Time to file: The Born Freelancer on taxing matters
This series of posts by the Born Freelancer will share personal experiences and thoughts on issues relevant to freelancers. Have something to add to the conversation? Your input is welcome in the comments.
Death and taxes. The only things certain in life. That and the fact there will be nothing I want to watch on TV when I turn it on tonight. (And of course I know I will always find out the next day that I had just missed something spectacular).
Preparing a freelancer’s taxes can be a bit intimidating at first. I’d like to share some general thoughts with you on this topic which I hope will be especially helpful to the novice Canadian freelancer. (It may or may not be helpful to those living in other countries.)
Caveat: The author is neither an accountant nor a tax expert. You should always seek professional guidance from your local tax office before filing your self-employed taxes. (They have always been extremely helpful to me.) If you don’t you may wish for the other certainty in life sooner rather than later! This blog will not be responsible for any adverse consequences if you fail to do diligent research on your own unique tax-related circumstances. OK, I think it’s now safe to move on…
For the successful working self-employed freelancer, having taxes prepared professionally should always be the first choice. A professional accountant or tax expert will know all the latest deductions and will be able to keep you up-to-date on all the various changes and sometimes conflicting information issued by your relevant tax revenue agency. Using a professional will give you peace of mind, free up your time for your own work and, besides, it is itself a tax deduction.
But like many freelancers you may feel you are not making enough money to hire an accountant. Or you may feel that you have a relatively straightforward tax return to file. In which case you may decide to handle the matter yourself. You should do so only if you are properly prepared and organized. As an incentive to do it correctly remember that it is always usually beneficial to the freelancer to file than not to file for reasons that I will describe below.
Whether you choose to file electronically or the old-fashioned paper way, there are still many general principles that will apply.
Easy as One, Two, Three (sort of)
For most self-employed freelancers, preparing to file your taxes is essentially a three-step process. Step One: Figure out your income. Step Two: Figure out all your legitimate business expenses. Step Three: Subtract your expenses from your income. Pay taxes on the result (or receive a tax refund if applicable). OK, so it’s a bit more complex than that, obviously, but keep those three general steps in mind as you read on…
First up? Documentation. You need documentation of all your incoming fees (T4 slips, invoices, contracts, letters of agreement, etc. I’ve written about the ins and outs of invoices in a previous post). Create a suitable filing system (electronic or old-school paper-based) so you can retrieve them when necessary. Many freelancers still prefer a paper-based accounting/tax preparation system. In the event of a total computer meltdown, at least we have all of our files and paperwork on hand. Other freelancers take exactly the opposite POV — they prefer everything stored electronically rather than waste the physical storage space. Whatever system you adopt, ensure your records are secure and readily accessible whenever you need them.
Next, you need documentation of all your outgoing purchases, costs, and expenses. Remember the invaluable Freelancer’s Three Rs — Receipts, Receipts and Receipts! As a freelancer you need to get into the habit of asking for a receipt for everything. Until your fiscal year is over, you won’t be sure what is an allowable deduction and what is not. Even long afterwards you may need to keep all your receipts archived in order to defend your tax return. Along with the rest of your annual tax forms you will probably need to store them safely for up to a decade depending upon your local applicable tax laws.
What exactly is an allowable deduction? In general, the key principle most of us have learned to follow is this: If you spend money directly in order to make more money, it is a tax-deductible expense (to some degree or another).
Because this approach can often be subject to some degree of personal interpretation, you must think defensively. If your local tax revenue agency calls you in one day for an audit, can you successfully defend all your deductions? You will need to prove not only are all your expenses business related but that there was a significant probability that you would actually make money from the results of having made them. This is an attitude encouraged by most tax agencies to deter mere hobbyists from claiming outrageous deductions. You will need therefore to prove you are serious about your self-employed freelancing status and intent to make money as a freelancer.
Again, documentation is key. Have documentation showing your efforts to obtain work, records of interviews, diaries of phone calls, copies of emails, etc., as well as membership in relevant professional guilds, unions and associations (if applicable). In this way you will be able to demonstrate — if called upon to do so — that your freelancing is a legitimate, genuine self-employed business and not some hobby or idle whim.
You should also consider registering as a business for tax purposes. In Canada this means having what was formerly known as a GST registration number (now known as an HST registration number). In theory, you don’t need to have one if your gross income for four running quarters (essentially a fiscal year) is less than $30,000. In addition to tax benefits, I believe having such a completed registration on file is one more step in demonstrating your commitment to making your freelancing career a successful business.
In addition to your general tax forms you will need to go to your local tax office (or go online) and obtain the necessary forms for self-employed businesses or professionals. While there, get all the information they have on self-employed freelancing as well as all relevant tax-related materials for your own specific career category.
Now that you have all your expense receipts, which ones should be carefully preserved and filed away as usable deductions? I would keep everything until such time as you have definitely proven to yourself that they are not applicable. I write on the backs of all my receipts exactly what they were for and when I made the purchases. This will save a lot of head-scratching later when you try to remember what they were all about. Receipts in categories such as (but not limited to) the following may prove useful when claiming tax deductions:
- Union dues; any professional union or affiliation fees
- Management or agent fees
- Rental or lease of any office or any office equipment
- Office supplies (paper, pencils, etc.)
- Post office expenses (when used directly for business correspondence)
- Advertising (or getting the word out about your business)
- Some travel expenses (when directly related to business travel)
- Dining expenses (when entertaining clients or conducting business; in Canada you are allowed to deduct half of most business meal expenses)
- Subscriptions to business-based publications
- Insurance (on business equipment and properties only)
- Health insurance (check with your local tax office for guidance)
- Accountancy fees
- Any other expenses you can reasonably tie to your freelance work
There may be additional percentage limitations placed upon particular categories of deductions. Read all your tax guides thoroughly for details.
Larger tangible purchases like computers or other hardware used only for business purposes may be deemed allowable capital costs. Each year you will be able to deduct a certain percentage for depreciation. Look into leasing or renting the same equipment, as it might result in a greater tax deduction opportunity. Check with your local tax office for specific details.
Identify less-obvious expenses…carefully
There will also be some expenses that are a bit more complex to pin down. They fall into the category of legitimate business expenses that have personal use components unique to your situation. In these cases you will need to consult with your local tax office to come up with an acceptable business expense percentage to deduct based upon demonstrable, documented usage patterns. Some freelancers will be more aggressive than others in using these expenses to their maximum possible tax benefit. Others will be more conservative. There is definitely some room for personal judgment. I can only advise to always do what is lawfully right for you.
But be warned — even seemingly obvious decisions can be disallowed upon review by your local tax revenue authority. I heard of one television freelancer who had to buy a particular style of wardrobe for his on-camera work. This required a wardrobe quite different than anything he would ever wear in real life. Accordingly his accountant considered the expense as a legitimate 100 per cent tax deduction. He couldn’t go on TV naked, and so in order to do his freelance job he had to make the purchases. But some time later his local tax agency challenged his claim, even though his accountant had approved it. Perhaps he might have fought it successfully in court, but rather than pay a possibly enormous legal bill he let it drop. As a result he then had to pay back quite a lot of money to the taxman. Go figure. But it is a lesson for all freelancers — never make any deduction lightly. Document everything and only submit those deductions you know are completely genuine and for which you are willing to fight. Even so, you may be forced to reassess those expenses if challenged. And if you are ever challenged, contact the CMG or any other guild or union to which you belong right away to see if they have legal advice.
Work-at-home (or so-called “business use of home”) expenses are additional outgoing costs in which the freelancer can often find legitimate tax deductions. If you work from home you need to determine what percentage of your home expenses you use for business purposes. As an old rule of thumb, figure out the actual amount of space in your home used exclusively for your business enterprise and no other purpose. Say you figure it out to be maybe 15 per cent of your total home floor space. So then you could deduct 15 per cent of most of your home-based expenses (heating, electricity, utilities, etc.) that you already pay out in the appropriate section of your return.
All of your income and all of your outgoing expenses should be added up and tracked on a regular monthly basis. While there are all kinds of accounting software out there many freelancers I know still do it quite happily by hand in paper ledgers. Why spend more money than you need to? But if you do, it will be an allowable expense, of course.
Back to the beginning
And so, in summary, we end where we began. When it comes time to file most self-employed freelancers’ taxes it will be a matter of adding up all your income, then adding up all your legitimate, documented expenses, subtracting the latter from the former, and either paying taxes on the amount rendered or receiving a refund when applicable. Based on previous filings you may be asked to file more frequently and you will need to adjust your system accordingly.
In Canada if you registered for a HST number you will also need to file your HST statement on an annual or more frequent basis (again, depending on earlier filings). You may be entitled to a refund. You will first need to calculate the total HST you collected, deducting allowable expenses based on their specific formula, in order to determine if you remit HST or receive a refund. You will receive all the HST-related information you require when you register for your HST number.
The whole concept of doing your own taxes may be daunting to the newbie freelancer, but there is no need to feel intimidated. Take a deep breath! Start with getting all the free advice offered by your local tax office online or in person. You should start early enough (i.e. now!) to collate all your paperwork (actual or virtual), create an accounting system with which you are comfortable, and approach the matter calmly and methodically. You should have no real trouble sorting it all out and seeing to it that you pay whatever taxes you rightly owe. And, just as importantly, you will be able to determine that you don’t pay more in taxes than is legally required. In many cases, you may be pleasantly surprised to discover you are entitled to a refund.
And now, having read this far, if it all seems too much and your head is spinning, I may have done you the biggest favour of all by convincing you to hire a professional tax expert or accountant!
Want info about proving your freelance status and claiming expenses with a personal-use component? Read Part Two of the Born Freelancer’s tax tips for freelancers here.