The Tax Rules Every Freelancer Should Know
Seven months ago, I quit my day job and started freelancing full time. Although it was scary at first and I’m still adapting, I’ve been feeling pretty positive about my career in the past couple of weeks. However, when I realized it was time to do my taxes, the bubble burst. While some people told me I needed to do certain things in order to stay on top of the tax situation, I heard them like Charlie Brown hears adults, as a general mwa-mwa-mwa background noise. Working as a freelancer means that I get to set my own schedule, but it also means I have to deal with a different set of problems. None of the companies I work for take taxes out of my paychecks. Now I’m coming to terms with the big chunk of change I owe the government and am finally doing my homework. Here’s what I wish someone had told me back in August—the tax rules every freelancer should know.
I’m a creative who loves to cook and read. I have never been good at numbers and finance, so the first thing I did when I realized I was in a predicament was find someone to help me! If you have the same type of brain, seek out a financial adviser. You don’t have to pay a professional if you can’t afford it, but do ask a trusted family member or friend to help you. Offer an exchange of services. For example, my cousin who works as an auditor is helping me. To thank her, I’m inviting her to dinner.
Be sure the person has a strong grasp of the paperwork involved with filing taxes. The papers are different for an independent contractor—that’s government speak for freelancer. In order to do your taxes, you’ll need a 1099 form (a form that lists how much your employer has paid you in the past year) from all your employers. You’ll also need a 1040 (a form that most people use to calculate how much you owe overall), Schedule C (a form used to calculate how much money you made minus business expenses), and Schedule SE (you’ll use your results from the Schedule C to calculate your self-employment tax).
Have a candid conversation with your adviser, and ask for help with any other financial planning aspects of your career. What’s the smartest way to plan for retirement? What are the cheapest options for health insurance? When you take your career into your own hands, you have to worry about a lot of things that a full-time employer would typically take care of. Address these things right now so they don’t come back to haunt you later.
Make a new bank account, with a separate credit card, and use this to pay for anything related to your business, including healthcare expenses. Doing this will make it much easier to track your cash flow and your business expenses. Thus, if I’m working as a freelance recipe developer, I should use my business credit card to pay for groceries that I will use to develop recipes. You should be able to write off anything on your business account.
To avoid having to pay a large lump sum to the government in April, pay your taxes four times a year. In order to do this, you have to figure out what your projected income for the year will be. Forbes says “you don’t want to ballpark this figure. Unless you understand taxes, you’re probably going to be way off.” Get a professional to figure out how much you’re likely to earn in the next year, and start paying your taxes quarterly.
Estimated taxes are due on the 15th of April, June, September, and January. However, these dates are not evenly spaced throughout the year. On April 15, turn in the taxes for income earned from January 1 through March 31. On June 15, turn in the taxes for income earned April 1 through May 31. On September 15, turn in the taxes for income earned June 1 through August 31. On January 15, turn in the taxes for income earned September 1 through December 31. The June payment covers just two months of income while the January payment covers four, but you are expected to pay the same amount each quarter.
Just as you set up a separate business bank account, set up a tax savings fund. Whenever you get paid a check, immediately withdraw a portion of it and put it into your tax fund. The tax fund is different from your savings fund, because you will use the money to pay off your taxes. What many freelancers don’t realize is that they have to pay an extra tax, the self-employment tax. When you work for a company, the company takes out a certain percentage of your wages to pay Social Security and Medicare taxes. The company also pays into the Social Security and Medicare for you.
“When you become a freelancer, you have to start paying self-employment tax, which covers both the money that would have normally been taken out of your wages by an employer and the money that your employer would have paid on your behalf,” explains Lara Rutherford-Morrison on Bustle. “So if you’re used to paying taxes through an employer, you may be surprised to find that you owe these extra fees.” Start by putting aside 30% of your paycheck toward a tax fund. Then pray that this will be enough money to cover your taxes! In 2015, the self-employment tax was 15.3%.
The IRS says you can deduct business expenses that are ordinary and necessary in your industry, so figure out what expenses are common for someone in your industry. When you’re working with a tax adviser, be very clear with the happenings of your day-to-day job. According to Forbes, you must know for certain what items you can deduct.
Laura Shin explains it like this: “People in most professions can count restaurant meals as business expenses only when they are entertaining clients—and then, only half the expense would qualify. However, if you write restaurant reviews, then eating out at restaurants is an expense you can write off even if you’re not eating with a client—and the full amount can be taken since it falls under research.”
Tax deductions fall into three categories: things you use exclusively in operating your business, things you eat in the course of doing business, and things related to the exclusive business use of the place where you operate your business. Expenses that fall into these categories include travel and hotel accommodations, home office, utilities for the home office, professional development, advertising and marketing, website, software, mileage and gas, and unpaid invoices.
In the odd chance that the IRS follows up with you, you need proof of everything that you have listed and deducted on your tax forms. Keep all receipts. File them by month, and store them in manila envelopes. Use a software program like Quickbooks to track your expenses and pay your bills. Be sure to note when you get paid and how much each employer is paying you. The more on top of things you are regularly throughout the year, the less pain you’ll experience come April.
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Are you a freelancer? What’s your plan for dealing with taxes?