More Americans are freelancing than ever before, with the current number hovering around 54 million. Also known as an independent contractor or sole proprietor, a freelancer works for his or herself and is not classified as an employee by the government.
Before becoming a full-time or even part-time freelancer, it’s important to understand the financial side of things and how you are taxed when you are self-employed.
Each American worker must file their own income tax return and freelancers are no exception. However, the way the IRS treats self-employed workers is different than a regular employee.
To help you understand the financial landscape as new freelancer, we’ve covered the basics of self-employed taxes and bookkeeping.
Self-Employment Tax and Estimated Tax
Self-employed individuals are required to file an income tax return every year and pay self-employment tax.
As a freelancer, you are not working for an employer who deducts taxes like Social Security or Medicare from your wage. Instead, you may be responsible for paying self-employment tax (SE Tax). To know whether you need to pay self-employment tax, you will need to figure out your net profit. If you earned more than $400, you are required to pay SE tax.
If you expect your tax bill to be over $1000, the IRS requires estimated tax payments on the liability, which result in quarterly payments that cover both income tax and self-employment tax. Estimated tax must be paid by four specific dates throughout the year. To calculate estimated tax payments, use a Form 1040-ES.
Not arranging to pay quarterly taxes could mean a late penalty from the IRS on top of what you owe.
Freelance Tax Deductions
Income tax deductions, or tax write-offs, are expenses for which you will not be taxed. Here are several deductions available for freelancers:
- Home office (must be used solely for your work and on a regular basis)
- Web services, such as domain registration, online tools, apps, subscriptions, etc.
- A portion of your utilities, such as internet and phone
- Promotional materials, such as business cards, ads, etc.
- Office supplies or equipment, repairs and maintenance on equipment
- Travel expenses that are business-related only
- 50% of business meals
- Professional fees, such as a lawyer or accountant
- Insurance (a portion of your home insurance if you work from home)
- Health care or insurance premiums
- Educational materials or courses related to your business
- Contractor or freelancer fees, such as when you contract work out to another freelancer
- Interest on business loans
Depending on your unique situation, including how long you’ve been freelancing, there may be more (or less) tax write offs that apply to you.
Bookkeeping as a Freelancer
Freelancing comes with a lot of digital communication and paperwork. Between invoices, emails, receipts, and contracts, it can be a long paper trail if you don’t have a bookkeeping system in place from the beginning.
Building a filing system may take time, but here is some of the information that you should collect:
- Client information
- Hours and schedule
- Payment details
- Expenses, including mileage, receipts, etc.
- Industry connections and their contact info
- Business banking information
- Previous tax returns
When you start organizing your data, a simple spreadsheet can help you to track your income and expenses. This is the most basic way to monitor your business’s finances. You can also use software or applications that serve the same function, but offer additional features.
Your goal is to know how much income you are generating in your freelance efforts and how much you are spending on your business.
Streamline your administrative tasks by:
- Keeping personal and business expenses separate
- Keeping both a paper and digital copy of records
- Getting in the habit of dating documents and putting memos on checks
- Inputting information as it comes so you are not bogged down with data-entry
- Knowing what you can handle on your own, what you need help with, and areas that could use work
While recording expenses or filing invoices may not be the most exciting part of your job, it will help you to prepare for your yearly (and quarterly) taxes and save you a large amount of work in the end.
Forms You Need
Form 1099: Freelancers and independent contractors should receive a Form 1099 from clients once they complete a job or project, which clients also send to the IRS. You must report all taxable income and enter the amounts from these forms directly on your Form 1040.
A Form 1040 is what you use to complete your individual tax return. You can put your freelance income on there and attach a Schedule C with your income as a sole-proprietor. Using the Schedule C Form, you must then calculate the amount of SE taxes you should have paid throughout the year and report it on a Schedule SE, which is also attached to the Form 1040.
An additional form you may need include is an Information Return. For more information on self-employed tax forms, see the IRS Self-Employed Individuals Tax Center.
Should You Hire an Accountant?
As you might have gathered, self-employment taxation can be confusing and complex. If you are struggling to understand how to report your income or manage your finances, a tax accountant may be a good person to speak with until you are more familiar with the process.
Alternatively, if you feel like you have a strong understanding of taxation and the terms as they apply to the self-employed, or if you didn’t make enough money to warrant a long list of deductions or paperwork, you might prefer to handle your finances yourself.
Your Financial Future
The first year as a freelancer may seem like the most overwhelming because there is so much to learn about everything from finances and self-promotion to scheduling and running a business. It will test your capabilities as an entrepreneur as well as your patience and perseverance. Although the initial learning curve may seem sharp, developing a better understanding of your personal finances will put you in a better position to succeed in all areas of your life .
Do you do your taxes yourself or do you hire an accountant?