Zero alarm clocks. Working from the couch. A full-time yoga pants wardrobe.
Freelancing certainly has its perks. Filing taxes is not one of them.
Whether you’re considering making the big leap into the world of freelancing or you’re already in the deep end, your tax situation doesn’t have to be that complicated — we promise!
Here’s what you need to know to keep Uncle Sam happy as you navigate your entrepreneurial venture.
How Do You Pay Taxes as an Independent Contractor?
The advice below will vary if you’ve chosen a business structure like an S-Corp or an LLC. Since sole proprietorships are the default for most freelancers, we’ll focus on what those taxes look like.
First thing’s first: making quarterly payments.
Estimated Quarterly Taxes: How Much Do You Need to Set Aside?
When you earn money as a freelancer, the transaction is direct: You name a price, you perform the service and your client pays you — without withholding any money to cover taxes or benefits.
Of course, the government still wants its cut even if you’re self-employed — which means it’s your responsibility to dole out that portion. A good rule of thumb: Set aside about 30-35% of every paycheck you make to cover your federal taxes.
This will include both federal income tax — which is organized by brackets and will likely run between 10-24%, unless you’re doing exceptionally well — and self-employment tax, an additional tax levied on independent contractors currently totalling 15.3%.
Instead of having these taxes withheld from each paycheck, you’ll ship them off on a quarterly basis using Form 1040-ES. Quarterly tax payments are due in January, April, June and September, and they’re super easy to file online. However, you can also pay by phone or snail mail; the address will vary depending on your location.
Keep in mind that the 30-35% you set aside may not cover state or local taxes, which vary depending on your location. For example, along with its regular state income tax, New Mexico charges small business owners a gross receipts tax for “the privilege of doing business” here — which ranges from 5.125% to 8.6875% depending on your county.
More on Self-Employment Tax
Although often decried among freelancers as punitive, self-employment tax is actually designed to cover independent contractors’ contributions to Social Security and Medicare.
As you may have noticed on your paystubs, however, the percentage withheld for these programs is only 7.65% when you work a traditional job. That’s because your employer is paying the other half.
Independent contractors — so long as they earn more than $400 in freelance income — are required to pay the full 15.3% to cover their full contribution.
Yes, freelancers, it doesn’t just feel like you pay more taxes. You actually do pay more because you don’t have an employer splitting the bill with you. Sorry.
The good news is, this percentage is levied against your net income… which means you calculate it after you take out your deductible expenses. (More on that in a minute!)
The Dreaded April Tax Return
Just like a “normal” worker, you’ll still need to file a tax return if you’ve made at least $400 in freelance income. So long as you’ve kept up with your quarterlies, this shouldn’t be too painful — but if you’ve missed payments or neglected the self-employment tax, you may find yourself owing the IRS.
Your April return should report the sum of your earnings, which is used to calculate your tax bracket and total tax burden. Of course, for freelancers, this means you’ll need to be diligent about recording every single penny you earn.
Calculating Your Total Income
Each client who pays you more than $600 in a year’s time must file a form 1099-MISC in your name, which you’ll receive at tax time in place of a W-2. It lists your earned wages but not any withheld taxes — because, again, as an independent contractor, that’s your responsibility.
Even if you earn less than $600 from a client, that income still counts toward your annual total, which means you need to include it on your return.
By the way, although it’s tempting to under-report your income in an effort to pay less in taxes, there’s good reason not to — namely, hefty penalties. And seriously, do you really want to go through the hassle of an audit? Save yourself time and money in the long term and just cough up what you owe.
Do You Still Get a W-2?
Freelancing isn’t exactly renowned for its reliability or, you know, health insurance, so a lot of freelancers work part-time for someone else in addition to their side hustle.
If that’s you, your employer will still need to file a W-2 for you. You’ll receive it sometime in February in anticipation of the big day in April, and you’ll need it to file your return. It displays your earned wages, Social Security contribution, withheld federal income and Medicare taxes, and more.
This will affect your overall tax burden, and may be a good reason to hire professional help.
What Can You Deduct as a Small Business Owner?
Now for a tax topic we can all love: deductions!
One cool thing about freelancing: as a small business owner, you’re eligible to make certain business-related deductions, which can lower your overall tax burden and help keep your enterprise cost-effective to run.
The IRS language on deductions is pretty open-ended: “To be deductible, a business expense must be both ordinary and necessary.” So you can make an argument for deducting an array of costs.
Some of the most common deductions for freelancers include the cost of your home office, office supplies and travel expenses related to work. But you can also deduct meals and entertainment — within reason — that are related to client meetings, as well as professional services, like those of an accountant.
Speaking of which…
Should You Hire an Accountant?
As soul-sucking as it can be to live in an all-digital world, the internet has made filing taxes a whole lot easier. Even freelancers can take advantage of the sophisticated software from companies like TurboTax or H&R Block, which are both low-cost and easy.
But in some cases, hiring professional help is well worth the money. Such as when…
1. You have a W-2 job (or three) alongside your freelance business.
Because working a traditional job means you’ve already contributed some of what you owe for Social Security and Medicare, it can complicate your self-employment return substantially — and that’s doubly true if you’re holding down several gigs to make ends meet. (Hey, we’ve all been there.)
An accountant can help you work out exactly how much you actually owe, which can end up saving you money, even after you factor in their charges.
2. You’ve elected a more convoluted business structure, such as an LLC with the S-selection.
While most freelancers operate as sole proprietorships, there can be benefits to incorporating a growing freelance business. For instance, by moving to an LLC and taking the S-corporation option, you could avoid paying self-employment tax on a significant portion of your income.
Overall it’s a complicated — though perfectly legal — scheme in which you hire yourself through the business as an employee and pay regular income taxes. It’s known as a “pass-through” taxation structure, and among other paperwork oddities, it means you’ll file a W-2 as both employee and employer.
And there’s even more such paperwork at tax time. A good accountant can make sure you have all your T’s crossed and I’s dotted — and when it comes to the IRS, you want to be as exact as possible.
3. You just don’t want to deal with it.
Many accountants charge a few hundred dollars to make the tax man happy. This is money well spent. For freelancers. For everyone.
Although independent contractor taxes are significantly more complex than for those who work a traditional job, it’s hard to compete with the freedom and flexibility of the freelance lifestyle.
I mean, yoga pants. And *only* yoga pants. Forever. The CPA fees are totally worth it.
Jamie Cattanach’s work has been featured at Fodor’s, Yahoo, SELF, The Huffington Post, The Motley Fool, Roads & Kingdoms and other outlets. Learn more at www.jamiecattanach.com.