Freelancing offers freedom but also a significant responsibility. That’s especially true when tax time rolls around.
You must report $400 of income from a single employer as a freelancer on your yearly tax return.
Your company can save hundreds of dollars by working with a tax accountant.
Saving money and avoiding tax audits depends on your ability to identify which tax deductions you are eligible for.
This post is for independent contractors and freelancers who want to understand their tax obligations.
There is a lot of freedom in owning and operating your independent firm. Setting your schedule, being your boss, choosing your clientele, and deciding which projects to take on or pass on are all thrilling. Part-time or full-time freelancing is becoming more and more popular.
According to Statista, 59 million people engaged in freelance work in 2020, whether it was a temporary position, a side gig, or a long-term professional path.
But working as a freelancer has its share of difficulties, from negotiating pricing to worrying about where your next client will come from or even if one will arrive at all.
Many independent contractors don’t give paying taxes much thought. New freelancers are used to having automatic deductions from their paychecks made by their employer, especially those who formerly held regular jobs with a firm. However, it is the self-responsibility employees’s to keep track of their tax responsibilities, determine how much they owe, and determine when to pay it.
Tax season is something that constantly looms over independent contractors and freelancers. You can get ready for tax season and beyond with the help of this advice for freelancers from tax professionals.
How to pay taxes while working for yourself
Freelancers must be aware of the taxes they must pay and the deductions they are entitled to. The following freelance tax best practices can guarantee that you adhere to the regulations and avoid a tax audit.
1. Have a basic understanding of freelance taxes.
You may be an expert in your field as a freelancer, but that doesn’t mean you understand the distinction between FICA and IRA.
According to Alexis Krystina, principal accountant and founder of Pink Moon Financial, “all business owners, whether they are freelancers or big-time CEOs, need to have a basic understanding of accounting and taxes so they can make their money work for them.”
Freelancers should be aware of the following three tax fundamentals:
Self-employment tax: The Internal Revenue Service (IRS) considers you self-employed and requires you to file taxes as a company owner if you make $400 or more as a freelancer from any one employer in a year. You must pay a self-employment tax of 15.3%, which is equal to your share of the Social Security and Medicare taxes you would generally pay as well as the share typically covered by a regular employer, in addition to the standard income taxes based on your tax bracket and filing status. According to Ellie Thompson, CEO of Money Therapy, “several new solopreneurs and entrepreneurs are astonished when they have to pay self-employment tax.” “Taxes like Medicare and Social Security are already taken out of your income when you work for a corporation. You have to take care of those on your own as a business.
Tax forms for contractors: For every client who pays them $600 or more, freelancers receive a 1099-MISC form instead of the yearly W-2 form you would get as a typical employee. In your tax return’s Schedule C attachment, include a list of your 1099-MISC income.
Requirements for freelance taxes: Because employers do not withhold freelance income throughout the year, freelancers who anticipate owing $1,000 or more must pay estimated taxes quarterly. You can use IRS Form 1040-ES to estimate your quarterly tax obligations; it’s important to come as near to the exact amount as you can with these payments. If your quarterly taxes are not paid in full, you must pay the IRS the difference by April 15 when you file your yearly tax return. You can be required to pay a fine if your quarterly taxes are underpaid excessively. Additionally, in addition to local taxes, freelancers could also be required to pay state income taxes.
2. Recognize the structure of your company.
What is the legal framework of your company? LLC, or limited liability company? The S Corporation? an S corporation? single-person business? Your assets and tax liability are impacted by the legal structure of your company.
Freelancers often file their taxes under the sole proprietorship status, which requires them to attach a Schedule C form to their tax returns.
When they start to generate thousands of dollars in net profit, Krystina suggested that they consider incorporating as an S-corp. Although more complicated, S-corp status may provide some tax advantages.”A sole proprietor is a terrific option, but if you’re sued, your assets could be at risk,” Thompson continued. “A corporation is far more complicated and has higher startup costs, but it safeguards your assets.”
Different LLC configurations will affect how you file your business’s taxes when it comes to LLC taxes. Freelancers who set up a corporation or LLC must pay unemployment insurance, federal, state, and half of the FICA tax; however, they may be eligible to defer some of the self-employment tax on some of their earnings.
Romeo Razi, CPA and proprietor of Taxed Right, stated, “However, the IRS will look at how much.” “This is a bit tough and intricate. And the recommendation for how much depends on the person’s career, if they employ subcontractors, their income, etc. It should be made individually.
3. Take into account working with a tax expert.
Come tax season, a CPA or accountant with experience in freelance taxes may prove to be your best ally. You might be able to complete your taxes if your income and filing status doesn’t change substantially from year to year, but most people’s financial situations fluctuate frequently. You might wish to engage a CPA or find the best accountant for your business if your tax return becomes more complex.
According to Josh Zimmelman, proprietor of Westwood Tax & Consulting, “filing your taxes” entails keeping track of all of your receipts and documents as well as comprehending what they all imply.
Every transaction counts, and if your finances are a disaster, it would be wiser for you to hire someone to organize them.
The IRS also often modifies its tax laws. You might need assistance in comprehending how these changes affect you.
4. Know how to calculate your quarterly taxes.
Freelancers must make quarterly anticipated tax payments if they anticipate owing at least $1,000 in taxes. To determine how much you should be paying each quarter, consult your tax return from the previous year.
You might not be able to calculate your tax payments precisely if this is your first year working as a freelancer. When you submit your annual tax return, the IRS will fix any errors you made by either underpaying or overpaying your estimated taxes. Any unpaid taxes will either be charged to your account or you will receive a tax refund.
According to Wade Schlosser, founder, and CEO of Solvable, “the IRS wants to see that you’ve paid 90% of your taxes or the equivalent of 100% of last year’s tax bill by December.” If not, there will be a penalty for unpaid estimated taxes.
To find the most recent estimated tax due dates, go to the IRS website. Schlosser claims that if you don’t pay your estimated quarterly taxes, the IRS won’t send you a bill or notice, but you will still be required to pay a penalty when you submit your taxes. The 1040-ES worksheet is one of the resources the IRS offers to assist you to estimate your yearly income and calculate your expected tax obligations.
If you’re a married freelancer, Schlosser suggested that you ask your partner to increase their tax withholding to reduce your tax burden.
The most important thing, he said, is to talk to a tax expert before the year is through. The ability to strategically choose deductions, withholding, quarterly payments, and even investments that can lower your overall tax bill depends on having your ducks in order.
5. Think weekly, not annually.
Self-employed individuals are advised by tax professionals to set aside time each day to focus on tax-related information, including updating income and expenses as they change. Your records are more accurate and you are less frantic the week before your accountant appointment when you keep track of your finances.
Keeping accurate and thorough records is essential for freelancers, according to Krystina. “I think the greatest thing to remember for freelancers is that even though they are freelancing – which tends to have the image that it’s just a side project – it’s still a business to the IRS,” she said. “That will not only make tax preparation simple, but it will also assist freelancers to realize how well their business is performing.”
6. Disclose every business profit.
Any business that paid a freelancer more than $600 during the recently finished tax year is required to provide them with a 1099-MISC form by January 31. You must nevertheless disclose all of your income, including any cash payments, whether or not you get 1099.
If you’re ever audited, Schlosser added, “you’ll have to answer for unreported or underreported revenue.” “Freelancers should also compare the numbers on the 1099 form to their accounting records. You don’t want to be responsible for paying taxes on the income you didn’t earn or get because businesses occasionally make mistakes.
You must file your taxes accurately and on time even if you are unable to pay them. You might be eligible for IRS taxpayer programs that can extend your time to pay if you are in good standing.
If your tax filings are current, a tax debt specialist might be able to assist you in negotiating a payment plan with the IRS, according to Schlosser.
7. Prepare yourself for Tax Day (s).
Co-founder of TaxCure and registered enrolled agent Charles Corsello Jr. suggests opening a special savings account to set away a portion of each paycheck for tax payments as well as getting a business credit card.
By assisting them in calculating profit or loss, he said, “this makes it far simpler for a freelancer to prepare their tax return [or returns].” Utilizing financial software also makes categorizing spending simpler.
How much money should you reserve? Finance experts advise setting aside 30% of your annual income for tax purposes.
Corsello said, “if you have significant income and live in a high-tax state, you want to withhold closer to 35%.”
8. Before filing, 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 aren’t allowed to write off. According to a Xero survey, 35% of independent contractors have trouble understanding and paying taxes, and 73% don’t deduct any expenditures at all. A tax expert can guide on reducing your tax obligations and assist you in locating small business tax incentives and deductions.
It’s preferable to speak with a tax accountant that specializes in 1099 contractors, according to Schlosser, 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.
These are some typical deductions used by independent contractors:
Office space at home
Phone and internet bills
Ad materials for hardware and software
professional or legal services
Licenses and taxes for contract workers
Let’s examine some of the most important deductions in greater detail.
Home-office deduction: If you work from home as a freelancer, you can be eligible for this tax break. 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, you are only permitted to utilize the space for work-related activities. When the kids are in school, a family room that also serves as your workstation does not qualify for this deduction. If you’re debating whether to set up an office at home or rent a location outside, keep in mind that home offices have some tax advantages. According to CPA Gail Rosen, “home-office firms have a benefit since the moment [freelancers] walk out of their home, the miles are deductible business miles.” “The drive to work is not deductible if you have an [outdoor] office.”
Auto expenses: Another typical tax deduction for independent contractors is auto expenses. Rosen advises maintaining thorough records of your spending, though, so you can compare the normal mileage rate and your real vehicle costs to see which one would result in a greater tax benefit. “There are limitations on moving to another method if you choose one of these techniques for deducting your auto expenditures.”
Health insurance premiums: Paul Jacobs, certified financial planner, enrolled agent, and chief investment officer at Palisades Hudson Financial Group, says that health insurance costs are an additional factor to take into account. Because of the high tax threshold, most employees cannot write off medical expenses, including insurance premiums. However, self-employed business owners can regard insurance payments as a business expense and deduct the cost from their income. But there are some restrictions. “ As long as your spouse doesn’t have an employer-sponsored health plan you can participate in, health and dental insurance can be written off, according to Corsello. He emphasized that you cannot deduct health insurance costs if your business experiences a loss.
You may also be able to deduct fees for web hosting, advertising, marketing, office supplies, computer hardware, software, and education and certification charges.
9. Be aware that not everything can be written off.
While it’s important to take advantage of your tax deductions, you should always avoid absurd and illegitimate tax deductions.
By attempting to deduct fictitious expenses, some taxpayers put themselves at risk of an audit, according to Zimmelman. “It must be routine and required to operate your business for it to be deductible.”
Why does that matter?
Think of a real estate agent and a hairdresser, Krystina remarked. “The hairstylist might incur costs like those for shampoo, which are completely normal and necessary. However, it would not be warmly received if a real estate agent attempted to claim shampoo as a deduction. To qualify as a deductible item, a cost must be common in your sector.
Entertainment costs, business dinners (though 50% of these costs are often reimbursed), and personal cell phones are other expenses that are frequently questioned.
Personal costs are never tax-deductible, and personal cell phones produce a lot of uncertainty, according to Krystina. “Get a second phone just for business if you want to deduct your cell phone.”
Rosen noted that many independent contractors believe they can write off all of their initial expenditures, but they can’t do this until they make their first sale. Even then, the expenses are written off over 15 years, although you have the option to write off the first $5,000 in charges right away.
You should carefully consider whether you want to deduct the first $5,000 in business expenses in the first year or decide to hold your beginning costs, according to Rosen. What year you anticipate being in a higher tax bracket will determine the answer.
10. As a freelancer, don’t count on getting a tax refund.
A tax refund is a great thing for everyone. However, as a freelancer, you must accept that it’s unlikely that you will. 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 the money you owe, if you work for yourself, this is less likely to occur.
According to Razi, independent contractors only get refunds in one of two situations: either they overpaid their quarterly anticipated tax payments or their annual income was so low that they qualified for the refundable earned income credit (EIC).
In general, most independent contractors who earn a respectable annual salary are ineligible for the EIC tax benefit, according to Razi.
11. Give retirement planning top priority.
Retirement preparation is not a top focus for many independent contractors. They are concentrated on the daily tasks of expanding their clientele and increasing their business. Since individuals cannot participate in employer-sponsored small business retirement plans as sole proprietors, they might also believe that their alternatives are limited.
One of the largest misconceptions regarding retirement plans among independent contractors, according to Kurt Rossi, president and wealth advisor at Independent Wealth Management, is that they are too expensive. A retirement plan frequently offers substantial net after-tax advantages.
For independent contractors, these are some plan choices:
Self-employed 401(k): According to Rossi, a self-employed 401(k) plan can be an excellent choice for self-employed individuals or business owners without any other employees besides their spouses. The plan permits contributions up to $58,000 ($64,000 for individuals over 50), or 100% of earned income, whichever is less, just like a conventional 401(k) profit-sharing plan. Taxation does not begin until after withdrawal.
Another approach to saving for retirement is through a SEP IRA or Simplified Employee Pension (SEP) IRA programs. You can contribute as much as 25% of your net earnings, or $61,000, whichever is less, to a SEP IRA.
One of the simplest ways to start saving for retirement as a freelancer is with a regular or Roth IRA. Anyone just starting, investing less than $6,000 annually, or wishing to roll over a 401(k) from a prior job should consider opening an IRA. Retirement Roth IRA withdrawals are tax-free.
Choosing a plan and getting started is more crucial than any other investment option, in Rossi’s opinion.
“Freelancers must act to guarantee their retirement,” he stated, “since Social Security payouts fall short of fulfilling the economic demands of retirees.” The good news is that they can use a variety of retirement planning tools to lower their tax obligations while helping them save money for the future.
Top tax and accounting programs for independent contractors
Using accounting software to maintain precise records and regularly update income and expenses in your firm is the best method to remain on top of your freelance business taxes. You may be certain to maintain organization and compliance if you use this technique in conjunction with competent tax advice.
We examined the top small business accounting software and identified a few excellent options for independent contractors:
Our choice for the top accounting program for independent contractors is Sage Business Cloud Accounting. Numerous accounting procedures are automated by it, including posting payments and expenses as well as sending invoices and notifications of past-due bills.
Our selection for the finest accounting solution overall is Intuit QuickBooks Online because of its performance, cost, and usability. To find out more about QuickBooks Online’s features and capabilities, read our review.
The finest accounting program for expanding firms is Xero, in our opinion. For independent contractors, brand-new small businesses, more seasoned small businesses, and even enterprises, Xero has many tiers. Read more in our comprehensive Xero review.
Receiving payments regularly on time is essential for any freelance business, and FreshBooks is our choice for the finest accounting software for invoicing. For more information, read our review of FreshBooks.
The best online tax software can assist you in remaining compliant, making on-time payments, and receiving any refunds owed if you’re thinking about filing your taxes on your own. The top online tax preparation tool for independent contractors and other self-employed individuals is H&R Block. You can report several revenue sources using its Self-Employed Online service tier, which also supports a large number of IRS tax forms.
paying your freelance taxes on time
Taxes are an inevitable part of being a freelancer. Any freelancing income that is over $400 must be reported to the IRS. You can deduct expenses from your revenue since the IRS views your freelance work as a business. When setting up your records and filing your first year’s taxes, it is advisable to get the advice of a tax advisor to prevent making expensive mistakes.