Feb 20, 2008

Freelancer Woes: Taxes, Taxes, and More Taxes

While I've gone through periods of working part-time gigs and freelancing for a little extra cash on the side, 2008-2009 will be the first year when I'm likely going to be a contractor all year long. I love the freelance lifestyle, as I can finish my work hours when everyone else is asleep, or get all my hours done straight through and leave myself time to relax for an extra weekend day, if possible. There are so many things I love about being a freelancer (albeit one with a stable freelance gig) that I'd be hard pressed to give it up.

One thing that might, just might be able to get me to give this wonderful lifestyle up is taxes.

Just trying to figure out how to sort out my taxes owed as a freelancer seems like a giant nightmare. On top of that I now have Prosper taxes (which sounds like it will be worse than a nightmare to file) and my various stocks, ETF and mutual fund accounts to tax...

Originally I thought sorting out my taxes would be simple as taking 25 percent of all my income each month and putting it into a highish-interest ING savings account. Come tax time, my tax money will have made a little money (although that will be taxed to) and if all worked out as I originally thought, the money in that account would certainly cover all my state and federal taxes... plus I would have saved some money by holding off on paying it throughout the year.

Given that I finally stopped to smell the dead roses, I did a little research and found out about the "Self Employment Tax" which seems to be another 15.3 % on top of the 25%. So does that mean I should be putting 35% of my income each month into my ING "for tax season" account?

And then... apparently freelancers are supposed to pay an estimated tax each month. What I don't understand is if this is for the convenience of the freelancer (don't have to worry about spending all your tax money and being in serious trouble come April 15) or if it's actually required by law to pay taxes on a monthly basis instead of in one lump sum at the end of the year. If it's not illegal, I really don't understand why more people wouldn't just do what I think I'm doing with this savings account and getting a few extra dollars on the money that will ultimately go to the IRS at the end of the year. But maybe I'm thinking about this all wrong.

I'm, quite frankly, terrified of tax season next year. This year is complicated enough with my two full-time jobs and freelance earnings. But next year? Well, I know I'll have to hire an accountant. But what is it I should do now, as it starting 1.5 months ago, to make my life bearable next year... and more importantly, so I don't accidentally end up in jail for tax fraud out of ignorance and confusion?

ps: I think I just found my answer... (I guess I do have to pay in advance!!!)
http://www.irs.gov/publications/p505/ch02.html#d0e5923


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(Thanks to the IRS for explaining, in fairly clear language, how I can give them my money)

When To Pay Estimated Tax

For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If you do not pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return. The payment periods and due dates for estimated tax payments are shown below.

For the period: Due date:
Jan. 1 1 - March 31 April 15
April 1 - May 31 June 15
June 1 - August 31 September 15
Sept. 1 - Dec. 31 January 15
next year 2

1If your tax year does not begin on January 1,
see Fiscal year taxpayers, below.
2See January payment, below.

Saturday, Sunday, holiday rule. If the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next business day. For example, a payment due on Saturday, September 15, 2007, will be on time if you make it by Monday, September 17, 2007.
January payment. If you file your 2007 Form 1040 or Form 1040A by January 31, 2008, and pay the rest of the tax you owe, you do not need to make the payment due on January 15, 2008.

Example.

Janet Adams does not pay any estimated tax for 2007. She files her 2007 income tax return and pays the balance due shown on her return on January 24, 2008.

Janet's estimated tax for the fourth payment period is considered to have been paid on time. However, she may owe a penalty for not making the first three estimated tax payments. Any penalty for not making those payments will be figured up to January 24, 2008.

Fiscal year taxpayers. If your tax year does not start on January 1, your payment due dates are:
  1. The 15th day of the 4th month of your fiscal year,

  2. The 15th day of the 6th month of your fiscal year,

  3. The 15th day of the 9th month of your fiscal year, and

  4. The 15th day of the 1st month after the end of your fiscal year.

You do not have to make the last payment listed above if you file your income tax return by the last day of the first month after the end of your fiscal year and pay all the tax you owe with your return.
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Ok, now I just have to figure out exactly how much I have to pay them. Hmm.

Here are some helpful links I'll be reviewing to help me figure out just that, and I'll report back here when I actually understand what I'm talking about:

1. Write From Home: Taxes for Writers: Paying your Estimated Tax
2. Huge Taxes for Freelancers?
3. California Tax Service Center

Once I do understand all this, I can work as a freelance freelance accountant. :)



4 comments:

stackingpennies said...

Yikes, sounds like a pain.

Of course you would have to pay quarterly estimates, otherwise everyone would just put their money in savings and pay later, earning interest in the meantime and the gov't would have no funds to run on.

I've never freelanced, but I hope you are a very good record keeper. I imagine that is key.

The self employment tax... does that cover stuff like FICA, Social security, and all that jazz? And don't forget to save up for your state taxes (if you have them)!

Alison said...

My tax deductions from my paycheck are always too large, and I end up getting a hefty refund in the spring. - Which I like...even though I miss out on interest. But it's less painful when I don't have to write them a check come April 15th

Your situation sounds like it'd get messy around this time of year!

living off dividends said...

you are allowed to expense a lot of your income as a self-employed person.

on top of that you might be able to sock away upto 40k a year in a SEP-IRA.

talk to a capable tax person NOW.NOW, not in a year.

Anonymous said...

I would very, very strongly recommend checking into what you need to do as a freelancer when it comes to city/state taxes, too.

When I was doing freelance writing in Seattle, I had to get a small business license and I had to pay additional taxes to both the city and the state.

In my current state, I have to pay state taxes, but not city taxes. I also don't have to have a small business license here.

In both states, the estimated taxes had to be paid on the same quartely schedule as federal taxes.

I like to keep enough money to pay my next two tax quarters in my checking account, along with living expenses for the same amount of time. That way, if a client pays late or a project gets cancelled, I'm not scrambling to withdraw money from my longer-term savings. I figure that if my income was so down for the year that I couldn't pay a third quarter out of my checking account, that would mean that I'd estimated too high and would consequently adjust the third/fourth payments downward to reflect what was actually happening. Fortunately, I've only had to do that once.

A couple of other comments, with respect to the advice from "living off dividends," above... I am not sure what kind of business setup you would have to have in order to count most of your income as an expense. I do know that my tax person has never suggested such a thing, and I would hesitate to try doing so unless someone knowledgeable and trustworthy explained how it was legal.

I do, however, agree with the importance of setting up an SEP-IRA or other retirement account. The 2007 tax year SEP-IRA rule is that you can put away 25% of your income or $45,000, whichever is smaller. They usually adjust the maximum a little bit each year, so it will probably be different for 2008.

The tax stuff can be complicated, but (speaking as someone who's freelanced for years), it's more than worth it. Good luck with your coming year!

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