Must-ReadThe Creative Professional’s Guide to Money: How to Think About It, How to Talk About it, How to Manage It by Ilise Benun
When I set out to write this book, I knew it would have to include a chapter on financial matters. After all, once you are earning money, you have to properly document and retain what comes in—and what goes out.
Luckily for creative professionals, we have accountants, tax preparers, enrolled agents, and tax software to help us make sense of the numbers. You can certainly hire a financial professional to offer advice and even tabulate your taxes, but you still have to know the financial basics of how a business runs.
Keep in mind as you read this chapter that I have broken everything down so it is easy to read, understand, and apply. That said, it’s a general overview. I cannot provide too many specifics, but I can give you the foundation you need so you can take charge of your finances, and spend less time with the calculator and more time with the canvas.
It is sort of a given that a creative professional doesn’t want to spend time tracking checks that come in or saving receipts for tax deductions. I’ll admit: I sort of detest doing those things. Yet if you know how to properly organize your financial records, it will make everything much easier come tax time. In fact, your business will function smoothly all year long because you will know where you stand, be able to stay on top of obligations, make informed choices, and do your all to stay protected legally.
Must-Read
The Creative Professional’s Guide to Money: How to Think About It, How to Talk About it, How to Manage It by Ilise Benun
I mentioned hiring an accountant or tax preparer, and that is music to the ears of many freelancers. It is wonderful to be able to hand off the tasks you don’t enjoy doing. Trust me: You’re not any less of a businessperson if you do not handle your accounting or bookkeeping. But that doesn’t mean you can afford not to understand the basic gist of how it all works because, at the end of the day, you are responsible for your finances.
I knew very little about tracking expenses when I began my business. I knew how to create a log to track invoices and payments. I saved business-related receipts for things such as postage and paper. That was about all I knew how to do. I hired an accountant to help me not only file my taxes, but to get a grip on how to manage the financial and recordkeeping aspects of my business. At the time, I dreaded dealing with money and only cared that I paid my rent each month.
That was a big year with lots of changes. I had started my own business, became engaged, and gotten married. Then, a year later, Tim and I purchased our first house. If owning my business wasn’t enough, money would now play a more prominent role in my life. I was forced to learn what terms such as deductible and escrow meant. (One can only evade it for so long!)
I used the accountant for the first two years of my business. The information she gave me was invaluable; in fact, she was helpful in educating Tim about the accounting process, something he was always intrigued by. (I contend that’s because he has only ever worked one job at a time!)
The accountant expanded my knowledge of what expenses were deductible, and showed me how to organize files and prepare my taxes. I didn’t know everything about accounting—and still do not—but I knew what files to retain and what expenses to deduct. Tim has taken over our taxes ever since and oddly enough enjoys it.
Most freelancers still use accountants every year, which is quite valuable because taxes are complicated, and new rules come up every year. But you do not have to rely on an accountant to handle your bookkeeping and/or accounting. I recommend doing so for the first few years, especially to master taxes, but after that, you can decide if you want to keep handing off your accounting and bookkeeping or if you want to tackle it yourself (or pawn it off on an unsuspecting spouse!).
Keep in mind as you read that I am tailoring my message to Americans so I will reference the Internal Revenue Service, or IRS, as the government tax agency.
What can I expect if I hire an accountant? Approximately how much will it cost?
“Accountants and tax preparers come in all shapes and sizes. As with any professional service, ask your questions before you engage. Some questions I would ask:
1. Do you charge a fixed rate, hourly, or ‘by the form’? Describe your scenario and ask for an estimate.
2. Is there any follow-up consultation included? Is there a charge if I call you with a question in a few months? Will you prepare estimated tax vouchers if needed?
3. What is the charge if you need to ‘clean up my books’ first? If your books are a mess the tax preparation will take longer and be more expensive. The professional may simply say, ‘Come back when you are organized.’
4. Make sure your expectations are realistic. If you just want a no-hassle tax prep for a cheap price, don’t expect a CPA at your doorstep explaining every line item. If you want extensive guidance, say that at the outset and be prepared to pay for it.”
—Richard Streitfeld, accountant, www.peaceloveandbusinessplanning.com
Accounting is not all about taxes. It includes documenting and tracking expenses, but also managing records such as invoices. Bookkeeping is the act of recording financial transactions, and that can include sales, purchases, income, receipts, and payments. Accounting includes bookkeeping but is more about the reporting of financial information as you will do with your taxes.
One thing is key for both aspects of financial management: You will need to be meticulous when it comes to documenting both income and expenses. For example, once I knew that I could deduct fuel for work-related travel, I hung on to those receipts like glue.
I know plenty of creative professionals that are big into technology. If you have listened to my Freelance Radio podcasts, you know that co-hosts Von and Dickie are big into the newest gadgets, whereas I am more old-school. I’ve learned that a good blend of paper documents and digital records is a smart mix to track your payments and expenses. That is, you may want to invest in a file folder to hang on to receipts and handle all of your payments using software such as QuickBooks. Point is, you have to keep track of money coming in and going out of your business—however you want to work it.
Another tip related to this is to have a separate bank account for your business. It makes sense because this route makes you appear more professional, especially if you are writing checks. A separate checking account also makes it easy to demonstrate your financial transparency in the event of a tax audit and can make tax time easier because you won’t have to separate out business expenses from personal outlays. In separating bank accounts, you can also more easily monitor the financial results for your business.
Resource
Check out www.shoeboxed.com, a tool that lets you scan and track receipts—and integrate the feature with the accounting software FreshBooks.
The first thing to understand about how to manage your income and taxes is that you will report them differently than you did when you may have worked a traditional job. At your old job, you would receive one W-2 form at the end of the year and plug in those figures to complete your taxes.
As a self-employed professional, however, you most likely will collect from multiple clients. Most clients will give you a 1099 form at the end of the year for all the projects you have worked on, but some don’t have to, depending on what type of business they are. In fact, a client is not required to send a 1099 form if the work was less than $600, if you are incorporated, or if you are an LLC. To sum up, instead of one W-2, you will probably have several 1099s. It gets confusing because you still have to report for clients that do not send 1099s. In fact, you need to report all income you make to the IRS—hence the need to track everything.
At the end of the year, you will have to match up payments you earned from clients that sent you 1099s with the amount on the forms. Then, as I said, you have to report on the income from clients that did not send you 1099s. This is why it’s good to have a system that tracks all of your income, regardless of whether it is from a client that sends 1099s or not.
Unfortunately, the money you get from clients is not yours alone. Why? Because you must pay taxes on it! So you’re going to owe the federal and state government some money—that’s income tax.
In addition to the income tax, there is a second tax you’ll also be assessed just for going solo: the self-employment tax, which is equivalent to the Social Security and Medicare taxes that were withheld from the paycheck you earned if you were employed traditionally. There, you split the cost of Social Security and Medicare taxes with your employer. When you are a freelancer, however, you have to pay both portions. The good thing is that you pay taxes on your income after, or net of, expenses, which employees with W-2 status cannot.
Must-Read
Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants by Stephen Fishman
By now you probably know that you’re going to wind up owing the government money because you are not having taxes withheld on the income you collect. You have two choices: pay up at the end of the tax year (a huge lump sum) or pay quarterly (four smaller payments). You’ll be paying the same amount of money you owe—you can’t change that. If you pay quarterly, however, you tend to avoid financial penalties. Plus, you won’t owe an overwhelming amount of money at the end of the year.
The type of tax return you file depends on the business structure you choose. We went over the types of business structures you can choose from in Chapter 2. Now we’ll review some basics about taxes.
Perhaps I should contribute my own “beginner mishap” story like you have read in other chapters. During my first year, I did not know what to expect with my taxes. By the time I hired an accountant, I had already worked a full year and was making a pretty impressive income. I didn’t know that I should pay quarterly taxes; I thought I could only pay a huge chunk at the end of the year. As a result, I got stuck paying several thousand dollars in taxes. It was like my own personal financial apocalypse, because that was just about the same time as Tim and I were closing on our house and also owed the down payment, an even bigger sum of money.
Lesson learned: I began paying quarterly taxes.
Quarterly payments are based on estimates of what you owe—your self-employment tax and your income tax. Because an employer will not withhold these taxes for you, you can use Form 1040-ES: Estimated Tax for Individuals to see if you have to file quarterly taxes. The form includes vouchers you submit (just as you would with, say, your electricity bill) with the payment. You can also make some payments using the Electronic Federal Tax Payment System (EFTPS).
Let’s say this is your first year as a solopreneur. You will need to estimate the amount of income you plan on earning. If you estimate too high or low, you just complete another Form 1040-ES worksheet to refigure your estimated tax for the next quarter. In the event you underestimate what you will owe and wind up overpaying, the IRS will return the money or you can credit it to your estimated taxes for the next year. In short, if you know you will owe more than $1,000, it is generally advisable to pay quarterly estimated taxes.
If you have tax records from previous years of self-employment, you can base your estimations on the previous year. (When my accountant did my taxes, she did all the estimations for me and gave me the vouchers pre-completed. Most tax software programs can also pre-estimate what you will owe in taxes so you can prepare your vouchers ahead of time.)
The general rule of thumb is that you can incur penalties if you have not paid your quarterly taxes (also known as estimated taxes) at the same rate that you did the year before. To avoid penalties and make nice with the IRS, pay your taxes quarterly, pay the right amount, and make those payments on time.
What happens if I don’t pay quarterly, but am supposed to?
“You will not go to jail for not paying in a timely fashion, but you will be penalized for not paying throughout the year as a W-2 employee would. You are expected to pay ‘ratably’ throughout the year. (There is an exception for seasonal income and major fluctuations, but that requires additional filings and may not be worth the effort.)
The penalties are one consequence (and they apply to state underpayments as well). The calendar for making estimated tax payments is not a calendar year. In fact, the first payment is due April 15. So if Paul the Piper owes $5,000 on April 15, 2013 for the 2012 tax year—and doesn’t have it—then guess what? He also won’t have the money for the first payment on his 2013 income, due the same date. It is really hard to dig yourself out of such a hole!
The IRS does not care what pocket you pay the taxes out of. So if you do have a W-2 job in addition to your freelance income, you can increase your withholdings from that job, or from a spouse’s W-2 (assuming you are going to file jointly), to cover the liability.”
—Richard Streitfeld, accountant, www.peaceloveandbusinessplanning.com
Even if you do make quarterly payments like a star freelancer, you still have to file an annual return. To file your annual income tax return, you will need to use Schedule SE (Form 1040). You also have to file either a Schedule C or Schedule C-EZ. According to the IRS, small businesses and statutory employees with less than $5,000 in expenses may be able to file Schedule C-EZ instead of Schedule C. To find out if you can use Schedule C-EZ, check the form.
In order to report your self-employment tax, you have to file Schedule SE (Form 1040), which covers the self-employment tax. Use the figures you report on Schedule C or Schedule C-EZ to calculate the amount in self-employment taxes that are due on that income.
What was your biggest financial mishap as a freelancer starting out?
“My big rookie mistake when I began my freelance writing business was underestimating my tax obligation. When you’re working for a company, income tax is pretty much invisible to you: It’s deducted automatically from your paycheck, and you only think about it in April. I knew I would be on the hook for 15 percent self-employment tax as an indie writer, but I underestimated the percentage of income tax I’d also owe quarterly. The first meeting with my accountant was an eye-opener, and it revealed to me how very important it is to deduct (legitimately) as many business expenses as possible to reduce taxable income.”
—Bryn Mooth, freelance writer, www.brynmooth.com
Resource
Find IRS tax forms at www.irs.gov/formspubs/index.html.
According to the IRS, if you report a negative figure on your Schedule C form for more than two out of five years, you can be subject to the Hobby Loss Rule of Thumb. This pretty much means that the IRS can decide your business is actually just a hobby, which can set you up for an audit. There are a variety of factors that can make you an easy target for the dreaded IRS audit.
“Just because you had continuous losses does not mean the IRS would disqualify you,” notes Richard Streitfeld (www.peaceloveandbusinessplanning.com), an accountant based in Rhode Island.
Audit is the buzz kill word in the freelance world. It doesn’t mean you are in trouble, but the IRS can examine your files with a fine tooth comb and come down pretty hard if they find any discrepancies.
Now, because you are self-employed as a creative professional, you may not have any major losses if you keep your overhead low and earn enough money. Unlike a small business with a storefront, products, and employees, you probably do not have to spend thousands to get your business running and you can probably work from home. Perhaps you need a new computer, or software. Maybe you need art supplies. It’s quite different than the outlay would be if you were forming a small business that required a physical setting, such as a restaurant or shop. Still, it is good to have an eye on keeping your overhead low and avoiding financial losses.
Another audit trigger is if you are not properly claiming deductions. We’ll delve into what’s legitimate to deduct, or subtract, off your income in just a bit so you can avoid that.
Keep in mind that “correspondence audits” are another type of audit where you simply send in documentation. The IRS can also randomly audit you, so if you get a notice, it doesn’t necessarily mean you have done something wrong. Audits are, unfortunately, a part of life for many people—not just creatives. Ensuring you are properly deducting expenses and reporting income is the best audit-preparedness method possible.
All the financial talk can be deafening. I have found the only positive with taxes, because I never get money back from the government, is to focus on deductions. It makes me happy to legitimately deduct money that Uncle Sam can’t tax me on. Without deductions, I’d pay a heck of a whole lot more in taxes. This is why I love deductions almost as much as my nieces and my nephew!
Tax deductions are amounts of money that you can subtract from your overall income. The more you deduct, within reason, the less money you pay taxes on.
If you are in business to make a profit, the IRS says you can deduct business expenses that are ordinary and necessary. The IRS defines an ordinary expense as a common or accepted expense in your trade or business. A necessary expense is one that is helpful and appropriate for your trade. The IRS states that an expense does not have to be indispensable to be considered necessary.
Deductions must relate to your business (most creative professionals use computers, a completely legitimate deduction). In the event that your cell phone is for business and personal use, you have to keep records (or a log) to show that. Same thing if you use your personal vehicle to visit client offices—gotta have those records.
Expenses you can deduct are kind of self-explanatory. For example, you purchase ink for your printer (assuming you use the printer for work), or you purchase a new phone for your home office—deductible. You renew your membership to a trade organization in your industry—another deduction. Some are more complicated, such as your utilities. My home office accounts for about 20 percent of my home, so I can’t deduct all of the gas, electricity, and water we use in our home, but I can deduct 20 percent from each bill through the home office deduction. If you are producing a tangible product for sale—say, a painting on a canvas—you can deduct the cost for art supplies. Just keep the receipts.
You have to be careful with deductions; it’s tempting to want to deduct just about everything. Whatever you deduct, though, you have to back up with receipts. And even if you have a receipt for something you deduct, it can still signal a red flag to the IRS. You want to make sure that whatever you deduct, it doesn’t sound fishy. After all, I work best with music on, but I cannot justify iTunes expenses as a must-have to the IRS. Well, I can try, but I’m going to go ahead and say that it probably wouldn’t go so well. Make sure you can justify “iffy” deductions!
The following is a basic list of typical expenses freelancers deduct:
→ Office or art supplies
→ Transportation (cab and bus fare, etc.)
→ Book, magazines and reference material
→ Telephone/Internet
→ Business insurance
→ Promotion (brochures, business cards, etc.)
→ Office rent.
→ Gas, electricity, water, mortgage/rent
→ Professional memberships
→ Postage
→ Tax preparation (software or accountant fees)
→ Travel
→ Business meals and entertainment
→ Equipment (including repairs/maintenance)
→ Health insurance
→ Web site costs (domain registration, hosting, etc.)
→ Legal and professional fees
Until you know for sure what is deductible, I recommend consulting a tax professional. Compile a list of questions about what deductions you can claim and bring the list to your accountant.
There are a few gray areas when it comes to what’s deductible. For example, travel expenses are deductible if you meet a client or attend a conference, but the event must be primarily for business and you must be away for at least one night.
Let’s say you attend a business event such as the Creative Freelancer Conference. You spend two days at the conference and stay an extra day to do some sightseeing. You can deduct all of your expenses for the duration of the conference (but only 50 percent of meals), but you cannot deduct expenses for the extra night you stayed, the enormous brunch you scarfed down the day after the conference, or the museum you visited to work off the calories. The rules get more complicated if you travel more than seven days or take your family with you, so be sure to consult a tax professional for advice.
When it comes to deductions, you almost always have to learn as you go. After a few years, you’ll be certain which receipts to save, what you can deduct, and (unfortunately in the case of my iTunes obsession) what you cannot. I would hang on to any receipt that you think could be a business-related deduction until you know what is allowed.
Claudine Hellmuth (www.collageartist.com), an illustrator and artist from Washington, D.C., says she never deducts things that could raise a red flag for an audit; it’s not worth the stress. “I am very careful with my deductions because I am crazy paranoid about getting audited,” she confesses.
“I learned I can’t deduct new clothes for when I go on TV which I think is a real bummer because usually I wouldn’t be buying these clothes if I wasn’t going on TV,” she notes.
What expenses are not deductible for a creative freelancer?
“The phrase ‘reasonable and necessary’ to run your business gives you wide latitude. That does not usually mean you can deduct what is reasonable and necessary for you to go to work and function as a professional. Commuting to your office: Nope. Food at work: Your daily brown bag lunch or take out from fast food joints—usually not. Exception: You go out with a colleague or prospect, or you are overnight on a business trip. Your daily cup o’ Joe from Starbucks: No! Unless you are there discussing business with someone.”
—Richard Streitfeld, accountant, www.peaceloveandbusinessplanning.com
The idea behind depreciation is that certain purchases generate income over a number of years. Hence, you cannot deduct the purchase of, let’s say, a $1,000,000 rental property in one year. But there are instances where you can deduct all your asset purchases; some common ones for freelancers are computers and cameras.
According to Stephen Fishman’s book Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants, you must spread depreciation over more than one year on the purchase of an asset if:
→ You use the item (or property) less than 51 percent of the time for your business.
→ The item is a property that you converted for business use.
→ The property has a structure located on it.
→ A relative sold the item to you.
→ You used a trade-in to finance the purchase.
→ You inherited the item or it was a gift.
→ The item is an intangible asset (a trademark, patent, or copyright).
→ It is a heating or air conditioning unit.
Another benefit to using depreciation is if you want to show maximum taxable income for the year by spreading the expense out over several years. This is particularly useful if your business has incurred a loss or not been profitable, and could be considered a hobby. It is also a good strategy if you want to save some deductions for future years when you may have more income and fewer expenses.
Unless you are able to depreciate the item in one year, you have to depreciate based on how long the item is expected yield value, according to the IRS. The IRS refers to this as an item’s “useful life,” and it offers a specific table depending on the type of asset. Creative professionals may not do a whole lot of depreciation, but if you own a trademark, it’s worth asking your accountant about amortization, which is the equivalent concept for “intangible assets” like trademarks.
Otherwise, you will deduct most expenses every year, and you may never wind up using depreciation, but it’s good to know it exists!
Resource
IRS Publication 946: How to Depreciate Property
Here is another scenario that most creative freelancers may never face, but I think it is important to note. If you choose to hire an independent contractor to farm out some work, keep in mind a few things.
First, make sure you can do that according to any legal agreement you have in place.
As for the tax implications, the IRS is concerned that independent contractors do not report all of their income—or pay taxes on it. So if you hire an unincorporated independent contractor and pay that person $600 or more a year for a business-related service, you must file IRS Form 1099-MISC and denote how much you paid the contractor and display the independent contractor’s identification number or Social Security number.
Also, have the contracted worker fill out a W-9 when you hire him or her so you don’t have to chase the worker down at the end of the year for that information. If you hire an incorporated independent contractor, you generally do not have to file a 1099 (an exception for lawyers exists), but be prepared because the IRS is asking more questions on tax forms on whether you have used 1099-eligible contractors, Streitfeld advises.
In the age of digital everything, it is still important to keep paper and electronic records. Establishing how you set up your recordkeeping processes is dependent on what types of methods you embrace, and there is no right way. In my opinion, the best way is to create a process that you can work with. That is, if you work best with a certain software, use it. Just keep in mind that paper will come into play somehow so long as you purchase items that come with paper receipts.
I keep two file cabinets in my office: one for work, and one for my personal documents. It includes files for clients as well as a file for my taxes. Then there is a huge yellow folder for receipts—and it is brimming with them. Because I can deduct a portion of my utilities, I keep separate files for those as well. Some clients pay me in checks, so I retain all of the stubs as well.
Invoicing, however, is done on the computer. I’m pretty high-tech in that respect. At the time I was writing this book, I finally agreed to give in and purchase QuickBooks. I’m going to be in the process of periodically entering receipts into the computer soon, which is a little overwhelming, but I am confident it will make things easier in the long run. I’ll still need to hang on to paper receipts and other documentation, but the thought of plugging in a number and having it generate an invoice automatically sounds almost better to me than sipping Starbucks chai tea on a chilly autumn afternoon.
The point in sharing all of this is to let you know that you have to come up with your own system. Whatever that is, just make sure you retain all pertinent records however you want to store them. Nowadays, you can buy gadgets that scan and electronically store receipts so you can have a relatively paperless office.
Good recordkeeping helps me calculate deductions, prepare tax returns, maintain audit preparedness, and accurately monitor the progress of my business. Once you find a system that works for you, it will take the hassle out of bookkeeping and you probably won’t dread it as much as before you began your business.
Must-Read
The Money Book for Freelancers, Part-Timers, and the Self-Employed: The Only Personal Finance System for People with Not-So-Regular Jobs by Joe D’Agnese and Denise Kiernan
Being able to prove your deductions—and deducting only legitimate expenses—is a must. If you do a fair amount of traveling to meet clients and use your own vehicle, it pays to keep a logbook so you can separate personal expenses from business purchases, because you probably use your car for both.
Keep a log to monitor your business travels. Use either your smart-phone or a small memo pad to jot down the trip date and purpose, then record your mileage before and after the trip, and compute the number of miles traveled. Streitfeld recommends hanging on to auto shop receipts and jotting down your vehicle’s mileage at the beginning and end of the year so it can support what you report on total miles driven during the year.
Keeping a log is not just for traveling in your vehicle, though. You may also want to keep a log for things like business entertainment and meals if those are frequent. I typically keep a small notepad in the console of my car to record these expenses, but if you keep everything on a phone or tablet, just make sure you keep it on you whenever you head out.
Resource
Check out these apps to help you track mileage on the go: Mileage Tracker, Mileage App, Trip Cubby, TripLog/1040, and Trip Master.
How long do I need to hang on to tax documents?
“In general, the IRS has three years from the date your return was filed to audit your return. They also have the right to go back longer if underreporting of income is suspected. If you are self-employed it is recommended to hold on to your receipts and documentation for seven years. Some records should be kept longer if the deductions take place over many years or later.”
—Richard Streitfeld, accountant, www.peaceloveandbusinessplanning.com
In addition to finances, I think it is important for freelancers to have some retirement planning information at the ready. Why should you have to consider this, especially if it requires you to spend more money when you may already be cash-strapped? Because you would probably set up an account if you held a traditional job. You need to plan for retirement regardless of who employs you!
When you were employed previously, you probably didn’t pay much attention to your retirement planning account or health insurance policy. You probably filled out a few forms to set them up when you started the job and didn’t give them much more thought. As a freelancer, however, you will need to arrange these benefits on your own.
I miss donating to my 401(k) and having my employer match the amount I put in. Ah, those were the days. I had some money when I left the company, but I didn’t do much with it when I began freelancing. I simply let it sit in the account. I swear, if the money could have spoken up, it would have said how much it missed matching contributions, too!
After a while freelancing, I took that money and rolled it into a Roth IRA. I had to get over the fact that I was in charge of my retirement savings. Now I was not only the account owner but the entity responsible for making contributions; no one would match what I put in anymore.
Even if you have never set up a retirement account or you can’t put in a ton of money right now, that’s okay. It is sometimes just a good idea to open an account and put a little money in, then add more when you get on your feet.
Resource
Check out the Freelancers Union (www.freelancersunion.org), which recently launched its own 401(k) plan. It costs $40 to sign up, and there is an $11 monthly fee, plus a 3 percent administration fee. If you receive 1099 income, you are eligible but you cannot contribute to this plan if you add money to a SEP IRA during the same year.
Let’s talk about the six basic individual retirement account (IRA) options for freelancers: Solo 401(k)s, Traditional IRAs, SIMPLE IRAs, Self-Directed IRAs, SEP IRAs, and Roth IRAs. You’ll need to talk to a specialist in the field to find out specifics on each, but this will expose you to some options.
1. Solo 401(k). This retirement option is similar to 401(k) plans that you may have had when you were employed, but it is for small business owners. It is limited to the business owner and a spouse and is also known as the Individual 401(k).
With this option, you can put more money away than a SIMPLE or SEP IRA, and more flexible contribution options exist. In 2012, if you were under the age of 50, you could make a maximum employee deferral contribution of $17,000, plus your business could put in up to a 25-percent profit-sharing donation, up to $50,000. If you were over 50, you could make a maximum employee deferral contribution in the amount of $22,500.
2. Traditional IRA. If you earned income and are under the age of 70½, you are eligible to contribute to a Traditional IRA, which is a Personal IRA. In 2012, you could contribute up to $5,000, and $6,000 if you are over 50. Contributions are tax-deductible, which is good news for those of you looking to deduct. Streitfeld notes that freelancers are not eligible if they are covered by a plan at a job that gives you a W-2 at the end of the year. If you are married and your spouse has a W-2 retirement plan, you may not be able to contribute to a Traditional IRA.
Once you reach age 59½, you can begin taking money out. You are required to withdraw a specified amount yearly beginning the year you turn 70½. If you withdraw from this account early, you’re going to likely take a 10-percent penalty and will be taxed on it.
3. SIMPLE IRA. A Savings Incentive Match Plan for Employees, or SIMPLE IRA, is pretty straightforward, indeed. Small businesses with fewer than 100 employees that earned $5,000 or more during the previous calendar year are eligible.
According to www.BankRate.com, the cost and complexity for a SIMPLE IRA is low. An employer must match elective deferrals dollar-for-dollar up to 3 percent of a participant’s compensation or make a 2-pecent contribution to all employees who earned more than $5,000 during the year. You can open a SIMPLE IRA if you are self-employed; it also can be useful if you wind up expanding and hiring staff members in the future.
4. Self-Directed IRA. If you want to put your retirement savings into investments such as real estate or business, you could choose a Self-Directed IRA. It has the same rules as a Traditional IRA, but a few restrictions exist. For instance, if you use the money for personal benefit and are under 59½, you could put the tax-deferred status of the account at risk. Streitfeld says this option is geared more for savvy investors with a significant amount to spend.
5. SEP IRA. A Simplified Employee Pension Individual Retirement Account, or SEP IRA, lets self-employed professionals contribute up to 20 percent of their net self-employment income—up to $50,000 maximum in 2012—into it. If you have employees, check about eligibility and coverage requirements.
6. Roth IRA. The maximum contribution you can make to a Roth IRA for 2012 is the same as for a Traditional IRA. Like the Traditional IRA, it is a Personal IRA, too. The contribution allowed remains unchanged from 2011 at $5,000 (or $6,000 if you’re 50 or older). Contributions are not deductible; however, your investment grows tax-free and you are not taxed on it when you withdraw it. There are also income limitations depending on your filing status.
You can split the contribution between your Roth and Traditional IRAs if you choose; any amount equaling $5,000. So if you want to put $2,500 in one account and $2,500 in the other, you can absolutely do so.
There are so many retirement plans out there, so it’s best to talk to someone at your bank, an accountant, or a financial planner about your options. If you want to do some research on the plans, I recommend visiting a Web site such as www.BankRate.com, www.SmartMoney.com, or www.irs.gov.
What’s a good retirement option for a creative freelancer starting out who isn’t sure if the business will make it?
“If your cash flow can support it there is no harm—and there is clear benefit—in setting up a retirement account in your first year of business. Personal IRAs—Traditional or Roth—are set up outside your business so there is no effect if the business closes. There are restrictions on eligibility. If you do a SIMPLE IRA or a SEP IRA, these provide tax deductions and can be rolled over into a Personal IRA should your business close or if you are unable to continue the contributions.
If you are thinking you may need that money back soon, then absolutely do not put it in a retirement account; you will get socked with income tax and, most likely, a 10 percent penalty if you need to withdraw it.”
—Richard Streitfeld, accountant, www.peaceloveandbusinessplanning.com
Like Claudine Hellmuth (www.collageartist.com), an illustrator and artist living in Washington, D.C., I am lucky enough to have health insurance through my husband’s job. Like her, I wasn’t always so fortunate.
Obtaining health insurance is a hot-button issue for creatives, because many of them can’t access the plans they held at their former jobs simply because they are not with a company. Individuals can sometimes purchase plans, but the costs are much higher for what would otherwise be more affordable had you stayed in cubicle-ville.
Hellmuth had to pay out-of-pocket for healthcare for a short time when she and her husband were not on the plan through his job. She said it cost about $400 a month for both of them.
I had to do the same after Tim was laid off for a while. I purchased a low-cost plan via www.ehealthinsurance.com, but it was basic—like Dr. Quinn, Medicine Woman basic. Even she probably offered more care for less.
So how can you acquire a decent health insurance policy? Hellmuth recommends choosing a high-deductible insurance plan to provide basic coverage, especially if you know you’ll be on the plan temporarily. I found when I was searching for an independent health plan that the kind of coverage comparable to what I had when I was working in Corporate America ran at least $800 a month for a couple—closer to $1,000 for the really good insurance and even more if you have children, depending on where you live.
As for the “extras” such as dental and vision care, Hellmuth advises passing on them when selecting a temporary plan, because the coverage can be poor. I think it depends which plan you choose. If you are on your own plan for a while, you may be able to purchase basic coverage and then join a discount program for prescription, vision, or dental care. Or take your chances and pay out of pocket. Otherwise, more affordable plans usually do not have the extras unless you pay for them.
Are there positives to paying for your own health insurance? Yes, actually. You can deduct the expenses from your self-employment income. Disadvantage: If you go for the bare-bones coverage and a catastrophe strikes, you may wind up paying a lot.
Buying insurance on your own or via a spouse isn’t the only option. You may be able to obtain a policy through a trade organization in your industry, or you can find a health insurance agent to see if he or she can get you better deals.
It is uncertain what will happen in the United States as far as healthcare is concerned. As of this writing, the U.S. government approved plans to move forward with a new healthcare reform platform that will let everyone purchase healthcare, supposedly at a more reasonably priced rate. Some say the plan will be better for self-employed professionals; others say we will be worse off. Like many of you, I’m eagerly awaiting to see how it all turns out.
Resource
Visit www.healthinsurance.org, www.healthcare.gov, www.ehealthinsurance.com, and www.NASE.org to learn more about health benefits for self-employed individuals.
Sweet Success
Scoring on Health Insurance
Tim Goldman (www.timgoldman.com), a designer and illustrator from New York, knows all about the trials that come with finding health insurance coverage—especially when you don’t have an employer to supply it. He went without insurance until his mid-30s.
Goldman once obtained insurance through the Graphic Artists Guild, which at the time offered coverage via a separate entity. He had an even better plan when he got insurance through his partner’s employer. Though his Guild insurance was affordable, the employer’s plan was more reasonably priced and provided better coverage.
When Goldman’s partner left the job, however, they were both without any coverage. “It was up to me to find a way back to insurance for freelancers that I could add my partner on to,” he says. Goldman turned to the Freelancers Union, which he says made it fairly easy to sign up (though you have to show paystubs and checks to prove you are working, he notes).
Luckily, he was working at an on-site contract job at the time and had no problem showing documentation. Even better, his partner was able to go on the plan, too.
Beginner Mishap
Taxmageddon
When she started out in the early ’90s as a solo-pro, writer Michelle Goodman (www.anti9to5guide.com) wasn’t concerned about how much she could owe in taxes because she wasn’t making much to begin with.
At the time, she had just moved into her own apartment, and was not spending excessively but not making ends meet too well, either. Goodman racked up some debt on her credit card. Tax time came and she didn’t pay quarterly, so she owed the full amount of taxes she accrued during the year.
“You start freelancing and you don’t make a lot of money, [and] you think, ‘I can’t owe that much in taxes,’ then you owe a year of taxes,” says Goodman. “That can be really painful!”
Her intention was never to get out of paying taxes; she just didn’t realize how much she would owe—nor did she save up for it. Goodman owed the government a few thousand dollars in taxes, and they set her up with a payment plan so she could reimburse them for the outstanding balance.
“It’s no joke; you have to pay. And they charge interest…they had the highest interest,” she says. “The best thing you can do [to save up for the money you will owe]—and I didn’t do this—you should put it [a portion of your earnings] in a savings account and pretend it’s not yours.”