Taxes are one of the most confusing parts of freelancing, and not just because you have more forms to deal with. If you’re used to traditional employment, you may feel entirely at a loss about how it all works.
The first thing to know is that freelancing doesn’t follow standard rules. Your income isn’t automatically deducted. You don’t wait to deal with your taxes until the official tax time rolls around.
Here, we’ll look at what to know about filing, deducting business expenses, and paying tax organizations. While you can only get personalized tax advice from a tax specialist, you can use this guide as a starting ground before you start making your next moves.
How do taxes work for freelancers?
Freelancers are considered self-employed, which means that they’re responsible for both tracking income and paying taxes. With traditional employers, you’re responsible for paying and filing, but the vast majority of the paperwork is done because taxes are automatically withheld from your paycheck. All you have to do is review the numbers, make any necessary changes, and give all of your documents to the IRS and, if necessary, state tax board.
Freelancers work off a very different system. You’ll usually work with different forms, including Schedule C, Schedule SE, and Form 1040. The exact mechanisms depend on several factors, including the structure of your business. For example, Schedule C forms can only be used if you file as either a sole proprietor or if your LLC doesn’t have any other partners or employers.
If you’re comparing freelance taxes to traditional taxes, the main similarity is that tax laws can and do change. While federal tax changes are relatively few and far between, state and local tax laws may change more frequently. It’s important to be aware of not just how freelance taxes work, but what types of changes might be coming down the pipeline.
Who has to file freelance taxes?
The term freelance encompasses side hustlers, independent contractors, and gig workers. Freelancers must file taxes if they earn at least $400 in net income from an employer.
In a perfect world, employers are supposed to send you a tax form if they pay you at least $600 for the job (regardless of your net income). However, because employers get busy and may not keep meticulous track of their freelancers, it’s still the freelancer’s responsibility to file taxes, even if they don’t receive an official tax form.
How to file taxes as a freelancer
Filing can be done via standard state and federal tax avenues. Whether you print out your forms or file them online, you’ll need to know what the government is asking for and how to prove the numbers.
Here are a few tips:
- Track all income records: Any income you make, even if it’s just a few dollars, should be tracked. You can do this via anything from deposit slips to accounting software to a spreadsheet if you’re paid in cash. Remember: just because you don’t need to declare something to the government, doesn’t mean you shouldn’t have a record of it.
- List all deductibles: All income-related expenses should be tracked, whether it’s your phone bill, car payment, office rent, or business lunches. When freelancers often use their own possessions for business (e.g., their home desktop for filing payroll), itemizing your deductibles may be more important than you realize.
- File every quarter: Most freelancers will look at their past annual income to estimate their taxes every quarter. However, if you’re just starting out, you can estimate anywhere between 25 – 30% of your income to pay the IRS and, if required, your state tax board. If there are any discrepancies, you can correct them by the tax filing deadline. Ideally, you’ll overpay rather than the other way around.
- Get help: Freelance income can get messy and even so-called tax specialists may not know how to step outside the traditional employer model. Working with an accountant who understands self-employment laws can save you more in the long term.
Keep in mind that these tips are broad stroke tips for freelancers. The realities of filing are impacted by everything from where you live to what you do to what your tax accountant considers deductibles. Still, it helps to have a framework in mind as you move forward.
How to pay taxes as a freelancer
Freelancers typically pay taxes once every quarter. Most freelancers use the standard IRS website to file Form 1040-ES, which is fairly straightforward to complete. If your state requires quarterly tax payments, you’ll need to visit their website and follow the directions to submit.
Please note that not all states require you to submit quarterly tax payments (e.g., if your state doesn’t have an income tax). If you fail to pay your estimates, this may result in penalties from the IRS or state tax board, so it’s important to set deadline alerts every season.
What taxes do freelancers pay?
Freelancers typically pay federal income tax and self-employment tax. States’ requirements based on income tax laws and minimum earnings thresholds. Your self-employment tax will go toward Social Security and Medicare.
If you’re transitioning from traditional employment, self-employment tax may be a startling expense. Where you once split Social Security and Medicare costs with your employer, now you’re responsible for all tax portions.
How much you pay, though, depends on your total income, deductions, and location. If you’re pulling in high monthly revenues but also have high expenses, then your net income (and taxes) may not be very much.
Common freelance tax deductions
Deductions refers to any expense that you make for your business. These costs can be deducted from your gross income to reveal your net income. Common tax deductions include:
- Office expenses: From coffee to furniture to rent, any expense related to your office can be classified as a deduction. This includes a portion of your rent or mortgage if you have a home office.
- IT expenses: Your internet, business tools, and project management software can all be classified as IT expenses.
- Travel: All travel expenses, including gas mileage, car payment, plane tickets, and hotel rooms, can all be deducted from your income.
- Health insurance: You may be able to deduct the cost of health insurance as long as you were not eligible for a plan through your employer.
- Marketing: Ads, networking events, and client courting can all be classified as marketing expenses.
Make sure you’re documenting all business-related expenses and that you can justify their connection to your business. As you list deductions, consider how all expenses related to their business. For example, a freelance novelist might draw inspiration for their next tale from a personal trip.
How much should freelancers set aside for taxes?
Ideally, you’ll set aside anywhere from 25% to 30% of your income, though this is a basic estimation and amounts can vary widely based on your net earnings and location. The good news is that if you overestimate your taxes, you won’t owe anything at the end of the year, and you’ll get a nice refund to boot.
Common mistakes freelancers make with taxes
The most common mistake is usually tracking-related. Freelancers often live in feast-or-famine mode. When things get busy, details usually fall to the wayside. This is understandable, but the excuse may not go over well with the IRS.
Keep the following tips in mind to reduce your odds of error:
- Develop a system: Whether it’s spreadsheets, folders, or accounting software, establish a system immediately. You can always adjust it as time goes by, but the sooner you start building habits, the better off you’ll be.
- Quarterly reminders: Setting calendar alerts can make it easier to pay taxes. Or, if these payments coincide with some of your busiest time periods, consider delegating the task.
- Separate business and personal expenses: Getting a business bank account and credit card may not be strictly necessary in every state, but you’ll thank yourself when you don’t have to separate your expenses.
- Don’t assume: Freelancers often make assumptions about taxes, which can lead to a lot of errors. For example, they may assume that it’s the employer’s job to keep up with all tax documents when, in reality, the employer’s failure to prepare tax forms does not absolve you of tracking your income and paying your taxes.
Managing taxes for the first time can be extremely daunting. It may not be rocket science, but there are a lot of variables that can lead to big errors. Becoming more aware of the logistics can help you stay out of hot water with the IRS.
Should freelancers form an LLC?
This ultimately depends on the freelance business. The biggest benefit when you start an LLC is that it protects your personal finances should anything happen to your business. If your business operates as sole proprietor, the government could technically come after your personal possessions, like your car or home.
Many freelancers start out as sole proprietors and then choose to legally separate into their business. This is especially true if you start as a side hustler and then that side hustle balloons.
Ideally, if you choose to register as an LLC, you’ll look for an accountant or specialist who can help you file because simply forming an LLC does not automatically change how or what you pay in taxes. For example, you might pursue a special tax status, like S Corp, to avoid double taxation. Just keep in mind that even though your business structure is related to your tax structure, they are ultimately two different concepts.
Preparing your freelance business before tax season
Organization is the key to preparation. Separating your accounts, tracking your expenses, and organizing receipts and deductions are all non-negotiable if you want to keep your finances above board.
If you’re looking for a partner as you get ready to launch, the team at Tailor Brands can help you form and organize your business, manage your books, and store all your documents in one place. This may not solve all of your legal or tax woes, but it can boost your compliance and help you avoid the headaches of an audit.
Conclusion
Freelance taxes are very different from the traditional tax game, and those differences can quickly become overwhelming. Even the most organized freelancer is liable to miss a scrap of income here or a few deductibles there.
The best thing that you can do to avoid penalties and stress is to find a system that works. For most freelancers, especially those who are either full-time or who want to be full-time, this means finding help somewhere along the way. Whether you hire a full-time bookkeeper or work with a team like Tailor Brands, finding solutions now helps you avoid painfully time-consuming questions later.