Tax Myths and Misconceptions for Freelancers

Last year was my first full year in business--and my first year making money entirely as a freelancer. Like a lot of first-year contract workers, I thought I was prepared for my tax bill--but it was much more painful than I expected. Part of the reason for the pain is that I'm a pretty frugal person by nature; I don't spend a lot on electronics or equipment unless I really feel I need them. My laptop is a few years old, but it still runs just fine--and I haven't replaced my printer in years. Still, I thought I'd be okay when it came to taxes--partly because of a few misinformed assumptions. Here are my big ones--and if you're operating under any of these, be warned.

Note: I'm not a tax professional or attorney, and this post shouldn't be construed as professional tax advice to you personally. Consult with an accountant or a tax attorney for more information on your situation.

All those deductions will cancel out your tax bill. I have a few family members and friends who own stores, build boats, run car mechanics' shops, and so on. In my first year of business, these sage businesspeople advised me not to worry too much about taxes--"the deductions will take care of it," they said.

Here's the thing about freelance writing, though: it's a low overhead business. Our big-ticket items tend to be things like printers, computers, and faxes--things you don't buy every year (although you can deduct the depreciation) and things that don't cost much more than a few thousand dollars. Sure, you can deduct a fraction of your housing expenses (if you have a single room dedicated to an office); your Elance fees (yeah, we're all earning a lot of money on Elance these days); your PayPal fees; your office supplies; and even some car expenses if you use your car for business. But that still adds up to pretty small potatoes--or at least it did for me. If you don't have any major equipment expenditures or employee salaries; or if you didn't buy some big-ticket website overhaul or spend a lot of money on classes and conventions, you may find yourself hurting at tax time.

You won't make enough your first year to pay much in taxes. I do pretty well--but I'm not ridiculously wealthy. I assumed that this year wouldn't be a big-ticket year for me in terms of taxes. I made about as much last year as I did in my nonprofit job the year before, and if any of you have worked in nonprofits before, you know they don't exactly pay top-tier wages. I figured I"d be under the tax radar.

But here's the thing: when you're an independent worker, you get smacked upside the head with the self-employment tax. That's 15% of your total earnings, just for social security and medicare. You've also got federal taxes, state taxes, and city taxes to deal with--and some cities levy extra taxes on businesses, too. I still wound up paying about 30% of my net income, total--even though I managed to scrape together enough deductions to make myself look just-this-side of poverty level.

A sole proprietorship is the best organization for you. I always assumed that a sole proprietorship was the appropriate business organization for me. I'm a sole proprietor, after all. No employees; no shareholders; just me and my computer. I thought it was better because it was easier to deal with, too--less paperwork needed. But that's not necessarily so. There are distinct tax advantages to incorporating--and nobody told me beforehand that I should think about this when I formed my business.

You don't need to save; you can finance your tax bill. Except if you do that, it comes with heavy fees and a high interest rate. If you have the money in the bank, you may be better off paying the bill--even if it'll wipe out your savings. The bottom line? Save a percentage of each client payment you recieve. It's tough to do--it takes tremendous willpower on my part--but if you don't, you'll be in trouble later. And pay your quarterlies, so you don't get hit all at once at the end of the year.

Don't assume everything will work itself out when it comes to taxes. Be proactive. Meet with an attorney or a tax accountant in the beginning stages of your business to determine the best organization--and save religiously for the day Uncle Sam comes knocking.