Freelancer, independent contractor, or sole proprietor – it's all the same as far as the IRS is concerned. That means even if you just do a couple odd jobs throughout the year, you may have some sneaky tax obligations you don't know about.
Not to worry. Let this (non-exhaustive) guide help you figure out how to reduce your tax burdens and start planning for tax success this year.
Making Sense of Freelancer Tax Obligations
First things first: let's establish that there are two types of taxes that freelancers who make a certain amount of income must pay. These are…
- Income taxes (both state and federal).
- Self-employment taxes (i.e., Social Security and Medicare taxes).
Now, to file federal income taxes, you must make a certain amount of money and that amount depends on your age, filing status (single, married, etc.), and annual gross income. According to FreelanceTaxation.com, a single freelancer under 65 years old must make $10,150 in order to file federal income taxes for 2014.
But that number doesn't hold true for self-employment taxes. Freelancers need only make $400 in taxable profit to owe self-employment taxes. According to Forbes, federal self-employment taxes are 15.3 percent of your income for 2014. Your state has self-employment taxes, too, but those rates vary depending on where you live. (Be warned: some states, like New York, have very high tax rates. Look up your state's rate so you're not taken by surprise.)
If you've been an employee in the past, you may already know that your employer usually pays half of your employment taxes. Now that you work for yourself, you're responsible for the whole amount. On the up side, you can deduct the employer portion of these taxes.
7 Tips for Freelance Tax Success
Now that you have a better understanding of your tax obligations, let's go over some pointers for making taxes a little less daunting.
- Work with an accountant. Your CPA is your best resource for keeping the most possible money in your pocket. Sit down with your accountant to estimate how much money you expect to earn from your freelance or contract work and plot out how much you should set aside for taxes each quarter based on that figure. This will ensure you're not caught off guard or underpaying your estimated quarterly taxes. Touch base with your accountant throughout the year in case your income significantly changes.
- Pay quarterly taxes. Remember, you need to only clear $400 in net earnings to be responsible for paying self-employment taxes, and if you make a living off of your freelance work, you may need to pay income taxes, too. Together, these are called your federal "estimated taxes." If you don't pay these taxes throughout the year, you may face a penalty for underpaying your estimated taxes when you file your annual return. (To learn how to avoid tax penalties, read this Investopedia article.) Typically, the IRS wants to receive equal installments of your taxes by January 15, April 15, June 15, and September 15. Your state may require you to pay quarterly estimated income and self-employment taxes, too. If you don't have an accountant and you're not sure how much to set aside for taxes, the ballpark starting point is usually 30 percent.
- Know that certain factors significantly impact your tax obligations. You will pay the most taxes if you live in a state with high income taxes, you're single, you don't have any deductions, and you make a lot of money from your freelance work. Owning a home, being married, having children, and having substantial business expenses can reduce your burden.
- Understand your deductions. Not everything you spend on your business is deductible. Your accountant can advise you on what deductions make sense for your business, such as a home office deduction if you freelance from home. For more pointers on tax deductions for small businesses, check out this guide by Nolo.com.
- Keep track of your expenses. If you want to take the most deductions possible, keep a careful record of your business expenditures. To help your accountant out, try to keep digital copies of these records. For instance, you may log your expenses into an Excel spreadsheet or scan your receipts and save them in a Dropbox folder called "2015 Taxes."
- Keep track of your earnings. Know that if you earned less than $600 from a client, they don't have to send you a 1099. However, you still need to report that income, so be sure you keep a record of what you make.
- Withhold extra from your W-2 job, if applicable. If you freelance just to make a little extra money but have a W-2 gig, you may sidestep your need to pay quarterly taxes by simply withholding more taxes from your regular paychecks. For instance, if you claim 2 or 1 on your W-4, switch that number to 1 or 0 to cover your freelance taxes. Again, you'll want to check in with your accountant to make sure that option is right for you.
For more tips, check out the post, "Tax Prep: 5 Ways to Be Prepared for Tax Time."