Freelancing and Taxes: Info on How to Avoid an Audit, How/What to File if You Live Abroad & More

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April 12, 2011

In the U.S. this Friday, April 15th is T-Day (Tax Day). It might as well be D-day for some of us, no? But, I digress.

If you freelance, taxes are probably one of those things that you deal with in one of two ways:

(i) You put them off until the very last minute and hope that good ole Uncle Sam stays out of your wallet this year (not a good strategy for fiscal success as a freelancer. Trust me, I know; or

(ii) You plan for tax season all year long so they don’t come back to bite you in the arse come April.

Freelance Tax Questions

Every since February, I’ve been getting questions about freelancing and taxes (some people are so early and organized – aarrgghhhh!). So, I reached out to some pros to get some solid info. Following are a couple of  the emails I’ve received that kind of summed up what most wanted to know, along with answers from some tax professionals.

Question #1: Received on 2/18/2011

freelance-taxesHi Yuwanda,

Thanks for the update on your life in Jamaica-it looks very beautiful there. I don’t think I mentioned this to you before, but I currently live with my wife’s family in the Philippines. I have lived here for 3 and 1/2 years.

We moved here out of necessity-we are adopting a non-orphan child and the only way to complete it was to live in this country for 3 years before starting the adoption. It is now moving through the courts and should be completed soon.

For most of the time here, we’ve been living off our savings, while I’ve been searching for a way to make money online to help support us. Thankfully, a friend I met in one of the forums . . . recommended your ebook [on SEO writing] to me and has been mentoring me on much of the details ever since, which has helped me to reach the point now where I have consistent weekly cash flow.

The reason I mention all this is I wanted to know what you know about the tax implications of living abroad. I have heard that if you are a US citizen and you live abroad, you are exempt for like the first $90k or something in income. This has never been an issue in the past, but this year it definitely will be.

When I read the IRS regulations on this, they are a bit confusing (no big surprise there). I was wondering if you could post sometime about how you handle your taxes and if you are able to qualify for this tax exemption.

 PL

Question #2: Received on 2/20/2011

Hi Yuwanda,
 
Just a question for you…are you required to submit taxes on your freelance earnings while living in Jamaica? Also, do you know much about whether a Jamaican freelancer (like myself) based in Jamaica would need to file taxes for my freelance writing earnings?
 
Thanks,
C-

My Quick Answer to Freelancer on This Question (See More Details from Tax Pros Below)

C-:
 
As a U.S. citizen, I am required to pay taxes on my earnings. I’m not sure about Jamaica’s laws; every country has their own. Consult a tax attorney in your country to find out.

FREELANCE TAX QUESTIONS: ANSWERS FROM PROFESSIONALS

When questions started coming in about this, I reached out to Sam on Twitter (@CanTaxPro), who was generous enough to send in a detailed response. Following is what I asked.

My Question to a Tax Professional about Freelancing and Taxes

Sam:
 
First, thank you for getting back to me. I know you must be swamped  this time of year and I really appreciate your time.
 
The reason I wanted to contact you is because I ran an SEO writing company and . . . particularly as SEO writing has grown, more and more of us are working abroad. For example, I’m American, but spend about half the year in Jamaica. One freelancer sent in the following question. Can you shed some light on this?
 
 QUESTION SENT IN BY AMERICAN FREELANCE WRITER LIVING IN THE PHILIPPINES
 
  . . . I want to know about the tax implications of living abroad. I have heard that if you are a US citizen and you live abroad, you are exempt for like the first $90k or something in income. This has never been an issue in the past, but this year it definitely will be. When I read the IRS regulations on this, they are a bit confusing (no big surprise there).

I was wondering if you could post sometime about how you handle your taxes and if you are able to qualify for this tax exemption.
 
To put it succinctly, what should freelance writers who live/work in another country know when it comes to taxes?

 Sam’s Answer

OK Yuwanda, here you go.

I have clients all over the world who are dealing with complex tax issues. Taxes on foreign income is a very common issue in my practice. Anyone needing help on this subject should feel free to contact me through my website, http://taxsupport.ca.
 
Hope the following helps.
 
Tax Info for US Citizens Living Abroad
 
In recent years, many U.S. citizens have left the U.S. and started settling and working from foreign lands. The advent of technology has made it easier for those working from anywhere to keep in touch with customers.
 
Working and living abroad has significant tax implication for U.S. citizens. If you are a U.S. citizen, you must report and file your income tax every year to IRS. Your income must include income from all sources — within and outside the USA. In tax terms, it is referred to as worldwide income.

As an aside, besides the USA, I think only North Korean citizens have to report worldwide income to their government.

Amount of Foreign Income That Is Exempt for U.S. Citizens Living & Working Abroad
 
For U.S. citizens, part of their income from foreign sources are excluded for tax purpose. The specific amount varies each year. For [tax year] 2010 this amount is $91,500. Any foreign income over that amount will be taxed at the marginal tax rate for the individual tax payer.

Additional IRS Forms U.S. Citizens Living & Working Abroad Must File – or Face Severe Consequences
 
Beside income tax filings, U.S. citizens living abroad must file several complicated informational tax forms to the IRS every year, whether they have to pay taxes or not.
 
Along with IRS Form 1040 and Form 2555 (Foreign Earned Income Exclusion), US Citizens must file Form TD F 90-22.1 (A report of all foreign bank and investment accounts). There are severe consequences for not filing Form TD F 90-22.1, including penalties, interest and prison time.

U.S. citizens living abroad who have to pay taxes on their foreign income should restructure their income to keep it tax exempt. Consult a tax professional to learn how to properly do this.

More “Food for Thought” Tax Info for U.S. Citizens Living & Working Abroad
 
Here is blog post that may interest your readers about citizens living abroad and how to avoid/lower their tax burden: http://www.taxsupport.ca/want-to-avoid-tax-denounce-your-citizenship/.
 
About Sam: Sam is a US/Canadian tax professional with 12 years experience of working with U.S. expatriates and duel citizens. Find him online at Taxsupport.ca and on Twitter at #cantaxpro. Learn more at Super Sam.
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Advice for Freelancers on How to Avoid an Audit: Insight from a Second Tax Professional for Freelancers

Last year, Outright.com provided readers here with some valuable info just in time for tax season. This year, they did it again. Jennifer Escalona, the [Social Media] Community Manager at Outright sent me the following email a couple of weeks ago, writing:

Did you know the IRS compares the deductions on your Schedule C to others in your industry and if yours are unusually high, they can flag you for an audit?

I’m writing to you because you covered Outright.com in the past on Inkwell and we thought, here at tax time, you and your readers might be interested in our newest widget, which allows you to compare your deductions against the averages of other businesses in your industry.

Freelance Tax Calculator: See – and Fix — “Audit Red Flags” before the IRS Does

It’s based on government info, so the “governmentese” isn’t as small business friendly as we would like, but it’s an interesting snapshot of U.S. business and income. And if you compare it against your Outright Schedule C (using this form of an income tax calculator that compares deductions), it can show you any red flags before the IRS sees them!
###

That wraps up what the professionals have to say about freelancing and taxes. Following is one more piece of info to help you weather tax season this year.

Freelancing? Taxes Got You Over a Barrel? File an Extension

If you’re not ready to file taxes by Friday (April 15th) – either because you’re too swamped with deadlines, don’t have all of your paperwork (eg, a missing 1099 from a firm you did contract work for), are travelling (me!) or just don’t want to deal with taxes right now, you can get an extension to file your taxes. And, it’s free to do so online.

Note: This does not give you any more time to pay; if you owe and you file an extension, you could incur penalties if you don’t pay up – on/before April 15, the tax filing deadline.

“But,” you may be thinking, “how do I know what I owe until I file?” Ahh, same question I had years ago when I first filed an extension.

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Freelancing and Taxes: What Filing a Tax Extension Does NOT Mean

The government gives you more time to do the actual filing, not compute your taxes. Hence, they ask they you send in an estimated amount due because they assume that you’re a great little recordkeeper and know more or less what you owe them.

The extra time allotted is for you to gather the paperwork and/or handle the other reasons you might not be able to do the actual filing (eg, get back from wherever you are outside the states, gather missing 1099s, get receipts in order for the deductions you claim, etc.).

In short, they want the monies you owe them by April 15th, or you will be assessed penalties.

The good news is, if you wind up not owing and you’ve filed an extension, there are no penalties or fees (ie, they’ll gladly hold on to monies they owe you, but they don’t want you holding on to monies you owe them).

Dont’cha just love Uncle Sam?!

And that’s the skinny on the freelance tax situation this year. Hope the info helps and that you get a big fat refund!

Sincerely,
Yuwanda
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3 Responses to “Freelancing and Taxes: Info on How to Avoid an Audit, How/What to File if You Live Abroad & More”

  1. jen says:

    So by foreign income, we mean income earned from foreign clients, right? Not an American who has American clients who decides to pick up and move to Europe for fun? That distinction is an important one that I need clarification on. Regardless of my physical location (New York, Cairo or wherever), if my income generated by three clients in Los Angeles, it’s NOT foreign income, correct?

  2. Yuwanda says:

    Jen,

    RE “by foreign income, we mean income earned from foreign clients, right?” No.

    “Foreign income” does not apply to where the company is located; “foreign” applies to your country of residence.

    For example, I’m American, but I live in Jamaica part-time and work with clients all over the world.

    BUT, as an American resident, I must report all of this income to the IRS; it doesn’t matter if the client is from Australia, Canada or Ireland.

    This is because my country of RESIDENCE is the United States.

    Check with a tax professional in your area. But, I think it’s if you live outside the U.S. for 6 months or more, then a certain amount of your income is exempt from U.S. taxes; for tax year 2010, it’s $91,500 as Sam stated in this post.

    Hope this clears things up.

  3. td insurance says:

    Thank you for writing this article. It’s good to have people out there letting us know what’s going on. Sometimes you have to wade through the chatter to get to the good stuff. Great post, thanks again!

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