With tax time nearly upon us, as the April 15 deadline quickly approaches, that familiar old saying comes to mind: “The only certainties in life are death and taxes,” and that’s certainly no April Fools!
No matter which “side of the aisle” you fall on politically, there's no doubt that the middle class gets squeezed with the highest effect tax rate relative to average gross income earned. And most welders, whether freelance, self-employed or employees, qualify as members of the middle class.
Therefore, the more you know about the ins and outs of the tax code, including all the tips and tricks to effectively navigating the often cumbersome tax return process, the less money you will end up having to fork over to Uncle Sam, and more cash you’ll keep in your pocket (where, frankly, it belongs).
Self-Employed as a Freelance Welder
When you make the decision to become a freelance welder, you’re taking the plunge into the world of the self-employed. No more W2 income statements, now all income is accounted for via the 1099 form.
From an income tax standpoint, there are both virtues and detriments to your status of self-employed. The increased capacity to make deductions and greater latitude in appling those deductions is wonderful, but on the downside employment taxes rise, and effectively navigating the tax code without incurring the wrath of the taxman is significantly more difficult than the good ole days of your regular “employee” tax status.
Top Tax Tips for Self-Employed Welders
The following tips for self-employed welders are intended to give you a heads up on how to best manage your finances for tax purposes as a Freelance or Self-Employed Welder. Some of these tips may not help you in this year’s round with the taxman, but are definitely applicable in the future:
Keep Adequate Records
One of the biggest issues tax professionals are really making a point of harping on this year is record keeping.
Filing taxes as a self-employed freelancer already arouses suspicion from the IRS, but to make matters worse, most state governments are broke and running enormous deficits, and the federal government is running the biggest deficit in the nation’s history (and it’s growing daily). Suffice it to say – the taxman is hungry for CASH! And individuals filing taxes with self-employed status are prime targets for the governments taxation hunt.
So, if you want to avoid being audited (which is definitely not fun) KEEP DETAILED RECORDS!
In fact, if you haven’t already done so, reviewing the 1040 tax form Schedule C, which outlines potential deductions, is probably a good idea – a little inspiration to help keep you on a straight and narrow path.
Business Income Vs. Business Losses
One of the biggest benefits of being self-employed is the ability it affords you to deduct your business expenses from you gross income, effectively lowering your taxable income base. On the other side of this coin, however, self-employed individuals with high wages offset by inordinately high business losses represent one of the biggest red flags to the IRS for those filing taxes with self-employed status.
As a freelancer, your profit is the amount of income remaining after you’ve covered all your business expenses. The equation looks something like this: income – expenses = profit. It’s not uncommon for freelancers to show a loss, but if your income is high (especially if it’s above average for your profession – and rest assured the IRS is well aware of the average), and you’re attempting to reduce that income by showing high business losses, you’re heading for trouble.
Showing a business loss year after year is another issue to avoid. If a business shows a loss 3 out of 5 years, the IRS can audit you to investigate whether or not you’re conducting a “hobby” as a business to incur business losses on purpose as a strategy to shelter your gross income and lower your taxable profit base.
Obviously you have to be aggressive with your tax return in order to avoid as much taxation as possible, but be careful, as you might be inviting the kind of attention you would prefer to avoid, i.e. nasty audit by the IRS.
The biggest difference between filing taxes and an employee and a self-employed individual is employment tax.
When you’re an employee, your employer matches or covers half of what the government refers to as your “employment taxes,” which includes: Social Security, Medicare, etc. When you’re self employed, however, you’re solely responsible for those so-called “employment taxes,” which are now referred to as “self-employment taxes.”
Self-employment taxes generally amount to about 15% of your gross income (up to $100,000, after which the rate increases), and ideally you should set this amount aside and pay quarterly estimated returns.
For example, if you estimate you income at approximately $50,000 year, that breaks down to $12,500 per quarter, and you should therefore pay $1,875 for each quarterly return.
By reducing your effective gross income with deductions, however, you can reduce your employment tax, and that brings us to our next tip.
The following is list of typically acceptable deductions for a freelance welder under Schedule C of the 1040 Tax form:
- Advertising – this includes business cards and web-marketing
- Insurance – for life, property & casualty, or business insurance. Do not include health insurance under this category
- Other interest – credit card or loan interest, such as interest paid on an equipment loan
- Legal and professional services – such as fees your accountant will charge
- Administrative expense – billing and invoicing services
- Rent or lease other business property – rent paid for a workshop or storage space
- Repairs and maintenance – repairing your computer, for example
- Supplies – routine office supplies like paper, toner, pens, pencils, notepads, etc.
- Travel – the cost of gas and wear on your car when traveling to jobs in the field
- Utilities – electricity, gas
- Other expenses – such as professional organization dues, web development, and business telephone expenses
Health care premiums are deductible on your 1040 tax form as personal deductions, unless your business shows a loss, in which case your premium has to be deducted on the Schedule A form as a medical expense.
Registering as an S-Corp
This is one of those tips that’s a little too late for this year's tax filing but may be a prudent measure for the future.
An S-Corp is a special kind of incorporation designation for self-employed individuals or very small businesses, which offers the personal protection of a corporation; your personal assets are protected from the legal liabilities and you are relieved of personal responsibility for business debts and losses.
The S-Corporation doesn’t pay taxes, but instead the taxes “pass-through” to the corporate officer – you, the freelance – and are treated like normal personal taxes.
Establishing an S-Corp is less of a tax exemption benefit and more of a move to protect your assets and reduce your legal liability.