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Grow Your Business Finances

Freelance Taxes: What Every Freelancer Needs to Know

image for simpson33 / Getty Images
simpson33 / Getty Images

Running your own freelance business comes with a lot of freedom. It's exhilarating to set your own hours, be your own boss, select your own clients, and decide which projects you want to pursue or pass on. In fact, about 57 million people – or 35% of the U.S. workforce – perform freelance work, whether as a temporary situation, side gig or long-term career path, according to the 2019 Freelancing in America survey.

However, freelancing comes with its share of challenges, from negotiating a fair price for your labor to worrying about where your next job will come from, and even if it will come at all.

One area many freelancers don't think much about is paying taxes. New freelancers, especially those who had traditional jobs with a company until recently, are accustomed to their employer automatically making deductions from their paychecks. However, the self-employed are responsible for staying on top of their tax obligations and figuring out what they owe and when they need to pay it on their own.

For freelancers and independent contractors, tax time isn't once a year – it's always on the horizon. These tips from tax experts will help you prepare for tax season and beyond.

As a freelancer, you may have exceptionally honed skills in your industry, but that doesn't mean you know the difference between FICA and IRA. So let's start by reviewing some tax basics as they relate to freelancers.

"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," said Alexis Krystina, principal accountant and founder of Advance Accounting.

If you earn $400 or more in a year as a freelancer, the Internal Revenue Service considers you self-employed and requires you to file taxes as a business owner. In addition to the standard income taxes based on your tax bracket and filing status, you are responsible for paying a self-employment tax of 15.3%, which represents the Social Security and Medicare taxes you would normally pay, as well as the half typically covered by a traditional employer.

"Some new solopreneurs and entrepreneurs are shocked when they have to pay self-employment tax," said Ellie Thompson, CEO of Money Therapy. "When you are working for a corporation, taxes like Medicare and Social Security tax are already deducted from your paycheck. As an entrepreneur, you have to account for those on your own."

In lieu of the single W-2 form you'd get annually as a traditional employee, freelancers receive a 1099-MISC form from every client who pays you $600 or more. You report your 1099-MISC income on a Schedule C attachment to your tax return.

Freelancers who expect to owe $1,000 or more in taxes are required to pay estimated taxes quarterly as well. Additionally, freelancers may have to pay state income taxes as well as local taxes. [Interested in online tax software for your business? Check out our best picks and reviews.]

What type of structure is your business? LLC? S-corp? C-corp? Sole proprietorship? The legal structure of your business not only affects your personal assets, it determines how much you owe in taxes, said Thompson.

Freelancers typically file taxes as sole proprietors, which means they file a Schedule C form that integrates with their personal tax return.

"Once they reach a point where they are making thousands in net profit, they may want to look into filing as an S-corp," Krystina said. "S-corp status is more complex but may offer some tax benefits."

"Sole proprietor is a great option, but your personal assets could be in jeopardy if you are sued," added Thompson. "A corporation is much more complex and requires additional setup fees, but it protects your individual assets."

Freelancers who form a corporation or LLC will pay unemployment tax, federal and state taxes, and half of the FICA tax, but they may be able to shield some of their money from the self-employment tax.

"However, the IRS will look at how much," said Romeo Razi, CPA and owner of Taxed Right. "This is somewhat complicated and tricky. And the advice on how much is based on profession, if they hire sub-freelancers, their income, etc., and should be determined on a person-by-person basis."

An accountant or CPA who is familiar with freelance taxes could be your best friend come tax time. If your income and filing status don't change much from year to year, you might be capable of doing your own taxes, but most people's financial situations change often. As your tax return gets more complicated, you might need help.

"Filing your own taxes means keeping track of all your receipts and statements and understanding what it all means," said Josh Zimmelman, owner of Westwood Tax & Consulting.

"Every transaction matters, and if your financials are kind of a mess, then you're better off paying someone else to sort it out for you."

Also, the IRS constantly updates its tax laws. You may need help understanding how these changes impact you.

Freelancers who expect to owe at least $1,000 in taxes are required to pay estimated taxes quarterly. Refer to your prior year's tax return to gauge how much you should be paying quarterly. If this is your first year as a freelancer, you may not be able to estimate your tax payments accurately. If you make a miscalculation – by either underpaying or overpaying your estimated taxes – the IRS will issue a correction when you file your annual tax return. You will either be asked to pay for any missing taxes or issued a tax return for any excess amount you paid.

"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," said Wade Schlosser, CEO and founder of Solvable. "Otherwise, you'll have to pay an estimated tax penalty."

The estimated tax due dates for 2019 are April 15, June 17, Sept. 16 and Jan. 15, 2020. According to Schlosser, if you don't pay your estimated quarterly taxes, you won't get a bill or notification from the IRS, but you will have to pay a penalty when you file your taxes. The IRS provides tools such as the 1040-ES worksheet to help you approximate your total income for the year and figure out your estimated tax payments.

If you are a married freelancer, you may have your spouse increase their withholding taxes to help defray your tax bill, Schlosser pointed out.

"The biggest thing is to speak to a tax professional before the year ends," he said. "That's crucial to getting your ducks in a row and making strategic decisions about deductions, withholding, quarterly payments, and even investments that can help reduce your overall tax debt."

Tax professionals advise self-employed workers to spend time each day focusing on tax-related information, which includes updating income and expenditures as they come in. When you keep on top of your financials, your records are more accurate, and you aren't rushing around in panic the week before meeting your accountant.

Freelancers can use QuickBooks or various accounting apps to do everything from tracking expenses to scanning receipts.

"I think the biggest thing to understand for freelancers is that even though they are freelancing – which tends to have the connotation that it's just a side gig – to the IRS, it's still a business, so keeping accurate and detailed records is key," said Krystina. "Not only will that help freelancers understand how well their business is performing, it will make filing taxes a breeze."

Freelancers should receive a 1099-MISC form by Jan. 31 from any company that paid them more than $600 for the tax year that just ended. However, whether or not you receive a 1099, you are responsible for reporting all your income, including any cash payments.

"If you're ever audited, you'll need to account for unreported or underreported income," said Schlosser. "Freelancers should also cross-reference their own accounting documents against the numbers on the 1099 form. Companies sometimes make mistakes, and you don't want to be on the hook for paying taxes on income you didn't earn or receive."

Even if you can't afford to pay your taxes, it's important to file accurately and on time. If you are in good standing, you may be able to tap into IRS taxpayer programs that can give you more time to pay.

"A tax debt specialist may be able to help you negotiate a payment plan with the IRS, but only if your tax filings are up to date," said Schlosser.

Charles Corsello Jr., a licensed enrolled agent and co-founder of TaxDebtHelp.com, recommends having a credit card just for the business, and setting up a dedicated savings account to put aside a certain percentage of each paycheck for tax payments.

"By doing this, it makes it way easier for a freelancer to prepare their tax return(s) by helping them determine profit or loss," he said. "It also makes it easier to classify expenses when leveraging financial software."

How much should you set aside? Financial professionals advise putting away about 30% of your total income to pay for taxes.

"In fact, you probably want to withhold closer to 35% if you have high income and you live in a high-taxed state," added Corsello.

Many freelancers leave valuable tax deductions and benefits on the table each April because they aren't sure what they can and cannot deduct. In fact, 35% of freelancers have a hard time understanding and paying taxes, and 73% don't deduct any expenses at all, according to a report by Xero. A tax professional can help you identify tax deductions and credits and offer advice on how to lower your tax bills.

"It's best to talk with a tax accountant specializing in 1099 contractors, because they can help you find deductions you didn't know you had, helping you to reduce your tax bill and avoid tax debt," said Schlosser.

For example, if you work from home as a freelancer, you may be able to take advantage of the home-office deduction. This allows you to write off expenses ranging from utilities to the rent for the space in your house that serves as your primary office. However, the area must be used strictly for business purposes, so if you have a family room that doubles as your workspace when the kids are in school, it doesn't meet the criteria for this deduction. If you are on the fence between setting up an office at home or renting an outside space, though, realize there are some tax perks with home offices.

"Home-office businesses have an advantage, since the minute [freelancers] walk out of their home, the miles are deductible business miles," said CPA Gail Rosen. "If you have an [outside] office, the commute to the office is not deductible." 

Auto expenses are another common tax deduction for freelancers. However, Rosen suggests keeping detailed records of you actual expenses so you can compare the standard mileage rate and actual vehicle expenses to see which one gets you the better tax deduction.

"Once you pick one of these methods for deducting your auto expenses, there are restrictions on switching to another method," she said.

Health insurance premiums are another area to consider, according to Paul Jacobs, certified financial planner, enrolled agent, and chief investment officer of Palisades Hudson Financial Group.

"While most employees can't deduct medical expenses, including insurance premiums, because the tax threshold is so high, self-employed business owners can treat insurance premiums as a business expense and use the cost to offset income," he said.

"Health and dental insurance can be deducted as long as your spouse doesn't have an employer-sponsored health plan you are eligible to participate in," said Corsello. He pointed out that if your business has a loss, you cannot deduct health insurance expenses either.

Additional expenses you may be able to deduct include education costs and certifications, advertising and marketing, office supplies, computer equipment, software, and web hosting fees.  

"On the other side of this issue is that some taxpayers put themselves at risk of an audit by trying to write off bogus expenses," said Zimmelman. "For it to be deductible, it must be ordinary and necessary to run your business."

What does that mean?

"Think about a hairstylist and a real estate agent," said Krystina. "The hairstylist might have expenses like shampoo – totally ordinary and necessary. However, if a real estate agent was trying to deduct shampoo, that would not go over well." It must be a normal expense in your industry for it to be tax deductible.

Other expenditures that often come into question are entertainment expenses, business meals (though 50% of the cost of these is usually covered) and personal cell phones.

"Personal expenses are never tax deductible, and personal cell phones create a very gray area," said Krystina. "If you want to deduct your cell phone, get a second phone specifically for business."

Rosen pointed out that many freelancers assume they can deduct all of their costs in starting a new business, but this can't be done until they have their first sale. Even then, the costs are deducted over 15 years, but you can elect to deduct the first $5,000 in expenses in the first year.

"You should carefully evaluate whether you want to hold your startup costs or elect to write off the first $5,000 in the first year of business," said Rosen. "It depends on what year you expect to be in a higher tax bracket."

There isn't a person who doesn't love getting a tax refund. As a freelancer, though, you need to get used to the idea that you are not likely to see one. When you have an employer, your taxes are automatically withheld from your paycheck, and you may get a refund if you overpaid the government throughout the year. This is less likely to happen if you are self-employed, since you are the one sending in the money you owe.

According to Razi, freelancers receive refunds under only two circumstances: They overpaid their quarterly estimated tax payments, or they made such little money for the year that they are entitled to an earned income credit (EIC), which is refundable.

"In general, most freelancers that make a decent amount in a year do not qualify for the EIC tax credit," said Razi.

For many freelancers, retirement planning is not a top priority, as they are laser-focused on the day-to-day responsibilities of growing their business and reaching new clients. They may also feel that they have few options since, as sole proprietors, they can't tap into employer-sponsored retirement accounts.

"One of the biggest misconceptions freelancers have about retirement plans is that they are too costly," said Kurt Rossi, president and wealth advisor at Independent Wealth Management. "A retirement plan often provides significant net after-tax benefits."

For a self-employed person or a business owner without any employees other than their spouse, a solo 401(k) plan can be a good option, suggests Rossi. The plan allows the same contributions as a traditional 401(k) profit-sharing plan, up to $56,000 ($62,000 for those over age 50) or 100% of earned income, whichever is less. The money is tax-deferred until withdrawal.

Simplified Employee Pension IRA plans are another way to save for retirement. A SEP IRA allows you to contribute up to 25% of your net earnings or $56,000, whichever is less.

Traditional and Roth IRAs are among the simplest ways to start saving for retirement as a freelancer. These are ideal for those just starting out, saving less than $6,000 a year or looking to roll over a 401(k) from a previous job. Withdrawals in retirement are tax-free.

Regardless of which investment option you select, the most important thing is choosing a plan and getting started, according to Rossi.

"With Social Security benefits falling short of meeting the income needs of retirees, freelancers must take action in order to secure their own retirement," he said. "The good news is there are many retirement planning options they can leverage to help stash funds away for the future while also reducing significant tax liability."

Additional reporting by Sue Marquette Poremba. Some source interviews were conducted for a previous version of this article.   

Paula Fernandes

Paula is a New Jersey-based writer with a bachelor's degree in English and a master's degree in education. She spent nearly a decade working in education, primarily as the director of a college's service-learning and community outreach center. Her prior experience includes stints in corporate communications, publishing, and public relations for nonprofits. Reach her at fernandes.write@gmail.com.