Becoming a freelancer is exciting. You get to make your own schedule, set your prices, and develop skills that will benefit you throughout your life.
5 Things a New Freelancer Must Know About Taxes
However, you are a business entity and must understand how taxes work for a self-employed entrepreneur.
Without this knowledge, you could get audited by the IRS or lose out on tax deductions to help manage costs.
The Basics: Self-Employment vs. Employee
Company employees don’t have to worry too much about taxes unless they want to deduct medical costs, insurance, or other necessities. By law, employers have to shoulder around 7% of the tax called “income tax.”
At the beginning of the following year, employees typically hire an accountant or use accounting software to file W-2 taxes. It’s a simple process.
Graduating from a W-2 form to a 1099-MISC form is where the complications begin. Freelancers who earn $400 or more in a year, regardless if they hold another job, are considered “self-employed” and must file that income as a business owner.
Solopreneurs are responsible for paying self-employment tax (15.3%) on top of income tax. Both taxes include what your employer would typically pay for Social Security and Medicare taxes.
Instead of a single W-2 form an employer would give you at the end of the year, every client who pays more than $600 must fill out a 1099-MISC form.
To make this easier, use a 1099 generator and fill them out as soon as your client hits that $600 threshold. You report 1099-MISC income on a Schedule C attachment located on your tax return.
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If you don’t hit the $600 threshold, you still need to report your income, but the IRS won’t require you to pay taxes on it.
Ensure that you report your net earnings, not gross, because, as a business, you’re allowed to deduct company expenses.
Freelancers Should Pay Taxes Quarterly
Freelancers who expect to owe $1,000 or more in taxes are required to pay estimated taxes quarterly. To estimate your income, fill out the IRS form 1040-ES so you can put away that amount in a saving account before you’re required to file taxes for next year.
With a quarterly filing, you can get ahead of your tax debt, but if you can’t top up the remaining balance, you must do so before April 15. You may have to pay an additional fee if you miss the deadline.
In your first year as a freelancer, you may not be able to estimate your quarterly taxes accurately, but the penalty for missing your estimate won’t be severe in your first year of filling.
The IRS will likely issue a warning before each quarterly date (April 15, June 15, September 15, and January 15) to ensure you meet your deadline. Talk to a tax professional to reduce overall tax debt.
Understand Deductibles and Business Income
Business entities are able to deduct business expenses and save money during tax time. Understand that you can’t deduct everything or go above a percentage threshold when deducting common tools related to your business.
You’re safe to deduct most of the following items:
- Vehicle expenses
- Travel expenses
- Home office space
- Health insurance
- Phone and internet bills
- Office supplies
- Software and hardware
- Marketing/Advertising materials
- Legal services
- Business meals
- Contracted labor
- Taxes and licenses
Additional expenses, like certifications, education costs, and computer equipment, are usually deductible. It’s better to ask a tax professional first before making multiple deductions, or you risk getting audited and paying a higher fee.
Stay on Top of Business Income by Recording Daily
Record and declare all of your business income at the end of your workday to ensure you don’t miss anything. The IRS is pretty strict when it comes to filling and will address underreported income with you immediately.
While each contract, client, and transaction is at the front of your mind, track your expenses in an accounting app like QuickBooks daily to avoid unexpected fees.
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