In 2005, only 7.4% of the American workforce was classified as freelance or independent contractors, but now, experts predict that by 2020 freelancers will make up over 50% of the American workforce. During the recent economic collapse, many people left the traditional workforce and now work from home in a variety of industries. Some chose to become consultants in their chosen fields, while others decided to rework hobbies into small businesses. Many of these new freelancers are not aware of the various legal requirements of running their own company, and this is where they can get into tax troubles very easily.

The term “freelancer” is a very general expression which denotes someone who works for themself without committing to any long term relationship with any employer. People freelance in almost every category of industry, including any type of journalism, web development and design, translating, video work, engineering, and more.

There are great benefits to working for yourself. You can choose the times you wish to work, how much you wish to get paid (in many cases), see more varied assignments than a traditional employee, and basically control how you wish to work. You, being self-employed, manage your own finances and taxes—you are in control. Personal freedom underlines all that a freelancer enjoys.

These benefits are offset by substantial drawbacks. Often, freelancers earn less than traditional employees, are personally required to meet stringent business obligations such as taxes, and lack traditional employment benefits such as health insurance, sick leave, and retirement. Freelancers are also subject to higher taxes (self-employment tax in addition to the income tax), and the required record-keeping takes a substantial amount of your time allotted to work.

Since about 2009, both state and federal agencies have recognized the growth in this segment of the working populace, and as a result, have significantly increased their oversight of freelancers. “Freelancer” is a generic term, and legally, you will more often see the term “independent contractor” used for freelancers. If you are an independent contractor, you have very specific tax guidelines to follow. Unless you decide otherwise, you are considered by the government to be a “sole proprietor” rather than some other type of legal entity, meaning you are self-employed. All of your income and expenses are reported on your 1040, Schedule C.

The IRS has established guidelines for anyone who wishes to be classified as an independent contractor rather than an employee. Their basic requirement is that you, as freelancer, choose when you work, where you work, and how you work. The employer/client cannot reimburse you for business or traveling expenses, cannot supply you with training to do the work required, and cannot supply you with the tools or materials used by you. Your relationship with an employer/client is always short-term, never permanent, when you are an independent contractor. There is a very fine line between employee and freelancer, and the IRS has defined it very specifically.

As an independent contractor, one of your first duties when considering “for hire” work is to determine that this work is truly for a freelancer rather than an employee. If you decide to accept the assignment, you set the hours of work and you can even hire others to do the work for you that you then pass on to the client. As you keep records, you need to keep your independent contractor income payments separate from any other income that you might have as well as specific business expenses that might be occurred when working as an IC. When paid, and this is the most difficult thing for a freelancer to do, you must set aside money to make your tax deposit on that payment. It requires rigid discipline to keep your taxes current, and this is where most people get into trouble. Not paying your taxes or not paying them in a timely matter will create huge tax and legal problems for you, the freelancer.

So as with any other business, the independent contractor must:
1. Keep complete and accurate business records. Show jobs and payments as well as related expenses.
2. Make sure the categories that you list for your expenses are what are acceptable for the IRS. Using the Schedule C categories will help you to get organized, and you can add any new categories that you might need.
3. Make regular tax deposits with the IRS. You can enroll in the EFTPS (Electronic Federal Tax Payment System), and this will allow you to make estimated tax payments by phone or the internet. Also fill out any necessary monthly, quarterly, and annual forms for government entities in a timely manner.

Being self-employed can be a very difficult way to earn a living, and if you don’t know all of the legal and tax implications of the business actions you take or don’t take, you can easily run into problems with the government. Since independent contractors are under heavy scrutiny at this time by the taxing agencies, it behooves you to proceed carefully when establishing and maintaining your freelance business. Set up your business properly from the beginning, and you will have a greater chance of success.

Once operations begin, if you should receive a letter from the IRS, your next action should be to enlist a tax lawyer. A tax lawyer will work with you and the IRS to resolve any issue. Negotiation is part of the training for the lawyer, and he will have the ability to propose certain resolutions which you, as the subject of the IRS complaint, cannot. A tax lawyer defends you, and can determine the information which shall be given to the IRS (attorney-client privilege). Bringing a tax lawyer onto your team balances the playing field. Any further discussion of tax issues is between the tax lawyer and the IRS agent, rather than the IRS agent and “Joe Citizen.” That tax lawyer knows the ins-and-outs of the tax laws which affect independent contractors, and can advise you as well as defend you. It is always better to consult a tax lawyer sooner rather than later, and let them keep the dragon under control.