Running your own freelancing business, whether it be a side gig or full-time job, brings you a lot of freedom. Being your own boss, setting your own hours, selecting clients, and choosing what projects you want to pursue or pass is exciting. The 2019 Freelancing America survey states that 35% of the American workforce, about 57 million people, pursue freelance work, whether it is temporary, a side gig, or a long-term career path. But running a freelancing business isn’t all fun and games. It does have its share of challenges. From negotiating prices, securing work on a regular basis, and paying taxes. As a freelancer, you are self-employed and responsible for knowing your tax obligations and determining how much and when to pay. As a freelancer, you must have a basic understanding of accounting and freelancer taxes.
Taxes for freelancers are substantially different from those for employees. If you want to prevent having a fatal encounter with your freelancer taxes, you must be aware of the procedures you must take throughout the year and during tax season.
We’ve prepared this tutorial to assist you understand the challenging world of taxes for independent contractors so you can really step up your tax game in the upcoming year.
Just bear in mind that while we’ve done our best to make sure this material is current and correct, it is not intended to be, and should not be regarded as, legal advice. It’s always advisable to seek advice from a tax professional or attorney who can point you in the proper direction if you have any tax questions.
The Basics of Freelancer Taxes
As a freelancer, if you earn $400 or more in a year, the Internal revenue service considers you as self-employed and requires that you pay taxes as a business owner. You will be responsible for paying a 15.3% self-employment tax that represents the Social Security and Medicare taxes that would normally be taken out of your paycheck if you were working as an employee. Additionally, you will also pay the half that is typically covered by an employer. You will also need to pay standard income taxes based on your tax bracket and filing status.
Instead of a single W-2 form that you would get as a traditional employee, as a freelancer, you will receive a 1099-MISC form from every client that pays you $600 or more in a single year. You report your 1099-MISC income on a Schedule C attachment on your tax return.
If you expect to owe more $1000 or more in taxes, you are required to pay estimated taxes quarterly as well. This can be convenient because you are basically paying as you earn, rather than having a large tax bill come tax season. Depending on where you live, you may also be required to pay state income taxes as well as local taxes.
Determine Your Business Structure
When you first establish yourself as a freelancer, you need to determine what your business structure is. You can choose an LLC, S-corp, or Sole Proprietorship. Each has its own legal structure that affects not only your personal assets but also how much you will owe in taxes. Most freelancers file taxes as sole proprietors. They simply file a Schedule C form that integrates with their personal tax return.
As your freelancing business grows to making thousands in profit, you may want to consider filing as an S-corp. This filing status is a bit more complicated but could offer tax benefits.
A sole proprietorship is a great option and the easiest for new freelancers. But it comes with a risk. Your personal assets could be in jeopardy if you were to be sued. A corporation is a lot more complex than a sole proprietorship and comes with set up fees, but it protects your personal assets.
A freelancer who forms a corporation or LLC will be required to pay unemployment tax, federal and state taxes, and half of the FICA tax. But, they may be able to protect some of their income from the self-employment tax. Determining how to structure your business can be complicated and confusing depending on your type of business. It could be beneficial for you to get the advice of a tax professional.
Estimating Quarterly Taxes
The easiest way to gauge how much you should pay quarterly is to refer to your last year’s tax return and divide the total amount you owed by four. If you are a new freelancer, you may not be able to estimate your tax obligations accurately. A good rule of thumb is to set aside 20% of your earnings to cover taxes. If you over or underpay, the IRS will issue a correction when you file your tax return. You will either be asked to pay any missing taxes or be issued a return for paying more than what you own.
Be Sure to Declare all of Your Business Income
As a freelancer, you should receive a 1099-MISC form by the end of January from any company that paid you more than $600. However, this isn’t always the case, and more often than not, you won’t receive one. However, whether or not you receive a 1099, you are still responsible and obligated to report all of your income, including cash payments.
It is essential that you keep accurate records of all income and expenses. If you were to ever be audited, you would need to account for any unreported or underreported income. You should cross-reference all your own accounting against the numbers on the 1099s that you receive. Companies can sometimes make mistakes, and you don’t want to be responsible for paying taxes on income that you didn’t receive.
Always File Freelancer Taxes and Pay On Time
Make sure you pay your taxes on time and file accurately, even if you can’t afford to pay your tax bill at the time of filing. There are IRS taxpayer programs that allow you more time to pay and even offer monthly payment plans. But you must be in good standing with the IRS by always filing your taxes accurately and on time.
These are just some of the basics of freelancer taxes. Depending on your industry and how much money you make, there could be a lot more factors, such as retirement savings and deductions. It can be frustrating trying to work through the tax processes and can even seem unfair at times. But if you understand your taxes and the requirements set for by the IRS, pursuing a career as a freelancer is worth all the trouble.
Before you file, be aware of your deductibles.
Each April, a lot of independent contractors miss out on key tax breaks and perks because they are unsure of what they are and are not allowed to write off. According to a Xero survey, 35% of independent contractors have trouble understanding and paying freelancer taxes, and 73% don’t deduct any expenditures at all. A tax expert may provide you guidance on how to reduce your tax obligations as well as assist you in locating tax credits and deductions.
It’s preferable to speak with a tax accountant that specializes in 1099 contractors, because they can help you discover deductions you didn’t realize you had, lowering your tax bill and assisting in the avoidance of tax debt.
Home office space is a frequent deduction used by independent contractors.
- Vehicle costs.
- travel costs.
- Phone and internet bills.
- health protection.
- office equipment.
- software and hardware.
- promotional materials
- professional or legal services.
- Hired labor.
- taxes and licenses.
- meals for work.
You might qualify for the home-office deduction, for instance, if you operate from home as a freelancer. This enables you to deduct costs such as utilities and rent for the area of your home that you use as your main office. However, the space must only be used for business-related activities; as such, if your family room doubles as your workstation while the kids are at school, it does not qualify for this deduction. However, if you are debating between setting up an office at home or renting a location outside, be aware that home offices have some tax advantages.
As a freelancer, don’t count on receiving a tax refund.
Absolutely everyone enjoys receiving a tax return. However, as a freelancer, you must accept that it is unlikely that you will encounter one. When you work for an employer, taxes are deducted from your pay automatically, and if you overpaid the government for the year, you might be eligible for a refund. Since you are the one paying in the money you owe, if you work for yourself, this is less likely to occur.
Freelancers only receive refunds in one of two situations, either they overpaid their quarterly anticipated tax payments or they earned so little money for the year that they are eligible for an earned income credit (EIC), which is a tax credit for low-income taxpayers.
Taxes for Employees versus Freelancers
You don’t have to stress too much about taxes if you’re an employee.
This is due to the fact that your company determines how much needs to be deducted from your paycheck. The IRS and the state tax authority are then directly paid those freelancer taxes. The only thing you have to do is submit an annual tax return.
But what occurs if you work for yourself as a freelancer? Since you are now an independent contractor, no one else is taking care of your tax obligations on your behalf.
Since you must file periodic tax returns and pay your taxes directly to the IRS and your state, things can rapidly become complicated. Oh, and you’ll also need to figure out your debt.
Additionally, you’ll need to maintain complete records of your business’s revenue and outlays in order to make the filings. Not to mention that you also need to file your annual tax return.
The fact that you will be reporting more than just the amount on your W2 makes tax season more challenging on top of everything else. Instead, you must record and deduct all of your freelance revenue.