By Justin Thompson
Tax season is upon us, with less than two months to go until the April 17th deadline.
Last year at this time I was a contract employee, and I remember the hassle of having to go through my taxes. I didn't know what I was getting myself into, but I did listen to my mother's sage advice to always "pay yourself first." I hid money away, because I knew I'd have to fork over cash to Uncle Sam since no taxes were taken out of my paycheck.
For those that are new to contracting and/or consulting, like I was, there are several things that you can use to your benefit when reporting taxes. Experts and freelancers recommend these nine tips for filing your 2012 tax returns as a consultant or contractor:
1. Track your business mileage
Freelance worker David Oro suggests keeping track of all your business-related mileage in a spreadsheet. "Going to a bank to cash a client check? Or going to the post office to check the [business] mail? That mileage, if used for business, is tax deductible," Oro says.
2. Decide whether to form a business structure
Nellie Akalp, CEO of CorpNet.com, helps freelancers and entrepreneurs start their own businesses, such as a Limited Liability Company. What's the perk? "While liability protection is the main benefit for incorporating or forming an LLC, in many cases, corporate tax rates are lower than individual tax rates," Akalp says. "And corporations and LLCs often qualify for additional tax benefits and deductions that aren't available to individuals." Be sure to consult a tax professional to see if this is the best avenue for your consulting business.
3. Review your 1099s carefully
Thursday R. Bram, a consultant to freelancers, says that consultants should "make sure the amount that your clients tell the IRS that they paid you last year actually matches what you received. It isn't a big deal if they report a little less, as long as you report everything to the IRS correctly. But if a client reports that she paid you more than you received, you need to get an amended 1099 ASAP – or the IRS will expect you to pay taxes on the full amount that client reported. Whether or not you actually received the money won't matter to the IRS."
4. Make bookkeeping easy
"Two great tools to automate bookkeeping are Outright.com and WaveAccounting.com," suggests Wray Rives, CPA, CGMA. "The biggest tax challenge for a freelance worker is actually having good records to prepare and support their tax return. Both Outright and Wave will automate your bookkeeping and are real simple to use even for a non-accountant." Other recommended programs are Quicken, Shoeboxed.com and Mint.com.
5. Pay yourself
Bob Hampton, CPA/PFS, ChFC at Impart Financial, LLC, advises you to pay yourself first. " ... Stash money away in savings to cover your tax liability," Hamption says. "As a rough rule of thumb, 30 percent of your net from freelancing will get you pretty close to your self-employment and income tax obligations."
6. Consider your medical expenses
Self-employed worker Sandy Drew suggests brushing up on the tax benefits associated with health care. "Many consumers overlook deductions built into the tax code that are designed to make medical care and health insurance more affordable," Drew says. "Consumers who had high medical expenditures in 2011, who pay for their own individually-purchased health insurance and who are self-employed should educate themselves on the opportunities to deduct a portion of these expenses from their federal income tax." Again, consult with a tax professional to understand what is and isn't deductible.
7. Receipts are cash, not trash
Thank Denise Winston from MoneyStartsHere.com for that brilliant and absolutely true one-liner. "You need your receipts to back up the deductions you claim," Winston says. "Each receipt must clearly indicate the purpose of each expense - example for travel: where, why and the amount or file folders for bookkeeping. Establish and carry a receipt envelope with you in your purse, car, briefcase, backpack - whatever works for you. As you make business expense purchases, simply place the receipt into the envelope after you note the purpose of the expense. As the envelope fills up, transfer to proper accounting files or systems – I use a color coded tax write-off category filing system. Red folder is for office expenses, blue for travel, green for banking, etc." The more organized you remain throughout the year with your business expenses, the less stressed you'll be during tax time.
8. Separate business accounts from personal accounts
"When you put all your job-related expenses on the same credit card and not use that card for anything else, it will be very easy to know what to write off and how much it cost," says Dr. Geraldine Boyer-Cussac, a self-employed pianist, music director and vocal coach. "Make sure not to use it for anything other than expenses for work." Keeping everything separated will be easier to manage than having to split out personal and business expenses.
9. Schedule C may be better bang for your buck
Attorney Diane Rosenberg of Rosenberg & Rosenberg LLP explains the benefits of the Schedule C. "One can deduct all expenses that were incurred in performing the work, including work at home and use of a personal vehicle when used for work. With Other Income, it's possible to net out expenses, but the IRS would raise an eyebrow as to why it's not reported in detail on Schedule C. And hobby losses are only deductible to the extent of hobby gains, so if the freelancing work happens to generate a loss, the loss would be available on Schedule C, but unavailable as a hobby loss." She warns that the home-office deduction is often a red flag for the IRS because many abuse the privilege. You should only be taken if there's actual space in the home dedicated to the freelancing activities.
As I learned when I freelanced, organization is key. Whether you prepare your own taxes or use a tax preparation service, you'll benefit from having all your ducks in a row, and you'll have a better understanding of what you may end up owing.
Disclaimer: I am not a tax expert. Also, those of us working at AOL Jobs, CareerBuilder.com and TheWorkBuzz.com are not tax experts. You should always consult a tax professional with your specific questions. One great resource is the TurboTax blog, which has answers to frequently-asked questions about taxes.
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