Susan Solovic, THE Small Business Expert, is an entrepreneur, attorney, keynote speaker, media personality, best-selling author, and former ABC News small biz contributor. She uses her expertise to help others run successful businesses.
Check out this video where Susan talks to tax attorney Barbara Weltman about what freelancers need to know about their self-employment taxes and home-office deductions. Full transcript below.
Insureon – Freelance with Barbara Weltman
Susan Solovic: Hi everyone, and welcome! I'm Susan Solovic, THE Small Business Expert.
Thanks for joining for today's Small Business Tip, and we're going to be concentrating mostly on those of you who are joining the freelancers’ revolution in this country. And many of you are working out of your home, so I reached out to one of my friends – and absolutely probably one of the best experts when it comes to taxes and legal issues for small businesses – and that’s Barbara Weltman. She is a tax and business attorney. She shares great advice and information to help you get ahead in your business, but also most importantly, to really protect your business. And I really encourage you to check out her website: it's just www.BarbaraWeltman.com.
One of the things that she has that I absolutely love is her “Idea of the Day,” which lands in your inbox with just a tidbit of important information to help you with your business. And she just told me she has a new book out. It’s J.K. Lasser’s Guide to Self-Employment. It’s all that information that you need about taxes to help you when you are now a Schedule C worker.
And Barbara, welcome. Thanks for joining me.
Barbara Weltman: Oh, it's my pleasure.
Susan: I'm just going to start off because I imagine a lot of people who are listening to us now don't even know what a Schedule C worker is. So when you're filing a Schedule C, what does that mean, Barbara?
Barbara: That means that you report your business activities – that is, the income that you earn and your expenses – on a Schedule C that’s part of your 1040 annual tax return.
Susan: Okay, so let's talk about taxes because, as I mentioned in the intro, there are so many people who are joining the freelancer revolution. They can't find jobs or simply it’s something they've always wanted to do. They get paid, and then, they just put that money in the bank. But there's a lot more they should consider when it comes to taxes because no one's withholding taxes for them. What should they do?
Barbara: Well, that’s a big challenge for people, especially people who used to be W-2 employees with mandatory and regular withholding. Versus now, they are what might be considered 1099 workers because the businesses that they provide services for will issue a form 1099 information return to them, as well as to the IRS. And it’s their responsibility to report their income and pay their taxes. And this is more than just filing a Schedule C. It also includes the responsibility of paying those taxes quarterly through estimated taxes because there is no withholding. And those estimated taxes include not only the tax on your profits – the income tax on your profits – but also your Social Security and Medicare taxes called self-employment tax. Which is really twice the FICA amount. Because, in effect, you pay the employer and employee share even though you're not an employer or an employee.
Susan: That's a good point and that surprises a lot of people. Barbara, if you're just starting out now, let’s say you’ve left your job and you’re starting freelancing just this year in 2014, how would you know though – how much to pay in those quarterly estimated taxes?
Barbara: Well, that’s a big challenge because you don't know what's going to happen in the future. You can always make adjustments, and there are certain safe harbors where you can rely on what you paid in the previous year to avoid any penalties. But the challenge is to make sure that you pay some taxes all along so that you don’t have this giant payment at the end – even if it's not going to be penalized because you have to come up with that cash to pay the tax.
So, what I advise is that you put a certain percentage aside, whatever you decide – whether it's 10 percent or 20 percent – of all the earnings that come through and put that aside so you'll have cash on hand when it's time to pay estimated taxes. And then as I said, you have to figure what those taxes should be. It may be wise to work with a CPA or some other tax advisor to help you get a handle on what you should be paying.
Susan: Great advice. Another question for you with freelancers out there, they're getting work coming in. I have a lot of people say to me, “Oh, I know Joe or Sally. I worked with them when I was in the corporate world. We're going to do this deal together. They agreed to pay me. You know, all is good. I don't need to put anything in writing.”
What would you say to that person?
Barbara: Oh well, you don’t want to find out at the end that there's a problem. You’d better address the issues upfront. And one of the things you can do, especially as a freelancer is, it's really advisable to structure your payments for the work that you do so that you get something all along – so that you're not left with a big bill at the end that you have to collect.
So, for example, if you're doing a project for a company, make sure that you get paid a portion on signing an agreement, a portion when a quarter of the work has been finished, or a certain milestone in the project has been completed. Again, this will prevent any problems later on about collection, and also you’ll have a regular stream of income coming in.
Susan: One of the things that I have seen personally is sometimes if you get a project with a major company, they want to know that you have a certain level of insurance policy to cover you if there are any mistakes or things made along the way. Can you explain that to me and why that's important for a freelancer?
Barbara: Sure. You may be required to have what's called an E&O policy, an Errors and Omissions policy. And you can talk to a commercial insurance broker, who can help you get the kind of coverage that you need. But basically, this kind of policy covers you for the agreements that you make so that if you make a mistake or you fail to do something that you should have done, the insurance will protect the company that you're doing the work for because there will be money on hand. And also, it’s a really great idea because many freelancers work as self-employed individuals. They don't incorporate; they have no personal liability protection. Having this insurance will make sure that the insurance pays if you goof rather than being sued and having your personal assets at risk.
Susan: Right. What is the old saying? An ounce of protection beats a pound of cure, or something like that, right?
Barbara: I think you nailed it.
Susan: Yeah, good. Okay, one more quick question. I get asked this a lot. So lots of freelancers are working out of their homes, should they take the home-based tax deduction, or is that a red flag?
Barbara: Great question, because I get asked that all the time. And the fact is that right now, 52 percent of all businesses in the U.S. are home-based. That’s a statistic that came from the Small Business Administration. And the IRS, just this previous year, instituted a simplified home office deduction option instead writing off your actual cost. Which I think kind of acknowledges the fact that so many people are working from home legitimately.
My advice to people is: make sure that you look at the requirements for eligibility to take the home office deduction. In other words, that the home office is your principal place of business and you don't have an office some other place that would prevent you from taking the write-off. And keep good books and records about any expenses if you're writing off your actual costs. In other words, if you're entitled to the deduction: take it, because even if the IRS should question your deduction, you will be protected. You will probably come out victorious. But more than that, I think that the IRS has backed off considerably on challenging home office deductions.
Susan: That's very good. We love to hear the IRS is backing off. So Barbara, thank you so much. You have so much information to share, so I encourage everyone, please, go to Barbara’s website. Once again, that’s www.BarbaraWeltman.com.
She has that “Idea of the Day” that I mentioned to you. She also has a great newsletter you should sign up for as well. And look for her new book, J.K. Lasser’s Guide to Self-Employment. She'll have lots more detail about this subject we've been talking about today, about protecting your freelance and/or home-based business.
Barbara, once again, thanks for being here.
Barbara: My pleasure.
Susan: And thanks for joining me, THE Small Business Expert, for today’s Small Business Tip. We'll see you next time.
Today’s Small Business Tip has been brought to you by insureon, America’s choice for small business insurance. Be sure to check us out on the web at insureon.com.