Since it's Tax Time and a lot of self-employed or freelance people are feeling the hit of a giant tax bill, I'd like to share a handful of things I've learned about taxes that Independent Businesspeople Might Like To Know. A thread! 1/
First caveat: I don't know what the new Republican tax bill will do to this information. It probably will change it a little bit. Also, I live in California and your area may differ w/r/t local taxes. So please remember to do research or consult a pro for your specific case. 2/
Second caveat: I only know what I have done and I'm comfortable recommending for people in GENERALLY my same shoes. I have a small business and I make my money as the owner of the business. Your situation may differ! 3/
OKAY. Starting from first principles: When we talk about "self-employed" people we mean people who get money NOT in the form of a paycheck. By "paycheck" I specifically mean a payroll-issued check with taxes taken out. 4/
Payroll checks are the ones that you get at most jobs. You fill out a W4 form with your social security number, number of exemptions (we'll get to that), etc. The company deducts, from your overall pay, payroll taxes and their share of any benefits you receive. 5/
Payroll taxes include charges for unemployment insurance (which you can claim if you are laid off), Social Security (which you can claim at retirement), and Medicare (same). At the end of the year, you get a W2 form that shows your total pay and the total amount of deductions. 6/
So at this point you have earned X amount and thus paid taxes on X amount. But when you have other deductions, say for dependents, or mortgage interest, or charitable deductions, etc., your taxable income total goes down. This means you likely get a refund for overpayment! 7/
(You can also take the "standard deduction" which is an average amount. If you have a lot of individual deductions that add up to more than the standard deduction, you should list them all, or "itemize". If you don't, you can claim the standard deduction instead.) 8/
(There is a lot in the new tax law changing the rules around deductions but that's getting away from the point of this thread.) BACK TO IT: If at the end of the year, you paid taxes on X amount, but then ALSO earned OTHER income, you now may have paid TOO LITTLE tax. Boo!!! 9/
This is where SELF-EMPLOYED INCOME comes in. Any income in which you are paid NOT via payroll and taxes are NOT deducted in advance (aside from investment gains, etc) is SELF-EMPLOYED income, also known as freelance or contract work. YOU'RE responsible for figuring that tax! 10/
Now: if you work in a regular job where THEY set the hours and THEY provide the work materials at THEIR location, technically speaking that is not supposed to be freelance work. They should put you on payroll. For short gigs it's often too much trouble, but for months on end? 11/
They may be keeping you as a contractor because they (or YOU!) don't want to deduct payroll taxes, and therefore diminish the size of your paycheck, or pay you benefits. But they can get in trouble if they treat a long-term full-time employee as a contractor. 12/
Unemployment is a benefit, by the way! If you are not on payroll then you cannot claim unemployment if you are laid off. Unemployment claims aren't paid by the employer, but they DO ding the employer -- it changes how much they have to pay into the system. 13/
So they may be trying to avoid that cost and that risk. BACK TO YOUR EARNINGS: If you are paid, as a contractor, by anyone in an amount under $600 in a year, neither you nor they have to report that income to the IRS. Cool! Easy peasy. 14/
If you are paid OVER $600 in a year, you will probably be asked to submit a W9 form and you will receive a 1099 statement of earnings at the end of the year. This means the IRS knows you earned that money, so you'd better report it on your tax return. You now owe…DUN DUN DUN 15/
SELF EMPLOYMENT TAX. In a nutshell, this means YOU are responsible for paying those payroll taxes that otherwise your employer would have otherwise paid. And guess what else? YOU HAVE TO PAY DOUBLE. The reason is because, even though taxes were taken out of your check… 16/
…your employer ALSO had to pay an equal amount FOR you, directly to the tax agency (state and federal). It's part of the "benefit" of being an employee. As a self-employed person, guess what? You are BOTH employee AND employer! You get to pay BOTH HALVES! Hooray!! 17/
There are MANY ways that government makes life difficult for small businesses and freelancers and this is just one of them. If you are issued a 1099 I believe you HAVE to file a Schedule C (or C-EZ, the short version) which is for SELF EMPLOYMENT INCOME. 18/
Both halves of the payroll tax (SSI, Medicare, etc) is about 15% of the total earned amount. You pay that! THEN you pay income tax (in whatever bracket you're in) on the remainder!! So if you're not planning for that, this can be QUITE A BIG BILL TO PAY. Save up! 19/
You can also pay QUARTERLY ESTIMATED TAXES. This is when you send in checks in June, September, and January (IN ADDITION to April 15) for what you THINK you MIGHT owe at the end of the year. If you overpay, you get a refund; if you underpay, your April bill is bigger. 20/
The reason for this is that the IRS figures people are more likely to pay if they have to pay smaller amounts throughout the year. Do you HAVE to pay quarterlies? No, but you get a (very small) penalty for "late payment" if you don't. Maybe less than $100 (?). 21/
If you otherwise would be put in hardship by paying the tax quarterly, then you can consider that penalty an "interest payment" for keeping the IRS's money a bit longer. BUT making quarterly payments can help you avoid a giant tax bill in April (you might even get a refund). 22/
Is there an income threshold at which you should be filing Schedule C and paying quarterly payments? Consult your tax professional! For a few hundred bucks here or there it may not be necessary. At the thousands of dollars of freelance income level, you are A Small Business. 23/
If you do NOTHING, by default you're a SOLE PROPRIETOR. "Your Name" is the name of your business and your Federal Tax ID number is your SSN. If you don't want to hand out your SSN all the time, you can apply for a Tax ID that is just for tax forms: irs.gov/businesses/sma… 24/
The Tax ID number you get still represents you (as a sole proprietor), but it's not linked to credit scores, loans, etc. Get one, it's free! As a Sole Proprietor, you are In Business but you are just a human being. You pay self-employment tax on your freelance earnings. 25/
"What else could I be?" Well, if you want to have a business name that's not your own, you can file a Fictitious Business Statement, also known as a DBA (Doing Business As). In my area it's administered at the county level. This gives you a DIFFERENT legal business name. 26/
You file a public record that says "I, Joan Smith, am doing business as Fancy Puppy Grooming." Then you can get a bank account in the name of, and cash checks as, Fancy Puppy Grooming. There's a record that points back to you since it's still just you. Taxes are unaffected. 27/
HERE IS THE INTERESTING PART. There is a way, as a freelancer, to AVOID SELF-EMPLOYMENT TAX. You can form an LLC or a corporation, and put YOURSELF on the payroll as your own employer AND employee! Reap those "pass-through" benefits everyone talks about! 28/
An LLC or a corporation is a SEPARATE LEGAL ENTITY that you can be the owner of (or a part owner of). If your job is doing something dangerous that could get you sued, you WANT a separate legal entity to be the one who did the thing, so only the company can get sued, not you! 29/
That is ONE reason to form an LLC/corporation, and it's a whole topic of its own, but the tax benefits for freelancers are another. There are different types of corporations and what you want is probably a Subchapter S corporation or "S corp". It's the simplest. 30/
Giant public companies are usually "C" corps. Their profits are taxed at the corporate level before earnings are passed down to shareholders. Small businesses are usually S corps because only the OWNER is taxed on income, not the company itself. The income "passes through". 31/
The differences between an LLC and S corp are very minor. For Machine of Death we have an LLC because one of the owners (@ryanqnorth) is a citizen of Canada. S corps don't allow foreign owners. So there are rules distinctions like that. Most freelancers can choose either. 32/
For the sake of simplicity I'll say "company" to refer to both S corps and LLCs. I have one of each and the rules are mostly identical. How do you form a company? You go to a law firm like eminutes.com and fill out a form, it's easy peasy. Costs a few hundo. 33/
It's SO easy to form a company that shady people trying to hide the true sources and owners of assets do it all the time! But it can also be used for non-nefarious things. The rules also differ state to state! You can form the company in your own state, or in, say, Nevada. 34/
See, SOME states want your out-of-state money, so they make their company-forming rules VERY FLEXIBLE. For example, you can rent a PO box in Nevada and form your company there. The PO box will forward your mail to wherever you are. Whole industries are set up to aid this. 35/
Why would you form a business in Nevada? Well, in California, companies have a MINIMUM income tax of $800, REGARDLESS of income. In Nevada there is no such thing! So you would save money operating out of Nevada. Or Delaware, or probably some other states. 36/
Every credit card firm is headquartered in Delaware because the laws there are VERY FRIENDLY to giant financial firms (thanks, Joe Biden!). "BUT WAIT," you say, "I thought you could SAVE MONEY by forming a company!" Ah, mon ami, we are getting to that, as Poirot would say! 37/
The rules for STATES vary. A company like eMinutes will form your company and also help with various legal filings that are necessary (for a fee). Your company gets its own Tax ID number and has to file its own tax returns. It issues you an earning statement called a K-1. 38/
California has that grody $800 minimum tax, and those filings and paperwork cost money, but it's STILL worth doing for me because the OVERALL benefit is greater (and it scales). OKAY: so you have a company. Now what? How do you...y'know, use it? 39/
You get a bank account in the name of the company, and pay in some money ("owner investment"). You get a credit card, if you like (I do). You use your BUSINESS accounts to purchase all your supplies and equipment and pay for expenses such as travel and web hosting and so on. 40/
You tell everyone who's going to pay you to pay the COMPANY instead, by issuing a W9 form in the name of the company. You let the company cash checks and receive deposits. Now the company has money, and you own the company! TECHNICALLY, YOU have money! 41/
If you get paid from places like Kickstarter, Kindle, Patreon, Square, PayPal, Gumroad, etc., they all have ways to set up the company as the recipient of funds. If you do freelance work, issue the invoice in the name of the company. Let the company make ALL the money. 42/
You can even do work you would ORDINARILY do as a payroll employee AS A COMPANY INSTEAD. This is called a "loan-out" -- your company is loaning its employee (you) to the other company. Some employers allow it, some don't. But if they do, they pay you your FULL WAGES, no tax! 43/
They assume (rightly) that YOUR company will deduct taxes when the employee (you) is paid. So you get the full amount upfront. OKAY, now the company has money! But now what happens? How do you GET that money as a human being, AND save taxes in the long run? 44/
First thing to realize is that if you are doing enough freelance business to make forming a company necessary (I'll explain the threshold shortly), PROBABLY most of the stuff you do is related to the business. Trips you take, stuff you buy (books, movies, games -- RESEARCH) 45/
Most of that is stuff that the company can pay for. So if the company earns money, and then buys the thing, then YOU as the owner/employee GET that thing. So lots of money doesn't NEED to ever LEAVE the company. You deduct those purchases as business expenses. Of course... 46/
that's true of a Sole Proprietor too. You can deduct business expenses no matter what kind of business you have. But in general just realize that your PAY from YOUR company doesn't need to be enough to cover all the THINGS and EXPENSES you have. The company pays for those! 47/
Of course, you do need SOME pay. You need cash to pay for your personal expenses (rent, groceries, emergency vet visit). If you have a home office or use your phone/internet for work, you can deduct a FAIR PERCENTAGE of your rent and phone/internet bill as a business expense. 48/
You can also always deduct your health insurance premiums as a business expense. (That's a whole other thing, gets into the weeds a bit.) BACK TO YOUR PAY: When you need money from your company, you have two choices: issue yourself a paycheck, or take an owner distribution. 49/
As the owner of the company, you own 100% of the shares. You can make the company issue a "distribution" to its shareholders at any time. This is -- pay attention here -- INVESTMENT INCOME and NOT PAYROLL INCOME. You DON'T pay payroll tax on this money. 50/
(I'll explain in more detail shortly.) The other thing to do is issue a paycheck. You can do this manually or through a payroll service (there are lots of them out there for freelancers). This means you pay yourself as an employee, and deduct the regular payroll tax. 51/
You send that tax to IRS & state, and take home a net amount like any other paycheck. "But wait," I hear you saying, "I thought I was trying to AVOID paying payroll tax?" Thing is, if you ONLY take distributions, the IRS looks askance at that. Besides, 52/
taking payroll is the only way to accumulate Social Security, Medicare, and unemployment credits. You won't want to claim unemployment, but that's the calculation that's used if you ever claim disability or take paid family leave. A small payroll record means less benefits. 53/
So you SOMETIMES pay yourself with a paycheck, deducting taxes, and SOMETIMES take a distribution. And you use the company money to buy yourself anything you need for your business, so you don't need AS MUCH payroll income. At the end of the year, you've got some numbers. 54/
As the owner of the company, you pay INCOME tax based on the company's earnings, because that's profits. This is the "pass-through" thing: the company ITSELF doesn't pay anything (except for weird cases like CA's minimum tax), but the SHAREHOLDERS (you) end up with INCOME. 55/
The reason this matters is because of what is actually being deducted when you are paid via payroll. There are two categories that take a chunk from your paycheck: income tax withholding, and the SSI/Medicare/SDI (disability/unemployment). Only the latter are "payroll taxes". 56/
Those are what you have to pay (double) on ALL your income on a Schedule C as a self-employed sole proprietor. As a company owner and employee, you still pay those on your PAYCHECKS, but NOT on your distributions or other company earnings. 57/
The first category (income tax withholding) is just prepaying your income tax. You always have to pay income tax on everything you earn. But on distributions and company earnings, it's the ONLY tax you pay. Let's do an example to make this clear. 58/
Let's say you, as a sole proprietor freelancer, make $50K in a year. You have to file a Schedule C. You deduct $10K in business expenses, leaving taxable income of $40K. You pay self-employment tax (double payroll tax) on that whole 40K, and then income tax on what's left. 59/
Or let's say your COMPANY makes $50K. You deduct $10K for expenses. You choose to take $15K in payroll, and pay payroll tax (twice, you are both employer and employee still) on that. The remaining $25K is the profit the company made (your payroll is a deductible expense). 60/
You can take some or all of that as a cash distribution (write yourself a check), but maybe not all; best to leave some of it in the company as working capital. The point is you pay income tax on all 40K of revenue, but payroll tax on ONLY the 15K you took as payroll. 61/
THERE'S the tax savings. You SAVE payroll tax on all the company profit that you DON'T take as a paycheck, but you still get to USE the company profit to do things for your business and yourself in your employee role. HERE'S THE RUB: 62/
It costs money to set up a company, and do tax filings, and sometimes there are other expenses such as the CA $800. It costs money to use a payroll service. So those tax savings -- 15% of the margin between your revenue and your paycheck -- have to outweigh those costs. 63/
It's not worth doing if that margin isn't big enough to save you money OVERALL (although there are other benefits, such as liability protection and also the ability to sell all or part of the company, if that has value to you). But if revenue is high, that margin can be big. 64/
My back-of-the envelope calculation (back in 2012, note) was that if you are making over $50K in freelancer income, you might see a tax benefit to working through a company. If you're making less, then the costs and trouble are probably too high to be worth any tax savings. 65/
Mainly because the more money you make, the smaller portion you actually NEED for personal expenses and so the less you actually have to take as payroll throughout the year. But I also LIKE having a company! It helps you keep things compartmentalized for accounting, etc. 66/
That said, I think California is a particularly hard state to stay compliant in -- there is a lot of paperwork and it can be more time-consuming and aggravating to do it all. But that is also true of a sufficiently successful sole proprietor. 67/
It is really frustrating to hear politicians talk so much about "helping small business" and "business friendly climate", etc., when it is FRIGGIN HARD to do the paperwork you need to run a business in accordance with city, county, state, and federal regulations. It's DUMB. 68/
Final caveat, this is all based on my own experience and understanding, please consult someone local and/or smart to answer specific questions in your own circumstance! Also sovereign citizens are not a thing. Thank you for your time. 69/
I'll end with a plug, if you are in California, my sister is a CPA and does my bookkeeping and taxes and does a great job, if you need someone with loads of experience in managing small business/freelancer stuff, I'm happy to pass on a referral. 70/
unroll
Oh I never got back to exemptions -- when you fill out a W4 at a job, you can tell them how MUCH tax to withhold for your eventual income tax bill based on how much you think you'll pay at year's end. If you withhold too little (to take home more), you pay the balance later. 71/
It affects the amount of your check each pay period but not how much tax you actually pay or owe. It's the equivalent of quarterly estimated taxes, it's just a choice to pay in more or less during the year. End of digression 72/
HERE'S THE WHOLE THREAD AT ONCE
