Special for Freelancers: Essential Tax Rules for 1099 Workersby
Most freelancers are “cash basis” taxpayers. That’s IRS jargon for, among others, writers who have to declare advances and royalties for books and payments for articles in the year that they actually receive them. Similarly, the IRS generally forbids freelancers from deducting business expenses and other allowable outlays until the year that they actually pay them. Cash-basis taxpayers are also subject to "constructive receipt" rules that require them to declare as income amounts that, though not actually received, have been credited to their account (interest on savings, to cite a common example), or made subject to their control or set aside for them. How does the IRS apply these requirements to a hypothetical freelance writer we’ll call Charlotte Vale?
Let’s say that Charlotte, who’s based in New York City, is immensely prolific and successful. In almost all years, her big month for earnings is December, when she receives lots of checks from book publishers for royalties or advances, and from magazines for articles.
In most years, Charlotte’s publishers mail December payments early in the month, and she deposits them in the middle of the month. But 2014’s Christmas crunch considerably slowed deliveries for her neighborhood. It wasn’t until three days after Christmas that the payments plopped into her mailbox. The delivery, unfortunately for Charlotte, happened right after she left home for a flight to Honolulu, where she remained for a few weeks. It was well into January of 2015 when Charlotte first became aware that her mailbox was stuffed with December-dated checks.
Charlotte asked the IRS to determine the right income tax return to report the payments as income. Is it the 2014 return? Or the one for 2015, the year she returned home to discover an accumulation of mail? One tidbit that Charlotte kept out of the conversation was that if she had her druthers, she’d prefer 2015.
Why does she want to know, when all of the payments count as reportable income anyway? What prompted tax-savvy Charlotte to inquire is that she wants to keep more money in her pocket and out of the IRS’s till. She anticipates that her income from writing and other sources (and tax tab) for 2014 will be higher than for 2015, when she intends to scale back on writing assignments. Charlotte will lose lots less to the IRS if it allows her to move a significant amount of income out of higher-bracket 2014 and into lower-bracket 2015.
For the IRS, the answer was a no-brainer. The law doesn’t allow Charlotte to game the system. She must report the payments as income for 2014, when the checks were dated and delivered. Too bad for her that she was five thousand miles away when the payments arrived.
Some filing reminders for Charlotte and other freelancers. Every January, Charlotte can count on receiving additional mailings from publishers. Each of them sends a Form 1099; this time around, all of the forms will show that they’re for 2014. The next step in the information-reporting process is that the publishers have to send copies of the forms to the IRS and, in Charlotte’s case, to New York State’s Department of Taxation and Finance. The federal and state tax collectors then match those forms to her Social Security number.
Before Charlotte fires off a return, it’s prudent to first make sure she includes all payments received for the year in question in the total figure shown on the line for gross receipts on Schedule C of the 1040 form. There’ll be trouble ahead if the amount of Schedule C receipts that she declares differs from the figures shown on her 1099 forms. The IRS’s computers are going to notice the discrepancy and ask her to account for the difference. Should Charlotte be unable to do so, she’ll be dunned for additional income taxes, self-employment taxes, interest and, perhaps, penalties on the unreported payments.
Why self-employment taxes? Because they’re more low-hanging fruit for the computers. An increase in the amount shown for gross receipts doesn’t just increase the amount shown for net profit on Schedule C, thereby increasing the amount of writing income subject to income taxes. It also increases the amount of writing income subject to self-employment taxes.
Worse yet, the IRS might decide to question other items on her return. It might also take a look at her returns for earlier years.
Charlotte’s tax travails aren’t ended, even if the IRS contents itself with collecting income taxes and self-employment taxes on the unreported income and asking no other questions. It routinely shares information with New York State and other states. So Charlotte should expect to be billed by New York State.
About the author:
Julian Block writes and practices law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator) and an attorney. More on this topic is available from “Julian Block’s Year Round Tax Strategies,” available at julianblocktaxexpert.com.