Let’s be real—filing taxes for freelancers is a complex endeavor, and one that most of us don’t look forward to. Are you a freelancer who fears the 1040? Keep reading for tips on fulfilling your financial responsibilities while also getting the most bang for your buck.
9 Tips on Taxes for Freelancers
If you think the holidays are the best time of the year, you have clearly never experienced the magic of tax season. Just kidding! Filing taxes as a freelancer can be overwhelming, but once you learn the ropes you may even find it enjoyable. Plus, you might also reduce your tax liability and earn back some serious coin.
So, don’t flee the country! Use these tips to up your acumen and take your freelancing venture to a whole new level of lawfulness.
1. Confirm Your Employment Status
First and foremost, make sure you understand your employment status before filing your annual returns. It’s not uncommon for companies to hire W-2 freelancers and independent contractors, which gets confusing during tax time.
The IRS classifies freelancers as self-employed individuals who are responsible for paying their own income-related taxes. Employees are not responsible for paying such taxes, as their employers withhold estimated income, state, local, Social Security, and Medicare taxes from their paychecks.
Therefore, if you filled out a W-4 form, have taxes withheld from your paychecks, and receive a W-2 form at the beginning of the year, you’re not a self-employed worker in the eyes of the IRS. Contrarily, if you completed a W-9 form, have zero withholding from your paychecks, and receive a 1099-MISC form, then you are considered self-employed. This means you’re accountable for paying your own income-related taxes.
Keep in mind, if you have a full-time W-2 job and a 1099 side gig, you’re only considered self-employed for the 1099 position, as the W-2 job withholds income tax from your paychecks. Additionally, online money transfer services like PayPal are required to issue 1099-K forms to individuals who sell at least $20,000 in goods and services and receive 200 payments for goods and services in the same year. So, if you accept payments through services like PayPal and meet their tax reporting thresholds, you shouldn’t receive 1099-MISC forms from your clients.
2. Know Your Tax Obligations
Though businesses are only required to issue 1099-MISC forms to contractors who earn at least $600 in a tax year, you are required to file an annual tax return if your net earnings from self-employment are at least $400 or if you meet any other filing requirement.
Quarterly Taxes for Freelancers
In addition to the annual return, taxes for freelancers must be paid on a quarterly basis.
These more frequent fillings include:
- Income tax – a percentage of your taxable income
- Self-employment tax – Social Security and Medicare taxes
Your taxable income is the net of your income, deductions, gains, and losses. You do not necessarily pay taxes on every penny you earn. Instead, you are taxed on what remains after you deduct expenses and losses.
The current self-employment tax rate is 15.3% of your net earnings. Of that percentage, 12.4% goes towards Social Security and 2.9% goes towards Medicare.
Since employers are required to pay 6.2% of their employees’ Social Security tax, you can deduct the employer-equivalent portion from your taxable income. As a freelancer, you may land gigs with companies outside the U.S. or travel the globe and pick up jobs wherever you venture. Though the IRS requires all U.S. citizens and resident aliens to report and pay taxes on all worldwide income, you may be eligible for a foreign earned income tax exclusion.
3. Maximize Your Deductions on Taxes for Freelancers
Deductions reduce your taxable income and keep more hard-earned cash in your pocket.
Qualified Business Income Deduction
For the 2019 tax year, you can deduct 20% of your net qualified business income in addition to claiming the standard deduction.
You might be thinking, “As a freelancer, do I technically qualify as a business?” If you work for yourself and have not registered with the government as a partnership, limited liability company (LLC), S corporation, or other business structure, then you’re considered a sole proprietor, which is one of the pass-through entities that qualify for the 20% deduction. Most states do not require that sole proprietors register their businesses.
Also, you can deduct all or a percentage of “ordinary and necessary” expenses, as the IRS calls them, that are directly related to your freelancing work. These may include:
- Travel and lodging
- Meals and meeting expenses
- Home office space
- Coworking center membership
- Office supplies
- Equipment and furniture
- Work-related education
- Retirement plan contributions
- Out-of-pocket medical costs
- Healthcare insurance premiums
Many freelancers fear the home office deduction because they believe it’ll raise a red flag and cause alarm for an audit. However, Gene Marks, a certified public accountant, told Forbes the IRS does not see home office deductions as suspicious and encourages self-employed workers to take advantage of the break. Therefore, the easiest way to reduce your taxable income is to use the simplified home office deduction option and claim $5 per square foot used exclusively for business.
4. Save Your Pennies
Instead of blowing all your hard-earned cash for the sake of a hefty tax deduction, put your money to work with a retirement account like a Simplified Employee Pension (SEP) IRA. For the 2019 calendar year, the IRS will let you contribute 25% of your self-employment income or $56,000 (whichever is less) to an SEP IRA, which you can deduct on your 2020 tax return.
Other retirement savings options for self-employed workers include:
- Individual 401(k)s
- SIMPLE IRAs
- Profit-sharing plans
- Money purchase plans
Research investment plans thoroughly before applying or signing up, as contributions may not be deductible on taxes for freelancers. However, disbursements may be tax-free.
5. Organize Your Business Finances
A smart rule for freelancer financial management is to separate business and personal accounts. For instance, open a checking, credit card, and PayPal account for exclusive business use. This makes tracking cash flow and claiming deductions easier.
Though many transactions may take place online, retain copies of all business-related receipts and label them according to their tax deduction categories. Save all hard copy receipts in a file and take pictures of them with your phone or scan them into your computer.
Consider using a cloud service to store financial documents so you don’t have to worry about backing up or recovering data. Plus, with cloud-based applications, you can access your numbers anywhere that has an internet or data connection.
Retain all digital and hard copy receipts, invoices, IRS forms, tax returns, and other pertinent documentation for at least seven years.
6. Legitimize Your Business
If you’re a serious freelancer who takes on new projects and contracts regularly, then it’s easy to prove you run a legitimate business and deserve federal tax advantages. However, if you dabble here and there without a genuine pursuit of earning a profit, the IRS may classify your work as a hobby and disallow hobby-related tax deductions.
Therefore, legitimize your freelancing business by creating a simple website, letterhead, business cards, and an occupation-related signature for your email account. Record meetings, phone calls, work hours, and travel in a calendar to show consistent activity. Spend money wisely and demonstrate that your expenses are being used to earn income and make a profit.
7. Protect Your Personal Assets
To protect your personal identity, investments, and belongings, consider getting an Employer Identification Number (EIN) through the IRS instead of using your Social Security Number (SSN) for freelance contracts, accounts, and transactions. The IRS doesn’t care if you use an EIN or SSN, but you leave yourself vulnerable to identity theft and other malicious activities by giving away your private information.
Plus, as a sole proprietor, you put your personal assets on the line when you include business income and expenses on your annual tax returns. As business picks up, you might consider registering as a partnership, LLC, or S corporation—all of which are considered pass-through entities for that 20% business tax deduction. Such business structures may complicate tax filing, but they can also reduce your personal liability and present additional tax advantages.
8. Check State and Local Requirements on Taxes for Freelancers
Though freelancers focus heavily on federal taxes, don’t forget about state and local filing requirements. State income tax rates vary, and the following seven states do not collect income tax:
- South Dakota
In addition to your state, be sure to check your city and county tax requirements, so that you don’t suffer penalties for nonpayment.
9. Hire Professional Services
Taxes for freelancers can be overwhelming sometimes, especially for those whose forte is not finance. If you file your taxes yourself using an online software application, consider purchasing audit protection or similar services for additional peace of mind. To play it safe, you may want to hire a CPA or professional tax preparer, especially if your cash flow is complicated or you feel insecure about your reporting. Though software helps bypass complicated paper forms and navigates you through changes to the 1040 form, counsel from an experienced professional can boost your confidence and cover all your bases.
Find Tax-Advantaged Freelance Jobs at Virtual Vocations
If you’re interested in leveraging the gig economy to increase your federal income tax deduction, start applying for remote freelance jobs at Virtual Vocations! Just sign up, fine-tune your resume, and search for remote contract work that aligns with your skills and goals.
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