Jan. 10, 2002 - You may be a freelancer and not even know it.

And if you are, there are certain tax considerations you need to know about, says Millian M. Toms, a Royal Oak CPA and small business advisor.

Anyone who earns income and does not receive a W-2 for withholding is a freelancer, also known as an outside contractor.

Let’s say you worked a side job for some extra income on top of your 40-hour-week profession. “If you earned income in addition to your regular employment, you have to report it,” Millian says.

If someone pays you more than $600 in one year for your services and does not take out taxes or social security, they must file a 1099 form reporting that payment to the Internal Revenue Service. But even if they don’t file a 1099 and you made less than $600, you still have to report that income, Millian explains.

Reporting income where there’s no taxes withheld
How do you report this income on your tax return? If you received income with no withholding and are not deducting any expenses, you’ll want to report that as Other Income on page 1 of your 1040 income tax return form. If you want to take deductions for expenses related to earning that income, you need to fill out a Schedule C form to take those expenses.

“Whether you file a Schedule C or not, though,” Millian says, “it’s important to remember that if your net income is over $400, you are going to have to pay Social Security taxes on it.”

On top of that, you are going to have to pay both halves. You see, when you are employed by someone else and they deduct taxes from your paycheck, they deduct your half of your Social Security taxes and they pay the other half. When you earn income as an outside contractor, you not only have to pay taxes on it, you also have to cover both halves of the Social Security taxes due.

“But the good news in this situation is that you get to deduct half of those Social Security payments on page 1 of the 1040 form under Adjustments.

Filing Schedule C
When you earn income as an outside contractor or freelancer, you are considered to be a business and, as such, are required to keep records that maybe your employer kept before.

What can you deduct?

The basic rule is that you can deduct anything ordinary and necessary to the earning of your income, unless there are regulations limiting or specifying what can be deducted or how it can be deducted. And all supporting documentation is your responsibility.

When you get down to the details, the list can be long and complicated. Ultimately, you really should seek the advice of a tax advisor, Millian says. Beyond anything that is ordinary and necessary, here’s a general idea of what exceptions are specifically addressed by those regulations.

Entertainment, Travel and Gifts in General
Even if your expenses are proper deductions, they will be disallowed if the required substantiation has not been met. The factors you must prove are:

• Amount

• Time, date and place of travel, entertainment, etc.

• Description, if gift, and donee's name

• Business purpose or reason, and

• Business relationship and name of person entertained

Method of Record Keeping
The regulations do not require any specific method of record keeping. They do state, however, that you must maintain an account book, diary or statement of expense. To give the elements of an expenditure a high degree of credibility, it should be recorded at or near the time of the expenditure, Millian says.

Documentary Evidence
Documentary evidence such as paid bills are required for any expenditure for lodging away from home, regardless of amount, and for any other expenditure of $75 or more, except that for transportation charges, paid bills are not required if not readily available. Documentary evidence will usually be sufficient if it shows amount, date, place and kind of expenditure, such as hotel statement or a statement from a restaurant. Cancelled checks are NOT sufficient proof.

It’s important to remember that you are required to answer specific questions as to business and personal use on you tax return form. First, if you have evidence to support the deduction and, second, is that evidence written.

Entertainment Expenses
No deduction is allowed unless you establish that the entertainment activity was "directly related to the active conduct of your business," Millian says

Associated goodwill entertainment can be deducted if there is a clear business purpose and it precedes or follows a bona fide business discussion.

Generally only 50% of such costs are deductible due to the belief that they involve an element of personal living expenses which are not deductible.

Travel Expenses
Travel expenses are deductible only if business related. If both business and personal, within the United States and primarily for business purposes, the entire amount is deductible. Primarily personal trips are not deductible. Trips outside the United States must be allocated between business and personal and require additional substantiation. Travel to and from work is not deductible.

Gift expenses
Gifts that qualify as ordinary and necessary expenses are limited to $25 annually for each recipient.

As always, consult your tax preparer to be sure you are meeting all the regulations.

Millian M. Toms is a Royal Oak-based CPA and business advisor. She is also an active member of the community including The Optimists and Greater Royal Oak Chamber of Commerce. 

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