Tax Tips for Freelance Professionals
What Independent Contractors Should Know About Paying Taxes
Freelancers have full control over their financial and tax situations, more so than those who work as employees, but that independence can come at a cost. Freelancers face higher taxes and more recordkeeping responsibilities than employees. Some special tax circumstances apply to them and to other independent professionals.
Net Self-Employment Income
The basics of tax planning for self-employed persons begins with understanding how you're taxed in the first place.
A freelance professional is an independent contractor. Independent contractors are taxed on their net self-employment income—gross receipts less tax-deductible business expenses. This net amount is then taxed twice: once for regular federal income tax and again for the self-employment tax.
You can arrive at your net income by completing Schedule C with your Form 1040. It's the "Profit or Loss From Business (Sole Proprietor)" and you must submit it with your tax return. You're a sole proprietor if you haven't taken legal steps to set your business up in some other form, such as a corporation.
Schedule C has five parts. Total up your all freelance income in Part I. Do not include any income you might have earned that was reported on a W-2. This is taxed separately on your 1040.
You can now add up and deduct your business expenses from your total income in Part II. Parts III through V deal with some unique expenses that you might or might not have such as inventory or auto expenses.
You can get away with completing and submitting the shorter and simpler Schedule C-EZ if you have no more than $5,000 in freelance income during the year, operate only one sole proprietorship, have no employees, have no inventory, and you do not claim a home office deduction for your business.
You'll find your net self-employment income on line 31 of your Schedule C after you complete it. Enter this number on line 12 of your 1040.
This self-employment tax functions pretty much like a flat tax except its highest rate caps out when earnings reach $128,400 for the year as of 2018.
The self-employment tax is comprised of Medicare and Social Security taxes. If you were not self-employed, you would pay half these taxes and your employer would also pay half. But freelance professionals are their own bosses. They must pay both halves of these taxes themselves.
This works out to 12.4 percent of net income up to $128,400 as of 2018 for Social Security and 2.9 percent of total net income for Medicare.
The IRS has a form for calculating the self-employment tax, too—Schedule SE, which you must also submit with your tax return.
If there's any good news here, it's that you can claim an above-the-line deduction for one half of your self-employment tax liability on line 27 of your 1040. But you must still enter the total self-employment tax you calculated on Schedule SE on line 57 of your 1040.
Estimated Tax Payments
None of these taxes will be deducted from your pay as a freelance professional, unlike if you worked as an employee.
If you were not self-employed, your employer would withhold income tax, Social Security tax, and Medicare tax from your pay each pay period and submit that money to the federal government on your behalf—along with its own contribution toward your Social Security and Medicare taxes.
But again, sole proprietors are their own bosses so they must take care of all this themselves and the Internal Revenue Service prefers that you do so on a pay-as-you-go basis.
Freelancers can send in tax payments throughout the year by sending in estimated taxes. You're paying as you go and this will prevent a cash crunch in April, at least if you estimate correctly, because all final tax payments are due by the April 15 tax deadline.
Estimated taxes are due quarterly. The due dates for 2018 are April 16, June 15, September 17, and January 15, 2019. It's important to plan for and budget these tax payments.
Business expense deductions obviously play a significant role in helping a freelancer keep her federal taxes under control. The more legitimate, qualifying expenses you have, the less your taxable income will be.
That ream of paper you bought last week for your office? It's tax deductible. Get in the habit of saving all your receipts whether in paper form or with a smartphone app. It should be a kneejerk reaction every time you spend money. Save credit card and bank statements, too.
Then sit down with everything once a week or so while all those purchases and payments are still fresh in your memory. Sort them out. Which were business expenses? Which were personal?
Schedule C includes lines for some of the most common deductions to guide you so you don't miss any and you can deduct others as well even if they don't appear here as long as they're "ordinary and necessary." This typically means that most others in your line of work claim the same expenses you do and that you could not produce income without spending money on them—or at least you wouldn't earn as much money if you didn't.
A typical tax planning strategy for freelancers begins by keeping track of income and expenses as the year progresses, then calculating estimated taxes. Then finetune your tax planning such as through investing in a retirement plan or optimizing his depreciation methods and send the IRS what you anticipate you'll owe at year's end.
You can make tax payments more often than quarterly. Some freelancers have found that it can be easier on their budgets to send estimated payments to the IRS monthly and this is perfectly OK.
After you calculate how much you'll owe quarterly, divide that number by three and remit that amount monthly. It can be easier to pay $400 a month rather than $1,200 quarterly if your income is relatively regular and doesn't fluctuate too much from month to month.
You might also get into the habit of withholding a percentage for taxes from each payment you receive as a sole proprietor and segregating the money into a separate account until you're ready to make the payment.