If you have taken the plunge and decided to freelance as a consultant or other independent contractor, congratulations! Although you have a whole new set of tax issues to consider, you also have plenty of new ways to trim your tax bill.
If you are paid $600 or more for your work for any individual client, you should receive a 1099-MISC from the business. And, yes, the IRS gets a copy, too. You report the income on Schedule C—along with the deductions from your business—which you will attach to your Form 1040. And if your net earnings from self-employment exceed $433, you will have to pay self-employment tax, which is figured on Schedule SE. You deduct one-half of that tax as an adjustment to income on Form 1040, so you don't have to itemize to claim the write-off. And if you have employees or use independent contractors in your business, you will have to file W-2s and 1099 forms for them.
Make sure you don't miss these tax-saving opportunities:
Hire your spouse and get a tax break on medical insurance. Although self-employed individuals can deduct 100% of health insurance premiums paid for themselves, a spouse and dependents, the deduction is allowed as an adjustment to income on the 1040. It does not go on Schedule C and therefore does not reduce the amount of self-employment tax due. However, look what happens if you hire your spouse as an employee to work for your business and you provide family health insurance coverage to employees: Both of you have medical coverage and, since the cost of the insurance for employees is deducted on Schedule C, the write-off trims your self-employment tax bill as well as your income tax tab.
Set up a home office and maximize your write-offs. If you regularly and exclusively use a portion of your home or apartment or use a separate structure not attached to your house as your principal place of business or as a place to meet with clients, you can claim deductions for using the space. Your office qualifies as a principal place of business if you use it as the sole place to perform administrative duties. Expenses that may be deducted include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, painting, repairs and depreciation. The amount of the deduction depends on the percentage of the home or apartment that is used for business. The write-off is claimed on Form 8829, and is deducted on Schedule C. Thus, it reduces your liability for self-employment tax.
Open a retirement plan to shelter your business profit. The two most common are a Simplified Employee Pension plan (SEP) and a Keogh plan. In either one, you can put in up to 20% of your net earnings from self-employment, which is your net Schedule C profit minus the deduction for one-half of your self-employment tax. The maximum annual contribution for 2007 is $45,000. (It will rise to $46,000 for 2008.) Compare that to the $4,000 cap on IRA contributions ($5,000 for anyone born before 1958). A SEP can be established for 2007 as late as April 15, 2008, or, if you filed an extension, October 15, 2008. There are two drawbacks for Keoghs: A Keogh plan must be established by Dec. 31, 2007, to accept pay-ins for 2007. And if you have employees, they may be eligible to have Keogh contributions made for them.
Hire your children. Sole proprietors who hire their kids to do data entry, answer phones, clean the office and the like can deduct their pay on Schedule C as long as the compensation is reasonable for the type of work performed. Wages paid to the children are exempt from Social Security tax if they are under 18 and are not subject to federal unemployment tax if they are under 21. In addition, unless the child has a lot of unearned income, the chances are that he or she won't owe income tax on the wages, which lowers the family's tax bill considerably. Also, a parent can make a contribution to an IRA or a Roth IRA for them based on their wages. Over time, that gift can grow into a nice nest egg for retirement.
Deduct your commuting costs. Employees are not allowed to deduct the cost of driving to and from home to work. But if you are self-employed and your home is your principal place of business, you can deduct the cost of driving from home to see a client or to go to another work location. You can claim 48.5 cents per mile in 2007, plus the cost of parking and any tolls you paid. Be sure to keep a record of your business driving or IRS can deny your deduction on audit.
Combine business with pleasure when traveling. If you fly on a business trip to another U.S. city and spend a few extra days there as a vacation, you can deduct 100 percent of your airfare as long as the number of days spent on business is more than your vacation days. In other words, the main purpose of the trip must be for business. Your other out-of-pocket expenses, such as lodging, hotel tips and 50 percent of meals, can be deducted for the business days only. Expenses for the personal days generally are not deductible. There is an exception if you spend an extra day or two away to get a cheaper airfare for a Saturday night stayover. If your added cost of meals and lodging for that period don't exceed what you saved in airfare, those costs (the hotel bill plus 50 percent of meals) can be deducted as business expenses.
The Wachovia Securities Tax Center site is designed to provide accurate, authoritative information regarding the subject matter covered. It is made available with the understanding that Wachovia Corporation and/or its affiliates are not engaged in rendering legal, accounting or tax advice. If legal, accounting, or tax assistance is required, the services of a competent professional should be sought. The hiring of a professional is an important decision and should not be based upon advertising. Ask for written information stating qualifications, experience and firm association before making a decision.
Securities and Insurance Products: Not Insured by FDIC or any Federal Government Agency; May Lose Value; Not a Deposit of or Guaranteed by a Bank or any Bank Affiliate
Wachovia Securities is the trade name used by two separate, registered broker-dealers and non-bank affiliates of Wachovia Corporation providing certain retail securities brokerage services: Wachovia Securities, LLC, Member NYSE/SIPC, and Wachovia Securities Financial Network, LLC, Member FINRA
/SIPC.
Content provided by The Kiplinger Washington Editors courtesy of TurboTax, a registered trademark of Intuit Inc. Wachovia Corporation and/or its affiliates did not assist in the preparation of this material, and its accuracy and completeness are not guaranteed. The opinions expressed in this material are those of the author(s) and are not necessarily those of Wachovia Corporation and/or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.