It takes some freelancers YEARS to develop an effective invoicing workflow and a strong strategy for tax season.
To help you beat the learning curve, we’ve teamed up with Ruby Money on the best practices for improving your cash flow throughout the year and acing your taxes.
Do I Have to Pay Taxes as a Freelancer?
What you’ll learn:
- How much you have to make to file taxes as a freelancer
- Tips for invoicing and bill pay to make filing easier
- What your tax obligations are as a freelancer
As a freelancer, you can chart your path, make your own decisions, and possibly earn more income than traditional jobs offer. But freelancers have unique tax obligations.
Unlike salaried employees, freelancers aren’t having tax money withheld from their paychecks throughout the year. That means it’s entirely your responsibility to understand how much you owe the IRS, adhere to rules regarding payment, and meet important deadlines. For example, if you plan to owe more than $1,000 in taxes for the year as a freelancer, you should probably be making quarterly payments rather than waiting to pay in a lump sum during tax season.
Use this guide to get a sense of how to calculate your taxes, set aside money as you invoice clients, and pay your taxes as a freelancer.
How much do I need to make to pay taxes as a freelancer?
If you’re a freelancer, the IRS will likely require that you pay a self-employment tax on your income. That includes freelancers who provide services in exchange for payment, such as writers, graphic designers, web developers, and consultants. And the first thing you need to understand is the income threshold for paying taxes.
The IRS requires that self-employed individuals pay taxes when their net earnings total $400 or more. To calculate your net earnings, you’ll need to subtract any expenses related to running your business from the total income you made for the year.
Gross Income Amount – Cost of Business Expenses = Net Earnings
For example, let’s say you made $450 in gross income from freelance work in one tax year. If your net income is $400 or less after subtracting the expenses and deductions for which you qualify, you wouldn’t be required to pay taxes on that $450 in gross income since it falls under the net earning threshold of $400.
It’s important to note that everyone who earns gross income must file their federal and (if applicable) state taxes, regardless of the income amount. Whether you are required to pay taxes on that income depends on your net earnings after expenses and deductions.
Certain states may require additional payment on freelance income earned, but the policies and tax rates differ from state to state.
Understanding how your business structure impacts your taxes
One major factor that can impact how much you owe in taxes as a freelancer is the structure of your business. The government considers you to be “self-employed” if you do business as a sole proprietor, an independent contractor, a member of a partnership, or a gig worker.
Your business structure determines which income tax return form you have to file, and in some cases, makes you liable for additional tax costs depending on where you live. For example, LLCs registered and doing business in California are subject to an $800 annual LLC tax—even if they don’t bring in any money that year! If you operate as a sole proprietor, you and your business are considered one single entity by the IRS and you will report your earnings and losses on your personal tax return.
Self-employment tax vs. income tax
Most salaried employees pay federal income taxes on their earnings. Freelancers typically have to pay federal self-employment tax as well as income tax on the profits they earn.
The self-employment tax rate is 15.3% (12.4% goes toward Social Security and 2.9% goes toward Medicare, benefits that you’re still entitled to as a freelancer and that you must pay into). If you were working as a W-2 employee, funds to cover this tax obligation would be withheld from your wages—and it would be a smaller obligation on your part, because your employer would also contribute a portion of the payment. As a freelancer, you’re footing the cost of the entire tax yourself.
On top of federal self-employment and income taxes, freelancers may need to pay state income taxes depending on where they live. Freelancers have to report all income and expenses to the IRS on their annual tax returns. If you work with multiple clients, you’ll receive a 1099 form from each of them as your primary tax documentation for the contract. You’re responsible for calculating how much self-employment tax you owe and filing any quarterly estimated tax payments based on these calculations.
Quarterly taxes as a freelancer
Estimated quarterly taxes must be paid to the IRS if you expect to owe $1,000+ in taxes for the year. Quarterly payments are based on estimates, so use IRS Form 1040-ES to determine how much you’ll owe in taxes each quarter after deductions and credits are applied, and try to be accurate in your calculations. If you underestimate how much you owe, you’ll need to pay the remaining balance when filing your annual tax return. If you drastically miss the mark, the IRS can fine you.
Fortunately, several deductions available for freelancers can help reduce your tax bill. For example, the home office deduction allows freelancers to write off expenses for the business use of their home. It’s important to keep detailed records of your expenses throughout the year to take full advantage of any deductions available to you.
Preparing to file taxes
Throughout the year, there are certain things freelancers can do to make tax filing and payment easier. Track all your invoices, bills, expenses, and sales. An organized system for keeping track of what’s going in and coming out of your business will help you make better estimates on your quarterly tax payments.
A great way to do this is by using a platform like Hopscotch that allows you to manage invoices and payments from your clients easily. It also integrates with Quickbooks, which will simplify invoicing and accounting tasks.
When it comes to tax season, research possible deductions – there may be certain expenses that you can deduct to reduce the amount of taxes owed. Double-check the accuracy of all your financial records to ensure nothing is amiss. Also, if you choose not to pay throughout the year, at least set aside money as you earn it so that you don’t run into any issues when it comes time to pay.
By following these steps and properly managing your finances throughout the year, tax season should be much easier for freelancers.
Work with professionals to get it right
Working with a tax professional or an expert can help ensure your taxes get done right and avoid fines or penalties due to mistakes.
A resource like Ruby Money can help fulfill freelance workers’ and independent contractors’ unique needs regarding filing taxes.
The best approach to taxes as a freelancer or self-employed professional is proactivity. Having a plan in place and understanding the nuances of taxes at the state and federal levels will give you great peace of mind throughout the year.
A great plan is best executed through good organization, and platforms like Hopscotch can help you stay organized throughout the year. Ready to set up an account? It’s free and only takes a few minutes to get started.
