Not just for freelancers, but to anyone dealing with tax dynamics can be intimidating. But, for freelancers (Who are self employed workers), it can be overwhelming too. Not knowing the tax terms can be a nightmare while filing during tax season.
Working in the gig economy means being accountable for everything.
Here are some of the tax terms every freelancer should know for a stress free tax filings.
If the company or an individual has paid you more than $600, they’ll likely issue a 1099-MISC.
To be noted: Whether you received 1099-MISC or not from a particular client, the freelancers must show the total earned amount on the tax return.
Adjusted Gross Income (AGI)
Adjusted Gross Income is the individual gross income minus specific deductions. The deduction can include contribution to the health savings or deduction of 50% self-employment tax paid.
For individual tax purposes, AGI is more relevant than gross income.
For tax purposes, the filing status determines your tax bracket and standard deduction size. One can choose from “single”, “Married filing jointly or separately”, “Widow/Widower”, “Head of Household”.
Credits vs Deductions
We often confuse tax credits with deductions. so, Let’s look into the actual definitions.
Tax credits provide dollar to dollar reduction of one’s income tax liability.
Example: For $1000 tax credits, one can save $1000 in taxes.
Deductions lowers taxable income which means that it reduces the mount of income subjected to tax.
Example: If a freelancer’s income tax bracket is 25% , then he/she can save $250 on $1000 tax deduction.
Employer Identification Number (EIN)
This is considered as the business version of Social Security Number (SSN). Most of the times, SSN will work for freelancing gigs. However, if you are operating under partnership or as a single member LLC, you are likely to file for one of these.
If you are operating as a proprietor or a single-member LLC, you need to fil for Schedule C along with personal tax return. This form is used to record profit-loss details from business income to calculate the net amount from freelance activities.
Below are the different parts of Schedule C.
- Part I is used to input information related to your income.
- Part II includes qualified business expenses.
- Part III is used for “Cost of Goods Sold.”
- Part IV is where you can record information about using a vehicle for business.
- Part V is for all other expenses that can’t be categorized elsewhere.
Home office expenses
As most of the freelancers work from home, one can file the tax return for home office expenses such as utilities, repairs and maintenance, rent.
You can only qualify if the mentioned space is exclusively used for business purposes.
Freelancers need to look after their taxes with great clarity and should document every bill/statement. This can be beneficial in lowering the taxes and getting more returns.