Your worth as an artist is not equivalent to the numbers that end up on your tax return.
Knowing the ins and outs of legitimate business expenses is an important part of maximizing deductions, minimizing tax, and staying in the good graces of the IRS. It’s one of the main reasons to seek the help of a professional when doing your taxes. For example, if you travel for work, the IRS permits the self-employed to deduct a per diem for meals and incidental expenses according to a government-approved rate. For a frugal freelancer, this can add up to more than your actual expenses. As we look forward to a year with (hopefully) more traveling, knowing how to correctly calculate per diems can be a substantial deduction on your Schedule C.
So, as a sole proprietor, you get to deduct expenses that employees can’t deduct. But you are also taxed differently than someone who is an employee. Understanding how a sole proprietorship is taxed is important—both for your sanity at tax time and for your financial planning year-round. The main line: As a self-employed person, you pay more taxes than someone who is an employee.
If you weren’t already aware of this, you probably just fell off your chair (unless you are using a standing desk).
When you are an employee—someone whose income is reported on a W-2—you pay your federal taxes, and you pay half of your Social Security and Medicare taxes; your employer pays the other half. But when you are your own business, you pay all of your Social Security and Medicare taxes. This is called the self-employment tax, and it is 15.3 percent of your net self-employment income. Of course, you also have to pay your federal tax, along with any state and local taxes. That can add up.
The best business practice in terms of paying these taxes is to “pay as you go,” just like employees do. Employees have taxes taken out of every paycheck; businesses pay estimated taxes every quarter. If you expect to owe one thousand dollars or more when you file your return, this is what the IRS wants you to do. (And if you wait until tax time to pay your entire tax bill, you may pay a little extra in interest and penalties.)
However, since a freelancer’s income can vary wildly from year to year, it can be hard to figure out what you owe. When estimated taxes for the current year are prepared for you by tax-preparation software at tax time, the number is based on your income for the previous year. This number might be about right. Or it might be too high. Or it might be too low.
In order to avoid a tax-time bill you can’t pay, set aside at least 25–30 percent of every check you receive. You can calculate and make quarterly payments to the IRS with that money, or you can put it in a savings account. Then, when tax time comes, you should be prepared to pay what you owe.
Thus far, I think I’ve said the word important a few times, but I’m going to say it again. This next bit is a very important piece of the self-employed taxpayer puzzle.
You are only allowed to deduct business expenses from your self-employment income if you can show the IRS a “profit motive.” If you can’t, you are deemed as having a hobby rather than a business. But note the second word in that phrase: You need to show that your objective is to earn money. You don’t need to show a profit every single year.
How can you show the IRS that you have a profit motive? Run your writing business like any other business. Market yourself as a professional. Keep good records of the work you do to build your business. Save paper receipts for cash purchases and download your monthly credit card and bank statements (which count as receipts). Track your income and expenses in an organized way. Bookkeeping software is the best way to do this, but an old-fashioned spreadsheet also does the job. Pay quarterly taxes!
And definitely separate your personal and business finances. You can begin that process in five minutes by going online and setting up a business account with your bank. Deposit your earnings into that account, and use that account—or a business credit card—to pay for business expenses. And remember that the expense of hiring an accountant or a tax preparer is deductible on your Schedule C, so don’t hesitate to get professional help when you feel you need it. Expenses such as these only add to the legitimacy of your business.
Now that you know a little bit more about the mysterious world of freelancer taxes, take a deep breath, gather your paperwork together, and get those taxes done. We get three extra days to file this year, since taxes are due on April 18 instead of April 15. But don’t put it off until the last minute! The early bird gets to not worry about their taxes for the next month and a half.
Disclaimer: This article is designed solely to provide guidance and is not a substitute for personalized advice based on specific situations.
As a tax preparer since 2018 with Philadelphia Tax Prep for Artists, Maria brings over 20 years of project management experience for arts and culture organizations to her work as a tax preparer for individuals and small businesses. In her artist life, she trained as an actor, worked as an actor and director, founded a theatre company, ran that theatre company, and then transitioned her creative practice to socially-engaged photography-based projects. She really likes it when things are neat and tidy. www.mariamollertaxprep.com