Learn the essential elements to successfully manage your taxes as a freelancer or independent contractor.
As a freelancer, you have an amazing amount of freedom and flexibility, but that independence means you are also the sole person responsible for your taxes. This can be a daunting task, but we have compiled some essential things to help make your taxes more manageable. The IRS classifies freelancers as self-employed individuals, so if you earn money as a freelancer, you have to file your taxes as a business owner. While there are different considerations for figuring out which taxes to pay based on your particular business structure, here’s what you need to keep in mind when filing taxes as a freelancer.
Paying income taxes via estimated quarterly payments.
As a freelancer, you do not have a company or employer withholding part of your paycheck for taxes to remit on your behalf each period. You have to put some of your earnings on the side for your taxes. This is why you must make estimated quarterly income tax payments. This is the IRS making sure you pay what you must ahead of time, so you don’t use up all your revenue. These payments can now be made online through the IRS website. If you want, you can even pay your quarterly taxes each month, which can be helpful if you’re worried about spending too fast.
You will have to report all sources of income, even if they are from multiple sources. Make sure to keep track of your income because, as a freelancer, you will likely have various 1099-NECs rather than the typical single W-2 of a permanent employee. Be aware of all tax forms you receive and stay organized with your accounting.
Don’t forget about self-employment tax.
On top of your income tax, you must also pay self-employment tax (15.3% in 2020). When you work as a W-2 employee, you and your employer each contribute half of the payroll tax (Social Security and Medicare), which is automatically taken out of your paychecks. However, as a freelancer, you are responsible for both portions of the tax — generally called self-employment tax. Again, included in this amount is the employer portion of the tax, since as a freelancer, you are your own employer and employee.
Figure out what taxes you have to pay.
It can be a good idea to try to estimate how much you’ll have to pay in income and self-employment taxes. If you’re new to self-employment and 1099 forms, the IRS’ Self-Employed Individuals Tax Center can help you figure out how much you’ll need to pay. The site has a link to a worksheet, which you can fill out in just 10-15 minutes, that will take in your income amount from the past three months and tell you what your payment for the quarter should be.
If you filed 1099 forms in the year before, then you can follow these percentages for how much you need to save (according to Glassdoor):
90 percent of what you’ll owe for the year
100 percent of what you paid the previous year
110 percent of what you paid the previous year if your income was above $150,000
Create a plan for savings.
Once you figure out how much you have to pay for taxes in total, it can be smart to set aside some money each quarter so you can meet those obligations. It can be incredibly difficult to dig yourself out of a hole if you start spending the money you’ll need to pay your taxes. You should try your best to budget and possibly even create a separate bank account to save up for tax payments. If you transfer somewhere between 25 and 30 percent of your earnings to that account each month, you should be able to make your quarterly payments just fine. Even if this is an overestimate, it is better to be safe than sorry, and you’ll have some extra cash at the end of the year!
Figure out what you can deduct from your taxes.
As a freelancer, you’ll often have more business expenses than the average employee since you have to cover all costs on your own. This means you’ll probably be able to make tax deductions that standard employees may not. Remember that you are only allowed to deduct what is necessary — don’t go crazy deducting random personal expenses because the IRS does check.
You can deduct for things like business-related food, lodging, or office expenses, as well as equipment or materials required in your trade. Many freelancers work from home, so the IRS allows you to write off things like rent and utilities for the part of your home that you use as an office, but don’t go cutting corners here. You can’t just work in your kitchen during the day and label that your “home office.” The rent and utilities that you deduct must be solely going towards your work.
You can also deduct travel costs (other than commuting to an office) at a 50% rate, but you will need to provide proof and receipts of everything. You can also write off classes that you take that pertain to your career field if you are looking to educate yourself in your business area further. Just make sure that you keep track of your business costs and keep them entirely separate from all personal expenses.
See if a tax professional or software can help you.
If you still feel nervous about your taxes as a freelancer, consider trying out a tax software or professional to guide you through the process. Accounting software like QuickBooks Self-Employed can help. In general, anything that allows you to keep on top of tracking your income and expenses will be useful. A tax professional could also help make sure you are getting the most out of your taxes and deductibles as possible. Remember that self-employed workers have very beneficial and rich tax rules that are meant to make business easier — you just have to know how to map it all out.