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Freelancing: The Tax Implications

A freelancer does work for another individual or business without an employment contract, often on an as needed basis.  Generally the term freelance is used for work that could be done by an employee, but is contracted out instead.  Journalists, online content marketers, and social media influencers are common examples of freelancers.

The tax implications of being a freelancer are essentially identical to owning a business, just without the headache of having employees. So whether your sole source of employment is freelance work, or you freelance to earn extra income on the side, you have to follow a radically different tax regiment than an employee.

The bottom line is that income from freelance work can be offset by expenses incurred in order to do the work, subject to limitations.  The deductibility of expenses is a large benefit for many freelancers.  One difference between a journalist who works remotely as an employee and a freelancer is that the freelancer can deduct portions of costs related to the freelance work.  Some examples are internet expense, continuing education, equipment purchases, and even certain meals and travel.  The employee cannot deduct those expenses even if they are not reimbursed by the employer.

One major downside to being a freelancer over an employee is that a freelancer pays both sides of self-employment tax.  An employee only pays half, and the other half is covered by the employer.  However, the extra tax hit from self-employment tax is partially offset by the new 20% business income deduction put in place by the Tax Cut and Jobs Act(TCJA).  There are limitations to who can tax the deduction and how much it can be, but for most freelancers up to 20% of the bottom line is an additional income tax deduction.

One issue for freelancers to keep in mind is the IRS distinction between a hobby and a business.  If the freelance work yields profit for tax purposes, this work is generally seen as business activity.  If the work results in a tax loss, however, the IRS can determine that the work done was a hobby.  In essence if the IRS determines that the freelance work is a hobby, expenses can only offset income.  That means that any loss is disallowed.  The IRS distinguishes a hobby from a business using nine criteria — with record keeping and intent for profitability among them.

Most freelancers are merely sole proprietors, which yields the simplest tax filing regiment.  Income and expenses are reported on Schedule C of the 1040.  Things are more complex for a freelancer that is partners with one or more other people, or has chosen to be taxed as an S Corp.  In those cases additional tax returns need to be prepared, and payroll may be required.

Taxes for freelancers can become complex quickly, especially with the changes made by the TCJA.  A tax professional can help navigate this complexity.

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