Sep 16

Extremely Important Tax Rules for Freelance Designers in the United States

Wed, 09/16/2009 - 01:44 — julie

Do you have to pay taxes on earnings you make online?

I’ll make this short and sweet: YES! If you live in the United States, you owe taxes on any money you make, whether it be online, offline, or in some alternate universe that the IRS has an ability to track (and they will be able to track it, I promise).

Contrary to what your best friend’s cousin’s sister-in-law’s friend Bob may have said, money made online isn’t different from money made anywhere else. In fact, the only difference between the money that you make online and the money you might make from a US business is that the online company (ie: Envato) won’t be sending you a 1099 at the end of the year – which means it’s your responsibility to record those earnings.The fact is that you are responsible (by law) to report and pay taxes on all income, regardless of its source.

A short preface: This article includes information that is specific to the United States of America’s tax laws only; if you live in another country or are not a US citizen, you’ll need to do your own research. Furthermore, I urge everyone (including US citizens) to speak with your own CPA regarding your specific tax situation; This article is only intended to lay out the generalities of this particular subject, and the advice given here may not be right for you. I am not a professional tax expert. However, to write this article, I did a LOT of research into tax rules. I also personally interviewed a handful of professional CPA’s (the folks in America responsible for actually navigating our tax law) just to be sure that I’m not blowing smoke. Like it or not, what follows are the facts regarding how the US government treats income made from online sources.

Rule Number 01: You Owe Taxes on Everything you Make.

In the US, you are required to pay taxes on any income that you receive, even if money is passed through Paypal accounts or is sent from a foreign entity. Let me be clear: As a United States citizen, you are responsible to document and pay taxes on quite literally any income that you make, ever.

It gets worse though: not only do you owe federal and maybe state taxes, you also owe Social Security & Medicare taxes! How much is that? Another 15.3 percent on top of whatever you already owe for the federal and state taxes. So, depending on how much you make in a given year, you likely owe somewhere between 40% and 50% of it back to the government! If that’s not that the financial equivalent to a punch in the stomach, I don’t know what is.

In my own case, I actually owe about 52% of my income back to Uncle Sam. Yikes! That means that out of the $200 that I was given to write this article, I get to keep just $96. That’s right – the IRS gets to keep $104 of my fee for writing an article that basically tells you to pay them. You’d think I’d get some sort of an IRS kickback… nope, but if they did offer me a kickback, you can be sure that they’d want to tax it.


Rule Number 02: Don’t Think you Can Hide it; Don’t Even Try.

Some have alluded to the fact that money moved around online is somehow able to evade the reach of the IRS. This simply isn’t true, and acting as though your online accounts are magical tax shelters is one of the quickest ways to place yourself into the boiling cauldron that the government calls “tax evasion”. The IRS considers a failure to report income from these accounts a crime – punishable by fines, interest, and imprisonment.

Paypal hasn’t ever officially reported income to the IRS… until now: Starting in the year 2010, Paypal is required by the US government to report all earnings over $20,000 a year. That might seem like a lot of dough for some of you… I can already feel a few of you breathing a sigh of relief. Wait, wait, wait! $20,000 is just the start – in the future that number can almost be guaranteed to drop as low as $200. What’s more is that that number represents all money going in and out of your Paypal account, NOT your total income for the year.

There’s also no guarantee that if the IRS is auditing you, that Paypal or any other company won’t be subpoenaed for records from previous years, which very well may still bind them to turn over past records even if they don’t officially do this on a yearly basis. Rather than play dumb or hope for less income, your best bet is just to assume that your records are completely visible to the IRS. The IRS is not naive to your Paypal or any other account with your name attached to it.


Rule Number 03: What the IRS Doesn’t Know Only Makes them Curious.

Now initially, the IRS will not necessarily know whether transactions made across Paypal are taxable because it can be used for so many things… but the IRS will still have full access to that information, which they can then investigate further if they think it is appropriate to do so. Chances are, the moment your name shows up on that list, the IRS will be undoubtedly more critical of your reported earnings in past years unless you’ve been diligently declaring your online earnings. The IRS can audit you for as far back as 7 years… that’s further back than a lot of us can even think.

It’s not just Paypal either. The IRS might be slow to hop on the online bandwagon, but once they smell blood in the water, you can be sure they’ll go into a frenzy. If I were a betting man, I’d say that most online transaction websites will be under intense scrutiny within the next few years (if they aren’t already).

Despite the temporal success of places like The Pirate Bay, these supposedly private sites just won’t be able to fight the IRS. If Swiss banks can’t fight them, what makes you think Payoneer or Google Checkout will? If the Pirate Bay were up against the IRS, that ship would have sank years ago – thank the pirate gods that the RIAA isn’t nearly as competent in their ruthlessness as our wonderful revenue service.

The notion that the IRS doesn’t know how to track online sources of income and therefore don’t care actually backfires in this case. Instead of shrugging and going on their merry way, the IRS is actually more likely to scrutinize anyone with a decent amount of income or expenditures online. Why? Because the IRS is inherently untrusting of citizens, and with every other guy on the street having his own personal brand of tax-evasion philosophy, you can imagine why.

This means that instead of being less-mindful of your online money management, you should actually be MORE mindful. Print receipts, invoices, payment stubs, etc. The IRS will very politely demand them if you are ever audited. If you can’t provide proof of what you actually earned/spent – the IRS will be kind enough to tell you what you earned using their own fuzzy logic, then hand you a bill for more than you probably make in a year.

Conclusion: Just Do It

Many people think that by just not doing the proper paperwork, you somehow fly under the radar of the IRS. Let me be clear about this: this strategy is only good until it fails (and let’s just be safe and assume that it will fail in the next 50-80 years of your life); and when it fails, it will blow your life into a massive pile of stink that most people wouldn’t touch with a 100 ft pole (even on the internet). Like my momma used to tell me: Evading taxes is real funny until someone gets stuck with a bill for $200,000 in back taxes + penalties and interest.

So What Can You Do?

To save yourself from fire, brimstone and tax debt, it’s not hard. Start with these steps:

1. Find a CPA that’s right for you. Your CPA can help you to maximize your deductions and keep as much of your hard-earned money in your pocket as possible. Check out this article on how to do this.

2. If you haven’t already, file your formal business declaration paperwork. Every state has different rules, so do the research (or better yet, let your CPA do it) and file the paperwork that’s right for you.

3. Get a bank account specifically for your business.

4. Begin documenting and saving all financial paperwork, from that receipt for ball-point pens to the invoice for your new liquid cooled computer, to the payment stub from Envato for your monthly earnings.

5. Report all of your earnings on your next tax filing. Yep, all of them. Then put the copy and all of your paperwork from step 4 for the year into a folder. Save it in a safe, dry place for at least 7 years.

6. Consider making quarterly tax estimate payments. Your CPA will tell you about these.

Finally, if you live in another country, seek out the professional advice of whoever it is in your area that is an expert on tax-law and filing taxes. While the specifics of your country’s tax laws might be different, there’s a good chance that your government still wants you to, at the very least, declare your income – my best guess is that they’ll want to tax it as well! Seek out a pro, get their advice; you’ll be better safe than sorry.

Don’t Shoot the Messenger!


I’m an author at ThemeForest (check out my account here) and I’ve been freelancing for about 6 years now for various companies both inside and outside the US. I also live in California, which boasts some of the highest taxes of any state in America, so believe me, this article has been written with as much sincerity and honesty as you can imagine.

Copyright 2009. E-mail Me
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