We covered what qualifies someone as a freelancer.
Then I gave you some best practices and tools to simplify the process.
And then we went over 30 tax deduction all Hollywood freelancers should take.
However, confusion regarding taxes always abound. It took me a long time to wrap my head around the intricacies, and today, even with the help of an accountant, there are still some things I miss.
Consult with your tax professional before you file. Before that, here are a list of 7 common tax mistakes freelancers make…
1. Not understanding the Self-Employment Tax (SE Tax)
If you make over $400 in your business that year, then you’ll pay a Self-Employment Tax. This is calculated using the Schedule SE (Form 1040). Only if you make less than $400 a year, do you not have to fill out the Schedule SE.
2. You will owe money to the IRS
This is a crucial point I don’t want anyone to overlook. Because you’re taking deductions, your net savings can be higher than a colleague who can’t take deductions, either because they didn’t take deductions or because they’re employees and they can’t.
However, you will not get a refund. The IRS will not owe you money. You’ve been earning money, tax-free, for an entire year, so you will owe the IRS money… possibly a healthy chunk. (I’ve been there. It’s an awful feeling, and I don’t want anyone else to get caught unprepared.)
You can mitigate the blow by saving a portion of your income (from one-fourth to one-third) each month in a separate savings account, to use at the end of the year to pay the tax man.
3. Understand when it’s worth tracking deductions
Tracking expenses, using an accountant, capturing receipts… are these gyrations worth the hassle? That’s completely up to you.
General rule of thumb: if you estimate the sum of your deductions will exceed the standard deduction ($5,500 if you’re filing as an individual, $11,900 if you’re married) then it’s worth it.
If it’s close, can always take the standard deduction.
If definitely not, then no, it’s not worth the energy.
To put this another way, the standard deduction amounts to less than $500/month. If my expenses exceed $500 per month, then it’s worth it. In my case, I clear that easily (my rent deduction alone clears more than half) so it’s worth my time.
4. Write-off doesn’t mean free
There’s the perception that deductions = free. Which can make it easy to justify lavish purchases (“I’m going to write it off anyway!”) No. This is not THE FIRM — you can’t write off every trip to the Cayman Islands and your Red Stripe tab and have enough saved over for a new Beamer.
Here’s the math:
When you take deduction X, it reduces your taxable income by X. What you save is X times your rate of tax.
For example, let’s say your taxable income is $40,000. You’re deducting $100 for office supplies in June. You’ll only be taxed for $39,900.
If your current rate of tax is 20%, then the amount saved is $100 times 20%, or $20.
Deductions are a great way to earn money back in the aggregate, but it’s hardly a blank check. Don’t try conning the system or fooling yourself into the idea that you’re saving money by spending money.
5. Not thoroughly documenting
The IRS has a catch-all category to cover expenses: “necessary and ordinary.” This feels like a free-license to spend whatever, but if you can’t backup, in writing, why it’s “necessary and ordinary,” the IRS may not count it.
6. Not using estimated taxes
If you plan to freelance again, in the second year, consider paying estimated taxes. Your accountant will provide you with quarterly forms, and you’ll send in four “estimated” tax payments to the IRS.
This way, you can spread out payments throughout the year, rather than try and pay everything back in one lump sum.
7. Qualifications for home/apartment deduction
Two requirements must be satisfied to count your home office as a deduction: “regular and exclusive use” and “principal place of business.” You must regularly and substantially use your home for business, and the area used can’t be used for other purposes.
In this series so far, we’ve covered what qualifies as a freelancer, best practices and tools to help you with your tax preparation, and 30 badass tax deductions for Hollywood freelancers. That about covers everything you need to know about your taxes for this series, but in true Fighting Broke fashion, next post I’ll wrap up this series from a strategic point of view, beyond taxes.
Photo Credit: Eric Gjerde