You've made the leap to freelancing, you have clients, you're making money, and everything is going good... until taxes come due. In this episode, Raj Bhaskar, founder of Hurdlr, gives a crash course on how to navigate taxes as a freelancer.
Raj talks about how to manage your freelancing finances, and especially, figuring out your deductions and making your that you are compliant with the tax regulations in your country.
Disclaimer: Everybody’s situation is different, and of course, different places have different laws. So before implementing anything in this episode, SPEAK TO AN ACCOUNTANT. Seriously.
Raj shares with us:
Why Raj started Hurdlr:
Like most freelancers and entrepreneurs, Raj started Hurdlr with the goal of helping people. He wanted to help entrepreneurs and small businesses figure out one of businesses biggest hassles: Accounting. Hurdlr, named off the idea of helping you get over financial hurdles, is a mobile app that helps freelancers, business owners, and entrepreneurs manage their business finances and taxes.
What's this tax thing anyway?
When you are an employee, a lot of you income tax is taken care of by your company and your paycheck already has tax deducted that the company has to pay. Easy peasy!
As a freelancer, you are on the other side of this and it can be a little more difficult figuring out all of your tax obligations. Here's some motivation: How will you know what your true profit is if you don't take taxes into account? If you don't figure this stuff you, you are probably looking at some penalties and you end up paying more.
It's not hard to figure out your tax obligations. It just takes time. You can certainly do it on your own with some research. Of course, always the entrepreneur, Raj suggests taking a close look at how much time you have to do this stuff. It might be cheaper to pay an accountant or use other tools rather than struggling through it on your own time, time you could be using to do client work.
Did you know that as a freelancer in the United States, you have to pay quarterly estimated payments? Many freelancers don't know this and only pay taxes once a year, plus the hefty penalties and interest for not paying the quarterly estimates. To figure out your estimated tax payments, you can do some worksheets provided by the government, just overpay so you don't get stuck with penalties, or you can use apps like Hurdlr (nice product placement, Raj – but really, the app is very useful for figuring this out for you).
A note about overpaying: Paying 110% of prior year's taxes usually does the trick and if you underestimated, you can pay the difference without penalty when you actually sit down to write a cheque to the government. Although overpaying covers your butt, freelancers are often strapped for cash and might not have the extra money around to overpay. Doing the calculation might be better in that case, or you will just have to accept the penalty. Not overpaying also means you can invest that capital into something else that might help you earn more revenue.
It might also be a good idea to set aside 30-40% of your income to taxes so you have the money available to pay for these payments right away. Penalties add up!
If you live in the United States, you also have to deal with the 1099 misc form. This is a form that your client, a business, sends to both you and the government declaring how much they paid for your services. It is a way to check what you claim to be your income. If the government recieves a 1099 from your client, but your income doesn't match up, you will be fined. This form is for any “non-corporate US resident independent contractor,” a.k.a freelancer. So, that's you. If you get income from other businesses, be aware that they are probably sending in this form and that you are accountable for declaring that income.
Top things you should do to manage your finances:
- Get a separate banking account and credit card for your business. If you do nothing else, DO THIS! If you take action on all the other advice too (you are awesome!) still start here. Having a separate banking account and credit card helps you clearly see the business finances, your income and expenses. Once you can see what's going on with your business, you can make better financial decisions such as trimming expenses, where you are spending, strategic spending, and even if you are being paid.
- Track ongoing expenses as they happen. The monthly statement from your credit card is a good start, but we humans are not known for our ability to remember every expense we made. It is really easy to forget what each expense was for, even as short as a month later.
But why is it important to track expenses? Deductibles. I mean, “Deductibles! Wooo!” Deductibles are meant to help your business out by taking away some of the expenses. And they can really add up and help you reduce your taxes with minimal effort on your part. For example, you can deduct a part of the expense of the coffee you bought for your client at the Starbucks meeting. Wouldn't it be awesome to get money back every time you bought coffee?
Yea, you're right, there is a catch. You need to be very specific about what you bought and why. For the Starbucks example, you need to know which client you were meeting with, what the meeting was about, and, most importantly, you need the receipt. If you get audited, a credit card statement isn't enough. You need to have the receipts to substantiate your claims on deductibles.
Don't be afraid of deductions.
Seriously, deductions are meant to help you out so you should use them. If you are making legit claims, its not going to trigger an audit. And if you do get audited, you have all the receipts and know all the details about the expense because you tracked as you went (you did, right? If not, you might want to start or you just have to be prepared to pay the penalties if you are audited).
There are a few things you should know about though to make good claims. First off, a business expense is any expense incurred by the business for business purposes. That's it. If the expense is not directly business related, it is not a business expense, so no, the haircut you got before a business meeting is not a business expense, that's a personal expense. Renting an office, definitely a business expense. All those software subscriptions for CRM, project management, marketing, invoicing, etc, are business expenses.
Buying a computer, well, it's a little tricky. If you are going to use that computer only for business purposes, then it is a business expense and 100% deductible. But if you use the computer for business only 50% of the time, then watch movies, play games, browse the web, or do whatever else the other 50% of the time, then you can only claim a 50% deductible.
What about a home office? If you have a dedicated space that is only for your business, then you can definitely deduct it, with limitations on square footage and percentages. (Aside, having a home office that has a closed door can definitely help your productivity.) Having a home office and an office outside of the home gets tricky. If you work on the kitchen table, it gets tricky. Check out 99deductions.com to help figure out what deductions apply to you based on your profession.
What about the car? Let's talk mileage. The simplest way is to track how far you drive for roundtrips to do business related activities, such as meeting a client at their office. Then you apply a rate to each mile/kilometer and voila! The hard way is to track every bit of gas and maintenance related to the car, but this is really only valuable if you tend to have a lot of vehicle maintenance expenses. It is a lot more work to track all the actual expenses verses just applying a rate, to the point that it might make more financial sense to get a car with less maintenance issues.
Don't be afraid of audits.
Audits are the equivalent to the monster under the bed, but that's just because you never had a flashlight to shine on them. So here's the flashlight.
About 10% of people are audited every year, so you are probably going to be audited at some point. It can be a pain to go through and can take up a lot of time if something is found to be erroneous or you can't substantiate your claims. If that happens, you will probably be looking at penalties and interest. If you do get audited, you can expect to have a meeting set up with the government. You will have to show all of your documents and systems. Government officials might actually show up at your door to check your claims. And remember, credit card statements aren't sufficient, you need the receipts.
But, you shouldn't have anything to fear if you substantiate expenses as you go along. Make it something you do everyday. If you do it now, it will save you from headaches later.
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