Freelancers, independent contractors, and taxes

It's easy to imagine freelances having the most elegant of lives.  They work at a wood table in a trendy cafe, fingers poised to create something amazing on their Macbook Pro - and get paid for it!  The reality is freelancers are always hustling; hustling to finish a job, hustling to find more work and hustling to keep up with the ever changing taxation regulations.

Freelancers have at least a couple tax issues they need to understand. The first, and most obvious, is that of income tax. We'll mention that briefly below, but the other is sales tax. Depending on the type of freelance work you are doing, you may find yourself selling taxable goods that require sales tax to be collected and remitted to state or local taxing authorities.

According to the IRS, freelancers, along with consultants, are both classified as independent contractors. Independent contractors are generally thought of as those individuals who are contractually obligated to perform a service while not having the legal status of an employee. The IRS offers the following definition, "an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done." From the IRS perspective being an independent contractor is defined mostly by the level of control the payer is granted.

If you are in doubt, you can ask the IRS to make the determination by filing Form SS-8.

Freelancers are often referred to as 1099s (the tax form you will receive from your client at the end of the year).  The freelance contract you sign with your client clearly states that you are responsible to pay all taxes.  Some freelancers work on projects on a W2 basis.  The client will withhold taxes and at year end will provide a W2.

Tax rules are constantly changing. Many states allow you to register your email address and they will send you updates to the tax laws. New York, Washington, and Massachusetts have this capability. The downside is you have to wade through information that may not be pertinent to your business. California Sales Tax Rates and other useful links are on the State Board of Equalization webpage. Texas allows you to subscribe to Tax Policy News to get the latest tax updates.

Depending on the type of work a freelancer is engaged in, sales tax may need to be collected. Understanding how the states you are working view your sales tax liability is crucial to being on the right side of the law. Moreover, every state requires businesses selling taxable goods to register for a state sellers permit prior to their first sale. Finally, any sales tax that is collected must be remitted (paid) to the state on an assigned frequency (typically monthly, quarterly, or annually).

When in doubt, consult a CPA to help you get set up.

The selling of ideas is not taxed. For example, if you meet with a client and discuss how to set up their new Shopify store and they pay you for your time, you haven’t sold anything tangible so the meeting isn’t taxed. If, however, the meeting is a so-called "working meeting" where tangible goods are produced (a marketing plan, a prototype, packaging, etc.), you should review the rules on collecting sales tax.

Generally speaking, if you are selling tangible goods in your state you need to pay sales tax. What is a good? Whether or not a specific tangible good is taxed is unique for every state. As an independent contractor, you should be knowledgable of the sale tax laws for the goods you are selling in the states you are selling them.

A good example is that of art or music. If your client orders a printed drawing from you for example, the drawing is a tangible good and thus taxed. If that drawing, however, is delivered digitally, (through email, Dropbox, etc.) it may or may not be taxed depending on state level laws. A digitally delivered asset falls under the category of digital service and the rules vary vastly state to state.

If you are a remote freelancer your relationship with your client may create nexus (physical presence) for your client. If this is the case your client would be required to pay sales tax in the state you are working from. This may not be a concern of yours, but it's good to understand and communicate so there aren't any surprise moments for your client.

Websites may have links or advertisements that provide click through revenue. A good example is the Amazon Associates program. Through it website owners (often bloggers or product reviewers) can host Amazon ads aligned with the content on the page. Click throughs that result in purchases lead to a small cut of the sale being paid to the website owner.

Participating in an affiliate program like that of Amazon usually requires a W9 to be completed at the beginning of the relationship.  The commissions you receive do not have taxes deducted from them. These commission checks are considered income and taxed by the IRS accordingly. Affiliate marketers are strongly encouraged to set aside a portion of their earnings to cover their tax requirements.

What constitutes nexus varies from state to state.  Some states consider an affiliate link as creating nexus in that state. For example, you might work in Minnesota and run your popular website from there.  If you have a link on your website to purchase a product from another company, and a customer purchases the product from this link, in some states you have created nexus.  The seller of the product is now required to pay sales tax in that state. Some companies opt not to do business in states where affiliate links create nexus.  The taxation of affiliate links is rife with controversy.