Here's some mythbusting for some common tax myths.
You just got through tax season, but if preparing this year’s taxes didn’t go as smoothly as you would have liked, there’s no time like the present to start thinking about how to better prepare for next year.
Creative freelancers tend to hear a lot of tax advice – some of it legitimate, some of it not so much. So we’re busting some tax myths to help you break through the anxiety of taxes and set you up for success this year.
Tax Myths #1: Didn’t Receive a 1099? Don’t Have to Pay Taxes on That Income
Creative freelancers don’t receive a W-2 at the end of the year summarizing their income and withholding. Instead, they may receive Form 1099-MISC from any clients who paid them during the year.
Copies of those 1099s are also sent to the IRS, and the agency compares those 1099s to the income reported on your tax return. If the amount of income you claim is less than the total of the 1099s the IRS received on your behalf, you can expect the agency to send you a notice assessing additional tax, penalties and interest on the difference.
However, many freelancers mistakenly believe that if they don’t receive a 1099, they don’t have to report the income on their return. That’s just not true.
For one, only people and organizations who paid you more than $600 during the calendar year are required to send a 1099. Secondly, sometimes companies just don’t send them, issue them late or mail them to an old address.
Whether you receive a 1099 or not, the income is taxable. So it’s a good idea to track your income throughout the year using cloud-based accounting software rather than relying on 1099s to report your income at year end. Then, you can use your records to ensure that the amounts reported on 1099s are accurate.
Tax Myths #2: Deducting a Home Office Is an Audit Red Flag
There was a time when claiming the home office deduction meant you had a higher chance of being audited. Cloud software that allows people to work and collaborate with others anywhere there is an internet connection didn’t really exist. As a result, legitimate home offices were pretty rare.
Today, home offices are much more common. Remote employees, side hustlers and gig economy workers making up a large percentage of the workforce. Claiming the home office deduction isn’t as much of an anomaly, so you no longer need to be afraid of claiming a legitimate home office deduction. Just make sure your office actually meets the IRS requirements for the deduction.
Tax Myths #3: All Business Meals Are Deductible
Creative freelancers might work from a coffee shop, grab a bite on the go while between appointments, or buy lunch for a potential client. If you’re working while eating, it’s deductible, right? Not always.
There are three categories of deductible meals:
- Meals while traveling for work. You can deduct 50 percent of the cost of meals while traveling for business. To qualify, you need to be outside of the general area where your work is located and be gone substantially longer than a day’s work, so that you need to rest or sleep while away.
- Meals with clients or employees. You can deduct 50 percent of the cost of meals with a current customer, potential client or employee. To be eligible, there must be some substantial business discussion before, during or after the meal.
- Meals provided to employees. If you have employees, you can deduct 100% o the cost of holiday parties and summer picnics. You can also deduct 50% of the cost of meals provided for the convenience of the employer, such as dinner bought while working late.
Simply put, grabbing lunch in between client meetings or ordering coffee and a croissant while working at your favorite coffee shop aren’t deductible. If you do have meals that meet the requirements outlined above, make sure you document the business purpose of any meals.
Pro tip: This is an area IRS auditors love to scrutinize.
Tax Myths #4: All Business Vehicles with External Advertising Are Deductible
Wouldn’t it be great if you could place your company logo all over your car and write off every gallon of gas, oil change and new set of tires? But the deduction for vehicle expenses isn’t based on advertising. It’s based on the number of miles driven for business versus personal purposes.
If you use your personal vehicle for business (i.e., visiting clients and temporary work sites, running business errands, etc.), keep a log of the miles you drive and their business purpose. Then you can claim a deduction based on the standard mileage rate or actual expenses.
That ad on your car? It might not turn your car into a rolling tax deduction, but you can deduct 100 percent of the cost of the decal or wrap as an advertising expense.
Tax Myths #5: Self-Employment Taxes Are Avoidable if an LLC / S-Corp Is Formed
Self-employment taxes can take a big bite out of your freelance income. If your net income from self-employment is at least $400, that amount is subject to the 15.3 percent self-employment tax – and that’s in addition to your federal and state income tax rate.
It’s no surprise then that freelancers and business owners are always looking for ways to reduce the SE tax burden. While there are some strategies for reducing the amount of your income that is subject to self-employment taxes, you can’t avoid it entirely.
For example, sole proprietors and single-member LLCs pay SE tax on their share of the business’ entire net income. If you form an S-Corporation or an LLC that is taxed as an S-Corp, you can pay yourself a salary and you’ll pay Social Security and Medicare taxes only on that salary rather than your total business profits.
But this strategy isn’t without its downsides. For one, you can’t pay yourself $1 in salary and avoid Social Security and Medicare tax altogether. The IRS requires that you pay yourself a “reasonable compensation” for the work you perform. What’s “reasonable” is based on a number of factors, including the average salary for someone performing your job in your industry and how much your employees are paid (if you have any).
This strategy also means you’ll need to form and maintain S-Corporation status, file a separate tax return for your business, set up payroll and pay unemployment taxes. You’ll have to weigh the cost of this additional administrative burden against the potential tax savings. For some creative freelancers, it just adds a layer of complexity to an already challenging tax season.
There are legitimate strategies for increasing your profits and lowering your tax liability. But there’s also a lot of misinformation out there about tax rules for freelancers. Be sure to do your research and get help from a qualified professional before you get yourself into hot water blindly following lousy tax advice.
about the author
Janet Berry-Johnson is a CPA and a freelance writer with a background in accounting and insurance. Her writing has appeared in , , , , and . Janet lives in Arizona with her husband and son and their rescue dog, Dexter. Outside of work and family time, she enjoys cooking, reading historical fiction and binge-watching Real Housewives.