Freelance Taxes: Everything You Need to Know
Being a freelancer comes with a lot of perks. You work on your own time, on the projects of your own choosing, at whatever rate you decide. Whether it’s your full-time job or just a side gig, it’s a great way to earn some extra money doing something you’re good at – or even better, something you enjoy! There is one catch, though: being self-employed means that you are totally responsible for calculating and paying your freelance taxes.
With a normal job, you complete a W-4 when you are hired and your employer automatically withholds the necessary taxes from your pay check. Often times, you can bank on getting a nice check back from the IRS every year when you file your tax return. But as a freelancer, it isn’t so easy. Your taxes aren’t automatically deducted from your checks, and it is up to you to make sure you pay enough and that you pay on time.
Of course, this doesn’t mean that you shouldn’t work for yourself, it just means that you have to understand what you need to do in order to avoid any big surprises come tax season. This article will provide you with everything you need to know to get started!
What is the Self-Employment Tax Rate?
When you are employed by a company, you pay income tax as well as FICA (your contribution to Social Security and Medicare) on every pay check. As a self-employed individual, you are expected to pay this manually because it is not deducted automatically.
Your income tax rate is, of course, based on the amount of money you make. But the FICA portion is slightly different if you are self-employed. Whereas normally the employer contributes 50% of FICA and the employee contributes the other half, as a self-employed individual you are the employer as well, so you are expected to pay the entire amount. The effective “self-employment tax rate” is 15.3% of the first $128,400 of income you receive, and 2.9% of anything you earn over this threshold.
Luckily, you can deduct the employer portion of the self-employment taxes on your tax return, but you are responsible to account for the entire amount. Either way, this means that you will pay both your income tax at the rate according to your bracket, as well as the 15.3% self-employment tax.
What is a 1099?
Unlike a “normal” job in which you get a W-2 from your employer at the end of every year, any businesses that pays you more than $400 in a year for freelance work will send you a 1099-MISC.
These days, though, many businesses pay their contractor through services like PayPal, so they send a slightly different form, a 1099-K. Unfortunately, they are only required to send one if they pay you $20,000 or more, or if they pay over 200 times. Whether you receive a 1099 from your client or not, though, you’re on the hook to report and pay taxes on those earnings, so it’s best if you track your earnings yourself. These earnings are reported on Schedule C of your regular 1040 tax return. The form is setup to account for both your self-employment earnings and expenses, and helps you calculate your net taxable income from freelancing. Completing Schedule SE along with Schedule C on your return makes it simple to tie your taxable self-employment income into your 1040.
Calculating your estimated freelance taxes
Even though you summarize your self-employment earning on your annual return, if you expect to owe more than $1,000 in taxes from freelance income, you are must pay estimated quarterly taxes to the IRS. The deadlines for quarterly tax payments are in April, June, September, and January.
You can use Form 1040-ES helps you estimate your what your annual taxes will be based on what you expect to earn. If you make less than around $2,000, you can probably skip estimated taxes, but if you aren’t sure if you’ll reach that threshold, it’s best to make quarterly payments in order to avoid fines.
It can be tough to estimate what your annual earnings will be, especially if it is your first year as a freelancer, or if the year will vary from previous years in amount or type of work you are doing. In any case, you should make an attempt to estimate your earnings and expenses, calculate your net taxable income, divide it by four, and pay about 28% of the amount each quarter. The good news is, if you overestimate, you’ll get money back when you file your return!
There are plenty of methods to tracking your income and calculating your freelance taxes, but no matter which method you choose, be sure you are tracking and saving enough money to cover your self-employment taxes.
The most common method, as suggested by Dave Ramsey, is to simply set aside 20-30% of every check you get for freelance work in a separate savings or checking account. If this seems like too much trouble, you can also reconcile your income at the end of each month, and do one bulk transfer to the separate account. In any case, you should be sure to track and save your income in a way that works well for you so that when the time comes to pay taxes, you are ready.
Make the Most of Your Tax Deductions
On the flip side, you should also diligently track your expenses that related to your freelancing work. As a self-employed individual, you can claim deductions on your taxes for any expenses that are, according to the IRS, “ordinary and necessary” for the operation of your business. Expenses are reported just like earnings on Schedule C of your from 1040, but if you have less than $5,000 in expenses, you can also use the Schedule C-EZ to simplify your net taxable income. Either way, there are many of types of expenses you should consider and track. Some common expenses include:
- Advertising and marketing
- Office supplies, Computer equipment and software
- Travel and business meals
- Home office
- Education & Certifications
While deductions can have a huge positive impact on your tax payments, be sure that you can prove and justify anything you claim. Remember, the things you deduct must be “ordinary and necessary” for your business, so good rule of thumb is: if you would have an item or an expense even if you weren’t running your freelance business, you probably shouldn’t claim it. Whatever you decide to deduct, be sure to keep your bills and receipts so that you can prove the expenses if you need to.
Get Some Help
At the end of the day, taxes are complicated. Even with this guide, it’s a good idea to find an adviser who can give you some assistance. In most cases, they will be able to help you save more money than they charge you! If you don’t want to find a local tax adviser in person, you can try a website like Picnic. They have a huge network of online advisers, so you can get great advice and guidance from the comfort of your own home.
While being a freelancer gives you a lot of freedom, it does come at a price. While you shouldn’t let the complicated freelance taxes process get in your way of pursuing a side gig or launching your own business, you should be educated and prepared. Once you get the hang of it, it’s simple: track everything, set money aside as you make it, make estimated payments, and don’t be afraid to get some help!