Freelancing can be quite different from regular employment in terms of setting working hours and overall flexibility. The two types of work arrangements also differ in how they are taxed. So, when filing taxes, freelancers need to understand these differences to provide the Internal Revenue Service with the correct information regarding income and deductions at the end of each financial year. Fortunately, the filing process can be simplified with a few practical tips.
1. Understand the basics
If one is unsure how to file taxes as a freelancer, understanding a few basics can help one get started.
Self-employment tax
If one earns $400 or more in a year from a single employer, the Internal Revenue Service (IRS) will consider them as self-employed. This means they will have to file their taxes as business owners do. They will have to pay an additional self-employment tax of around 15.3% along with the standard income tax based on filing status and tax bracket. This additional tax represents one’s share and a traditional employer’s share of Social Security taxes. These taxes are already deducted from the paychecks of regular employees; however, freelancers have to pay them out of pocket.
Freelance tax forms
An employee gets a single W-2 form every year, but self-employed individuals or freelancers need to use 1099-MISC and/or 1099-NEC forms when filing taxes. These forms can be obtained from clients who have paid around $600 or more for the freelance work. This form has to be reported on the Schedule C attachment of the tax return.
Estimated tax requirements
Freelancers who owe the IRS more than $1,000 each year must pay their taxes every quarter. This is crucial, as, unlike employees, taxes aren’t withheld from freelancers throughout the year. So, to ensure they do not need to pay tax in a lump sum in April, they can pay the government every three months. Estimated taxes are payments consisting of self-employment tax and income tax. As it is not possible to know beforehand the exact taxes at the end of the year, these estimated tax payments partly or completely fulfill the annual tax obligation. Calculating these payments as accurately as possible is crucial, as paying less than the required amount could invite a penalty.
2. Determine the business structure
To manage freelance taxes as smoothly as possible, it is important to know about the overall structure of one’s business. Most businesses are categorized under options like Limited liability corporation (LLC), S corporation, C corporation, or sole proprietorship. Figuring out the structure of one’s freelancing business is important since it will directly determine the personal assets and the tax liability.
Most freelancers file their taxes as sole proprietors with the help of a Schedule C form, which reports income or loss from a business.
3. Seek professional assistance
If, even after doing their research, one is still unsure about how to file taxes as a freelancer, one can always hire an accountant or a tax professional who has expertise in freelance taxes. In situations where the filing status and income do not change much from year to year, one can do their taxes themselves. However, fluctuations in finances are common for most freelancers, which makes the tax filing process complicated at times. So, hiring a tax professional can be a good idea. They will help keep track of all the statements and receipts, which makes the filing process easier. Besides, they are likely to keep up with any changes made to the tax laws by the IRS. So, they can understand how these modifications will affect the freelancing business and the taxes owed.
4. Use available resources to calculate taxes
A key tip for freelancers filing taxes is figuring out how to calculate the estimated quarterly taxes. To do that, one can start by referring to the previous year’s tax return.
For freelancers in their first year of business, calculating the payment amount can be tricky. In such situations, using all the available resources and IRS tools like the 1040-ES worksheet to accurately calculate the estimated taxes is crucial. In case of miscalculation, one may end up overpaying or underpaying. This will result in the IRS issuing a correction at the time of the annual tax return. So, one will have to pay the balance tax or receive a refund. Additionally, the IRS can impose a penalty if the filing is not done on time.
5. Utilize deductibles
Most freelance income tax guides would tell one to pay close attention to deductibles—expenses that can be subtracted from adjusted gross income to reduce tax liability. These expenses are often overlooked while filing taxes, especially when one is unsure what can and cannot be deducted. Here, a tax professional can provide the necessary assistance in identifying the various small business tax deductions. They can also suggest ways to lower the tax liability and avoid tax debt.
Freelancers can typically utilize deductibles like home office space costs, vehicle expenses, travel expenses, internet and phone bills, and personal insurance. Expenses related to office supplies, hardware and software, advertising materials, legal or professional services, contract labor, licenses, and business meals can also be claimed as deductions.
