear by tax software, but if that’s not you (or even if it is, but you want another pair of eyes on things), hire a professional to prepare your taxes. A knowledgeable accountant can also help you understand the financial ramifications of business decisions. Vet that person well because you’re responsible for your tax return’s accuracy, no matter who prepares it.
CPAs (certified public accountants) usually have to have a college degree, postgrad study in some states, and pass a national exam. They also have to take continuing professional education credits (CPEs) to stay current in their industry. Some tips for choosing an accountant:
• Get recommendations from trusted family, friends, and freelancers.
• Ask candidates for client references, and follow up.
• Find out where they got their tax and accounting training, degrees, and license to practice. In some states, tax preparers need to be licensed or registered. Ask if they’re licensed in yours. Some states have tougher licensing requirements than others—which is why you should also check references.
• Ask if they have clients with businesses like yours. You need someone who understands freelancers’ tax needs.
• Ask what professional organizations they belong to. Do those organizations offer continuing education? What about having a code of ethics?
• Ask about their availability to answer questions and advise you—obviously especially if the IRS contacts you.
• Ask who would handle the day-to-day and how knowledgeable they are if they’re not the senior person.
• See if they can give you a ballpark cost. Keep in mind an experienced accountant, just like a freelancer, might charge more but have valuable experience and get the work done faster. So it’s not only about the fee.
• Notice if they ask questions about your business. You want someone interested in your business who can guide you in how the tax laws apply to you.
• Red flags: saying they can help you get bigger refunds than other preparers, calculating their fees as a percentage of the refund, not wanting to sign the return or send you a copy.
• Check out the American Institute of CPAs (aicpa.org). P.S. Accounting and tax prep fees are deductible!
Stephanie loves Apartment Haven, a store that sells space-efficient stuff for apartment dwellers. On one visit, she buys a set of colored stacking boxes and standup files for her home office. She charges them on her credit card. At tax time, she deducts the amount paid to the store as a business expense and uses the store entry on her credit card statement as proof of payment.
But wait. How do we know every item she bought was for business? Maybe she also bought a collapsible drying rack for her delicates. Which is why, for the IRS, proof of payment alone doesn’t legitimize a deduction. Stephanie needs to save the store receipt itemizing her purchases, proving they were for business.
Then does she even need the credit card statement? Yes. It proves that she, not someone else, paid for the business items. Otherwise, what’s to stop her from submitting the store receipt for her boyfriend’s purchases as her own?
There’s a symbiosis between proof of purchase (receipt) and proof of payment (such as credit card statement, canceled check, debit card record). You need both as backup when claiming business expenses (scans or photocopies of receipts are OK). For more on record keeping, see Chapter 14.
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Q Dear Sara, Can I deduct business expenses before I have clients and actually start freelancing?
A You can deduct up to a certain amount of some start-up costs for your freelance business—assuming you’re running a business, not a hobby (the IRS has specifics defining this: See the IRS’s “Is Your Hobby a For-Profit Endeavor?”), can justify your costs as necessary business expenses, and have supporting documents as for any business expense. Want to know more? See IRS Publication 535, Business Expenses, Chapter 7: Costs You Can Deduct or Capitalize, or talk to your accountant.
Below is an overview of some business deductions freelancers may typically take. While not exhaustive, it’ll get you thinking about the deductions you might be able to take. Every profession and freelancer is unique, so read up on tax issues in your field and consider teaming up with a tax preparer (see Hiring an Accountant) who can help customize the fit between you and the tax code. Also refer to IRS Publication 535, Business Expenses. For information on taxes as related to retirement plans, see Chapter 17.
The IRS says a business expense can be deducted only if it’s “ordinary and necessary.” They define “ordinary” as “common and accepted” in your industry and “necessary” as “helpful and appropriate for your business, trade, or profession.”
There’s a lot you can deduct, in whole or in part, if it’s business-related and not reimbursed by a client or employer. Just take a look at Schedule C. You might even use it to set up your expense records. If you don’t see an expense mentioned there, track it anyway, since you may be able to deduct it.
In order to deduct home office expenses, with few exceptions it has to fulfill the IRS’s requirement that you use it “exclusively and regularly” as your primary business space, whether a separate room (ideal) or a cordoned-off section (it doesn’t have to be a permanent divider); there’s no other office where you can work (such as at an employer’s workplace or a rented space you’re deducting); and it meets the other requirements discussed in Chapter 2. Take a photo of it, so if the IRS comes sniffing and you’ve moved in the meantime, you’ve got proof.
If your home office qualifies, you can deduct the percentage of your general (indirect) home expenses correlating to the percentage your home office comprises of your home.
How to figure that? Two common methods are the rooms method or the square footage method, described in Chapter 2.
Examples of indirect expenses you can usually deduct include rent, insurance (excluding health), utilities, your security system, depreciation for the business-use portion of your home if you own it, and certain common repairs, among others.
Some home expenses are deductible, home office or not, such as real estate taxes and mortgage interest. Again, use your home office percentage to calculate the deductible portion for your business. For more info on deducting mortgage interest, see IRS Publication 936, Home Mortgage Interest Deduction.
Direct expenses incurred just for the business-use part of your home—say, painting your office—are generally fully deductible. Expenses incurred solely in nonbusiness-use areas—such as painting a room not used for your work—aren’t deductible.
If your total business expenses exceed your gross income, deduction of some expenses relating to business use of your home will be more limited. You can carry those to the next tax year, with some restrictions. Visit the IRS website or consult your accountant for details.
If you maintain an office away from home, you can’t claim deductions for both. And if you worked at someone’s office, you may not be able to claim home office expenses for that time.
Not sure if your home workspace passes the tests, or how to figure out what’s deductible? Check the IRS website (for starters, see Selected IRS Tax Resources and ask your accountant.
You don’t have to prove that business income resulted from every business meal or entertainment you have with a contact. But as with the home office, each meal or entertainment expense has to pass some tests to be deductible in the eyes of the IRS:
• It has to be an “ordinary expense” that’s “common and accepted” in your profession.
• It has to be a “necessary expense” that’s “helpful and appropriate” to your business.
Also, you usually have to be able to show that:
• It was “directly related”: It happened in a business space, or the primary goal was to do business and you actually did business or expected a particular business outcome, or
• It was “associated” with your profession and happened immediately before or after a considerable discussion of business.
Plus:
• Any meals or entertainment expenses that you were reimbursed for aren’t deductible.
• “Lavish or extravagant” expenses don’t qualify. The expense has to be “reasonable” in the course of business.
If they qualify, you can usually deduct 50 percent of the cost of business-related meals and entertainment (for tickets, it’s usually 50 percent of face value).
What if you buy dinner for a mixed group of business contacts and friends? You can only deduct your own and the business contacts’ expenses. Can’t tell who ordered the Caesar salad and who had the porterhouse? Pro-rate the total cost over everyone and deduct just the business head count.
The IRS can take a close look at meals and entertainment deductions, so make sure you can support your claims. Know your business reason (who you were with, their business connection with you, what business you discussed), and the date and location. Write all this on your receipt or in your records. If you aren’t sure whether something’s deductible, check the IRS website (including IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses) and ask your accountant.
Buying a gift for a client could be deductible, to a limit (generally twenty-five dollars per recipient). Check the IRS website (IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses). See if any professional organizations you belong to offers discounts on gift items. At this writing, Freelancers Union members can get discounts on flowers, concert tickets, and gift baskets. Deductible or not, stretch those dollars!
Depreciation accounts for the value over time of certain kinds of business property that have a useful life of more than a year. Some examples: your car, computer, camera, cell phone, office fixtures, and furniture.
Whether and how business property is depreciated depends on multiple factors. The IRS has mind-boggling—I mean, meticulous—rules and regulations on all this.
Depreciation requires good record keeping maintained over time—kind of like depreciable items! When you buy equipment, furniture, machinery, or other longer-lasting items, keep proof of purchase and payment in a separate file with your tax-prep materials, with a log where you record when you bought the item, its make, its cost, when you started using it for your business, whether you’re deducting it in the first year or depreciating it over X years, and (if you sell it) records of your price and any expenses incurred in the sale. In some circumstances, you may be able to deduct the asset fully in the first year rather than depreciate it—that’s called a section 179 deduction. Check the IRS website and consult your accountant.
To learn more, see IRS Publication 946, How to Depreciate Property, check out the form where you show your math to the IRS (Internal Revenue Service Form 4562, Depreciation and Amortization) and its instructions, and huddle with your accountant about what’s best for you.
If an item or an expense has both business and personal applications, you can deduct the percentage used for business. If you aren’t sure what percentage to assign, jot down each time you use it over several weeks and use that as your basis for figuring out your business use percentage over twelve months.
Business purchases that last significantly longer than the year you start using them for business might have to be depreciated, i.e., deducted over time.
Office furniture and equipment used just for your business might be deductible. If it does business/personal double duty (like that vintage bureau where you stow art supplies and winter sweaters), just the business-use percentage is potentially deductible.
Tech is a huge part of most freelancers’ business life, so you want to be able to take every deduction or depreciation you’re entitled to. Keep purchase/payment records on every item, from your computer and peripherals to any other tech stuff you use for business (backup drives? calculator? digital recorder? audio/video equipment? software?).
Often you can deduct Internet expenses—for example, Internet service; the cost of building, maintaining, and hosting your website; buying your domain name. If you’re not the only person using the Internet, come up with a fair percentage for your business use.
If you only have one phone line (aka a landline) installed at home, you can’t deduct the cost of that line, but you can deduct long-distance business calls you make on it—they should be broken out on your bill and you should be able to verify each was a business call. Rather than rely on your memory, keep a list of your daily long-distance business calls for the month, match and attach it to your monthly phone statement, and file ’em.
If you add a second line at home just for business use, that line’s deductible as a business expense.
At this writing, if you use your cell phone for business only, those costs are deductible. Are personal calls mixed in? You know the drill: Only the business percentage is deductible; the minutes spent on business calls are calculated as a percentage of the total.
Depending on your child’s age, you may be able to claim a tax credit for child-care expenses if you (and your spouse, if you’re married) are both working or actively looking for work and need the child care in order to do work. Special regulations apply around divorce, separation, and custody. For more info see IRS Publication 503, Child and Dependent Care Expenses and talk with your accountant.
Business-related supplies, materials, books, and “professional instruments.” These and other items you’d typically use within a year are usually deductible. Items with a longer useful life may have to be depreciated.
Advertising and marketing. From business cards to brochures to print ads to online promotion.
Professional services and permit fees. Examples include business tax prep and “ordinary and necessary” business-related accountants’ and attorney’s fees.
Professional subscriptions. That online industry newsletter; that trade magazine; that technical journal.
Professional licenses, membership fees, and dues. Usually business or trade license fees are deductible. For memberships and dues, make sure there’s a clear business connection. Note: Club membership fees usually aren’t deductible.
Fees to maintain or repair your business property. From fixing your laptop to painting your home office.
You can usually deduct expenses for business use of your car. As mentioned in Chapter 14, one of the methods below is normally used to track car expenses. Once you choose, you can’t switch for that car. Make sure you check the IRS website or consult your accountant about how your method of depreciating your car affects how you can deduct car expenses. For leased cars, check the IRS website.
1 Standard mileage rate. Every year, the IRS establishes what it calls the “standard mileage rate”: a certain amount per mile, based on an assessment of the costs of using a car, which you can use to calculate your business mileage for your car.
2 Actual car expenses. With this method, you deduct the business percentage of your actual annual car expenses (including fuel, maintenance, insurance, tolls, and parking fees, to name some).
Which method to use? One way to decide is to keep the records you’d need for both methods during the first year (see Chapter 14 for details). At year’s end, do the math to figure which gives you the better deduction.
If your car doesn’t need much fixing, actual car expenses might not be as beneficial as the standard mileage rate. For a junker needing lots of TLC in the shop, the actual method might give you a better deduction.
If you’ve already got enough receipts to keep track of, the standard mileage method doesn’t require receipt keeping. For both methods, you do need to track your business miles, dates traveled, and the business purpose.
For more deductible local transportation expenses, read on.
You can also deduct expenses for using other modes of transportation for local business, including mass transit, cabs, rail, even rental car (for travel away from home, see Travel).
While you can deduct transportation costs for going to and from business meetings and for traveling between meetings or workplaces, you can’t deduct commuting costs. To find out more about how transportation deductions apply to your particular situation, check IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses and consult your accountant.
As with everything else, keep your receipts and track your costs.
If you travel for business—for example, staying overnight or being away from home significantly beyond a normal workday—you can deduct quite a few of your expenses if the trip’s necessary for your work. Have clear, credible records of the when, where, and business reason for your trip. Deductible expenses include transportation, lodging, and usually 50 percent of the cost of (neither-lavish-nor-extravagant!) meals and entertainment—using either the actual costs (keep receipts and records) or the rates that the U.S. General Services Administration (GSA) provides for meals and incidental expenses in cities across the continental United States.
Combining vacation time with business travel? Great—but not on your taxes! It’s the by-now-familiar deduction of the percentage applicable to business.
For more information on travel expenses, see IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses and “Per Diem Rates” on the GSA Website (gsa.gov).
The health insurance industry is undergoing huge changes, but as of this writing, health insurance premiums are deductible for the self-employed who buy their own health coverage if their business showed a net profit for the year and if they weren’t eligible to participate in an employer-subsidized health plan, including through their spouse (if they are in any given month, they can’t take the deduction for that period). No can do? If you itemize deductions, look into whether some deduction is possible under medical expenses, elsewhere on your tax form.
There are limits on how much you can deduct for medical expenses. Keep good records of your health expenses and see if you’re able to take some deduction. For specifics, check out IRS Publication 502, Medical and Dental Expenses.
People with high-deductible health plans may have another option: opening a Health Savings Account, or HSA, out of which they can pay many of their medical expenses tax-free. For details, see Chapter 17 and IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
The cost of training or education can be deductible (and possibly travel relating to it), if you can show that it’s needed to improve or maintain necessary skills for your business, or that it’s mandated by law or other regulations to maintain your license or ability to practice. You can’t deduct education costs for meeting your trade’s minimum requirements or that make you eligible for a new trade.
If you can’t deduct education as a business expense, see if you qualify for a tax credit for education (a tax credit cuts your tax bill, while a tax deduction reduces your taxable income). Talk to your accountant about your plans and check out IRS Publication 970, Tax Benefits for Education. For info on tax-advantaged ways to save for education, see Chapter 17.
You can deduct credit card and loan interest for purely business-related items. So, suppose you used 60 percent of a loan for business and 40 percent for personal purposes, you can deduct 60 percent of the interest. If the credit card interest is for business and personal items, you can deduct just the interest on the cost of the business purchases.
We talked about bartering in Chapter 11, so check there if you’re interested in trying it. Even though money doesn’t change hands, the value of what you received in a barter has, well, value. So the IRS says you to have to report and pay tax on it. Find out your state’s bartering regulations, too, as sales tax and income tax may be due. In a rocky economy, the government’s looking for extra dough, just like everyone else. And since assigning value to a barter deal is something of a judgment call, it’s apt to attract the notice of our friends in the tax department.
The regulations for reporting bartering depend on the specifics involved. If you barter on any basis, make sure you understand and follow the tax requirements for bartering. Consult your accountant and refer to the IRS website for information. One place to start is its Bartering Tax Center; selected IRS Tax Resources are listed at the end of this chapter.
Remember how we said taxes are a pay-as-you-go proposition? Estimated taxes (federal and state) are the government’s way of making sure you pay as your money is made. Below is a summary of how estimated taxes work. For a full explanation, see IRS Publication 505, Tax Withholding and Estimated Tax.
In general, if you anticipate owing one thousand dollars or more on your tax return after subtracting any withholding and refundable credits, you’ll need to pay estimated taxes four times a year. Underpay and (no surprise) look for an “underpayment penalty” in the form of an interest charge.
One good thing about paying estimated taxes is that it forces you to budget for taxes by setting aside money from each client payment.
There are two main methods for calculating estimated taxes, oversimplified below:
1 You make quarterly payments of equal amounts, based at minimum on your tax liability of the year before. A minimum percentage gets added if your adjusted gross income for that year exceeded a certain amount established by the IRS, and you should also revisit your calculations if it looks like your income will be a fair amount higher than the previous year. Depending on how your actual return comes out, you may owe additional tax (generally without penalty if you paid your estimated taxes on time and calculated them properly—see Publication 505 for full details), or you may be owed a refund.
2 You calculate your estimated tax every quarter by figuring your quarterly profit (nutshell: gross income minus deductions and other factors that would affect your net profit). Yes, you or your accountant have to do calculations each quarter, but this method can help you keep your estimated tax payments more aligned with your actual income: less in lean times, more in flush. It also lets you see exactly how your business is doing, which can help you make better Freelance Portfolio decisions.
First, stop forgetting. Put the dates in your calendar: “I put a ‘warning date’ earlier in my calendar, so I can make sure the funds are in my account to make the payments.” If you miss a date, send payment as soon as you discover you missed it. If you don’t realize until you’re about to make the next payment, add it to the check and the voucher you send.
Expect to pay interest on the late payment. Just to take the government’s side here for a minute: If taxes are owed as income is earned, how fair is it to bank the IRS’s share, earning interest on it while the IRS can’t? And how fair would it be to require employees to pay taxes out of every paycheck via withholding, while you, freelancer, could retain your entire income until tax time? So: You pay estimated taxes, and interest for late payments.
We’ve talked elsewhere about the problems of misclassifying workers. If you’re going to engage subcontractors, hire employees, or both, understand the differences between them and be sure you’re treating employees as employees and independent contractors as independent contractors; otherwise you may be held liable for employment taxes and penalties. Which is why your bedtime reading should include IRS Publication 15-A, Employer’s Supplemental Tax Guide and you should have a frank talk with your accountant and attorney if you’re considering bringing a few additional hands on deck as independent subcontractors, as employees, or you’re not sure of the distinctions.
If you engage independent contractors, you usually don’t have to withhold or pay taxes on what you pay them, since as self-employed individuals, they have to do the kinds of tax stuff on their own that we’ve been talking about. Have them promptly fill out and send you Form W-9, Request for Taxpayer Identification Number and Certification (if they’re a U.S. citizen or entity or resident alien; if not, check the IRS website and discuss with your accountant), which supplies essential info for your needs.
For each independent contractor to whom you paid a total of $600 or more during the tax year for business-related services, you must file Form 1099-MISC, Miscellaneous Income. You send the form to the contractor and to the IRS (along with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, a top sheet of sorts to use when filing certain paper forms with the IRS—you can batch all the 1099-MISCs under one top sheet). Remember, the IRS likes to match things up—in this case your 1099-MISCs against the indies’ reported income. For more information, see the IRS website: General Instructions for Certain Information Returns (Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G).
All this, plus invoices from the contractor and proof of payment, will support your tax return claims about making these business payments.
If you hire employees, you’ll need to pay employment taxes, including Social Security and Medicare taxes (acronym FICA, as worker benefits received under the Federal Insurance Contributions Act) and Federal Unemployment Tax (acronym FUTA, as this tax comes under the Federal Unemployment Tax Act). You’ll also pay SUTA, the stateside version of FUTA. Depending on your state, you might have to have workers’ compensation and disability insurance or face tough penalties. And for your bedtime reading: IRS Publication 15 (Circular E), Employer’s Tax Guide. Check your state tax department for local payroll regulations.
FICA taxes are paid by both you and the employee: You’ll withhold an amount from their paychecks and pay a matching amount. Only you, the employer, pay FUTA tax, which is paid to workers if they lose their jobs.
You and each employee need to fill out Form I-9, Employment Eligibility Verification, verifying that the employee can legally work in the United States. Each employee also completes Form W-4, Employee’s Withholding Allowance Certificate, which you’ll use to calculate how much income tax to withhold.
After the end of the calendar year, you’ll file and send employee copies of Form W-2, Wage and Tax Statement, detailing among other things their wages and other compensation for that year, and the tax amounts mentioned above. And, as with filing 1099s with the IRS, there’s a top sheet you use to file the W-2s called Form W-3SS, Transmittal of Wage and Tax Statements.
Obviously, there are deadlines for all this paperwork and penalties for missing them, so if you’re considering hiring, talk to your accountant about what you need to be doing. There are payroll services that can handle payroll paperwork.
Below are some of the many resources you can find on the IRS website (irs.gov). Check these out, surf the site, and keep an eye out for articles on taxes in publications you read. Wade in and get acclimated to tax logic and language. Look up terms you don’t know online or ask your accountant when you meet. You’ll feel great knowing you’re getting a handle on this part of your freelance life. Just type the phrase or number of the publication into your browser.
• A–Z Index for Business
• Bartering Income
• Bartering Tax Center
• Child Care Tax Center
• General Instructions for Certain Information Returns (Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G)
• How to Choose a Tax Return
• Preparer and Avoid Preparer Fraud
• Instructions for the Requester of Form W-9
• IRS Publication 15 (Circular E), Employer’s Tax Guide
• IRS Publication 15-A, Employer’s Supplemental Tax Guide
• IRS Publication 334, Tax Guide for Small Business
• IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses
• IRS Publication 502, Medical and Dental Expenses
• IRS Publication 503, Child and Dependent Care Expenses
• IRS Publication 505, Tax Withholding and Estimated Tax
• IRS Publication 509, Tax Calendars
• IRS Publication 526, Charitable Contributions
• IRS Publication 530, Tax Information for Homeowners
• IRS Publication 535, Business Expenses
• IRS Publication 538, Accounting Periods and Methods
• IRS Publication 583, Starting a Business and Keeping Records
• IRS Publication 587, Business Use of Your Home
• IRS Publication 936, Home Mortgage Interest Deduction
• IRS Publication 946, How to Depreciate Property
• IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
• IRS Publication 970, Tax Benefits for Education
• Recordkeeping Tips for Barter Transactions
• Self-Employed Individuals Tax Center
• Self-Employment Tax (Social Security and Medicare Taxes)
• Tax Topics—Topic 420 Bartering Income
• Is Your Hobby a For-Profit Endeavor?
Taxes are part of life in this country. Don’t be fazed, crazed, or dazed by them. Instead, get to know them. Knowledge is power. Not only because mistakes and missed deadlines will cost you, but because missed opportunities will, too—such as not taking deductions you didn’t know about or can’t claim because you don’t have the necessary documentation. So live and learn, work hard, keep good records, pay your taxes, and take your tax breaks wherever they’re rightfully due.