Tax Planning Tips for Freelancers
Freelance work provides a unique opportunity for you to set your own schedule and choose your own projects. While the flexibility of a freelance job is unmatched, it also comes with some major financial responsibilities. You can prepare year-round for your taxes with these simple habits so that you’re not surprised or stressed during tax time.
The Taxes Freelancers Should File
Freelancers are generally responsible for the same state and federal income taxes that employees pay, but taxes are not withheld from freelancers’ checks. When you receive payment from your clients, you’ll have to set aside a portion of the funds for your taxes. There are also some additional tax burdens placed on freelancers that employees don’t have to worry about.
The Difference between Freelancers and Employees
One of the biggest differences between freelancers and employees is the self-employment tax. As a freelancer, you’re required to put 15.3% of your earnings toward Social Security and Medicare taxes. Employees only pay half of this amount while their employers cover the other half. Because you’re self-employed as a freelancer, though, you must pay both the employee and employer portions of the tax.
However, you can claim half of your self-employment tax payment as a deduction on your federal income taxes. This is an above-the-line deduction, which means you can deduct the amount in addition to the standard deduction.
Instead of receiving a W–2 form from an employer, freelancers receive 1099-NEC forms from any clients that paid them $600 or more throughout the year. If you, like most freelancers, file as a sole proprietor, you’ll fill out a Schedule C (Form 1040) to report your profit and loss. Fortunately, freelancers can claim far more business expenses than employees. For example, you may be able to claim a deduction for the miles you drove for work. If you have a home office, you might be able to claim a portion of your housing or utility costs.
Quarterly Estimated Taxes
If you’ll owe $1,000 or more in taxes for the year, you must make quarterly estimated tax payments. These payments are typically due on April 15, June 15, September 15, and January 15. To calculate how much to pay quarterly, you can complete the Estimated Tax Worksheet in Form 1040-ES.
Although it can be difficult to estimate your income and expenses for the year, especially if you’re new to freelancing, you should strive to be as precise as possible. Underpaying could result in penalties and interest from federal, state and local taxing agencies. If you overpay on your quarterly taxes, you’ll get the extra money back as a refund when you file your tax return.
Consistent Record-Keeping Makes Everything Easier
Taxes can become complex for some freelancers, particularly those who receive income from multiple clients. Keeping a careful record of your income, expenses, and tax payments is essential if you want tax season to be a stress-free experience.
What You Should Track
First and foremost, freelancers must keep careful track of their income. Underreporting your income can lead to serious trouble with tax authorities, so it’s critical that you have a consistent bookkeeping method. Most freelancers track their income on a monthly basis, which can be especially helpful if your income fluctuates throughout the year. After a few years of freelancing, you can use your monthly records to predict which months will bring you higher or lower income.
You should also track your business expenses so that you can reduce your tax liability when you file your return. Even seemingly small business expenses can add up over the course of the year. Mileage can be a particularly sizeable deduction if you regularly travel from your home office to meetings. You could keep a written mileage log in your car, or you could create an Excel spreadsheet to track the date, destination, and total mileage for each trip. There are also apps that can help with this.
Keep It All in One Place
Keeping all of your records in one location is also vital for successful tax planning. It’s very easy for freelancers to mix personal and business expenses, but keeping your work records completely separate from your personal life will benefit you greatly when tax season approaches. This will also reduce the risk of errors in reporting your income or expenses.
You could use an Excel spreadsheet or bookkeeping software to track your monthly income and expenses. Updating the data regularly will ensure that you don’t miss any payments or purchases. Try to set aside 30 minutes to an hour in your schedule each week to log your income and expenses. While this may seem tedious, it’s much easier to update your bookkeeping regularly than to try to track down a year’s worth of payments and purchases at once.
If possible, you could open a credit card solely for business use. This allows you to easily separate your business expenses from your personal ones, and it provides a clear and simple record of your business purchases.
Many freelancers also prefer to have a separate bank account for their quarterly taxes. It might be helpful to put away a monthly amount to cover the payments. After calculating your quarterly tax payment, split the amount into thirds. As soon as possible each month, put that amount into your tax account. The sooner you separate the funds from your personal account, the easier it will be to make your full quarterly payments.
Grow Your Business
Whether you’re a part-time freelancer or a full-time entrepreneur, careful financial planning is the foundation to success. As you prepare to grow your business, you should develop a record-keeping system that’s easy and intuitive to use. This will make your life much easier when business is more mature. Everyone has different preferences, so you should expect some trial and error before you settle into a comfortable rhythm with your tax planning. What’s most important is that you’re always keeping records and preparing for your upcoming tax payments.