While I don’t know of anyone who particularly enjoys tax season, for freelancers, that April 15th deadline looms even larger. As a freelancer — or contract worker, depending on how you think of yourself — you’re responsible for the bulk of your tax record-keeping, filing and, of course, paying.
If you’re coming from the world of regular Joe, works-for-someone-else employment, this is probably all new to you.
When you work for a larger business, the business itself takes taxes out of your paycheck, and even pays part of the taxes for you. (We’ll talk more about this in a minute.) At the beginning of the next year, you can just wait for your W-2, fill out your Form 1040 and be on your merry way.
If your employer didn’t withdraw enough from your paychecks throughout the year, you might get stuck with a small tax bill. If your employer took out too much, you’ll get a nice check in the mail — or even a direct deposit into your bank account within a few days.
Except in cases of gross accounting errors, regular employees rarely have to deal with hefty tax bills. But freelancers might.
Besides being responsible for keeping track of all your income and expenses, you’re also responsible for paying 100% of your income taxes, including Social Security taxes. And even if you only made a few thousand bucks this year, you could still have a surprisingly large tax bill.
But don’t panic! This easy guide will help you sort through what you need to know and do to get your freelance taxes under control.
1. Don’t Panic If You Didn’t File Quarterly Taxes…
If you’re new to the freelancing game, you may not have known this, but freelancers and other business owners are supposed to file taxes quarterly. Basically, you need to pay the IRS part of your estimated tax bill on April 15th, June 15th, September 15th and January 15th every year. (January comes at the end because on that date, you’re actually paying taxes for the end of the previous year.)
So if you’ve been freelancing for a full year now, you’re supposed to have made at least three quarterly tax payments.
But don’t freak out if you haven’t. According to the IRS, you only technically have to pay estimated quarterly taxes if you’re a sole proprietor (which you probably are as a freelancer) and you expect to owe at least $1,000 when you file your tax return. So if you were just freelancing on the side this year and didn’t make a ton of money — which would mean you wouldn’t have to pay $1,000+ in taxes — then you won’t be penalized for not filing quarterly taxes.
If you did pay quarterly taxes but underestimated how much you’d owe, you’ll avoid the penalty if you paid at least 90% of the total of what you owed for the year. However, even if you owe more than $1,000, didn’t pay at least 90% of your taxes throughout the year and get penalized, breathe easy — the penalty is very, very low. In my first year of freelancing (when I didn’t even know about quarterly taxes), I paid a penalty of, maybe, five bucks.
And if you wind up with a huge, unexpected tax bill you aren’t prepared to pay (see next section for tips on saving up for this), you can call the IRS and set up a payment plan to get your taxes paid off in a timely manner. You’ll have to pay interest on your balance this way, but the interest is also ridiculously low.
It’s better to pay the interest and spread out your tax payments, if you must, than it is to completely drain your checking account and try to live on a shoestring while you catch up on your taxes. Trust me. I’ve done it both ways.
2. …But Do Get Ready to File Quarterly for the Next Year
At this point in the year, there’s not a whole lot you can do to remedy the fact that you didn’t pay quarterly taxes. But you should prepare yourself to pay these taxes in the next year. There are a couple of ways to figure out your quarterly taxes.
One is to simply divide your tax liability from the previous tax year by four. If your income and financial situation is pretty much the same throughout the next year, this should get you pretty close to paying what you need to pay.
Another option is to use Form 1040-ES: Estimated Taxes for Individuals. You can fill out this form four times a year when you get ready to send in that quarter’s estimated tax payment. This form will get you even closer to a correct estimate of your taxes, especially if your income is different from the previous year.
It’s a good idea to get an estimate of what percentage of your income you’ll need to pay in taxes. Then, make a habit of setting aside that percentage of every single check or transfer you get. That way, you won’t find yourself scrambling to make your next quarterly payment.
3. Take Filing Status Into Account When Planning
One thing to keep in mind is your filing status. If you’re filing single, then it’s just your income that counts in estimating your taxes. In some ways, this is easier, even if you’ll pay a higher tax rate. If you’re married filing jointly, however, your spouse’s income and tax payments will affect your own. For instance, your spouse’s income could bump you to the next tax bracket, which means you’ll owe even more of your freelancing income.
You could also use your spouse’s steady paychecks to reduce your own tax liability. My family does this by having my husband’s paychecks withhold taxes at the higher single rate. He pays more than he technically should so that I don’t have to take as much out of my freelancing income.
When you’re married, all the taxes come out of the same financial pot, so to speak, whether you pay taxes from your freelance income or your spouse pays taxes from their paychecks. (Or, if you’re freelancing and working a regular job, you could increase your own withholding for the same effect.)
This approach works well for my family because I’m admittedly not always a disciplined saver. By having more money taken from my husband’s checks, I’m forcing us to “save” at least most of the money we’ll owe by going ahead and giving it to the IRS.
4. You’ll Need to Gather Income and Receipts
Confession: Just as I’m not always a disciplined saver, I’m also not always a disciplined record-keeper. Improving this is already on my New Year’s resolution list.
Not keeping good records throughout the year means that in January, I’m scrambling around trying to find receipts and online payments so I can record my income and expenses. Admittedly, this isn’t all that bad for me, since 90% of my client payments are automatically tracked through my online payment systems and since I don’t take all that many business deductions.
However, if you get lots of checks from clients, if your income comes to you through many forms (PayPal, Freshbooks, direct deposit, etc.), or if you do qualify to take plenty of business deductions (i.e. you have a legit home office, you travel for your business or you wine and dine potential clients), then you need be sure to get your income and receipts straight.
Even though your clients don’t withhold taxes, most of them will still report the payments they made to you as part of their own business accounting procedures. That means you can’t leave out income, or the IRS will know. And that will not be good.
You also definitely want to be sure you’re taking every possible deduction you can get your hands on. Last year, I took a home office deduction that amounted to about 10% of our rent for the year because my office was actually a converted reach-in closet. Since the home office deduction is based on the percentage of your home’s square footage that your office occupies, it wasn’t much. But it helped!
So if you use your household Internet connection for work, have a secondary work phone line, travel to meet clients, pay for business services or conferences, or have other business-related expenses, make sure you get all of that information together as soon as possible. Like, you should start gathering it today.
And while you’re at it, consider making a profit/loss statement for each month of the year. This isn’t strictly necessary — the IRS only cares about your sum total profits and expenses for this tax year — but keeping track of your profits and losses throughout the year is a good way to force yourself to track your expenses. It can also help you see patterns in your income, or just give you that satisfied feeling that comes when you see your income steadily on the upswing.
5. You Don’t Need to Hire a Pro, But You May Want To
Many freelancers will tell you that you absolutely have to hire a professional to prepare your taxes. I’m here to tell you this isn’t always true. Sometimes it’s a good idea to hire a pro, and sometimes it’s better to go it alone.
I say this having done things both ways. My first year as a freelancer, I hired a professional. It cost me a couple hundred bucks, but it was worth it that year to walk through all the possible deductions with this very nice man who totally knew what he was doing. Since then, though, I’ve just used TurboTax Home and Business software to file my taxes on my own.
TurboTax is a whole lot cheaper, and it does walk you through most of the options for deductions. I don’t feel I’ve missed any major deductions in the past few years, and my taxes have always been filed correctly.
However, if your freelancing business is more complicated than mine — if you hire out some of your work, have a partner or have a number of business deductions to track — then hiring a professional might be worth your money.
If you think hiring a tax pro will save you a lot of work, however, think again. Automated software can help you fill out every form you need to hit, including Schedules B, C, D and E, by just filling in the blanks. And even if you work with a tax pro (unless you’re talking about hiring an actual business accountant, which is an entirely different proposition), you still have to get all your information and receipts together yourself, which is often the hardest part.
What other tax tips would you share with first-time freelancers?
Abby Hayes is a freelance blogger and copywriter who writes about personal finances for Dough Roller. She loves detailed budgets, dark chocolate and fat Victorian novels.
Image: Flickr
