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For some people, tax season is an event to look forward to. Many Americans eagerly await their tax returns, which account for the year’s largest financial windfall for 30% of workers!
But if you’re just starting out as a freelancer and learning to navigate self-employment taxes, that beginning-of-the-year enthusiasm may feel more like cool dread. What if you owe money? How do you make all the deductions you keep hearing about? What happens if you can’t afford it? Do you really need to claim ALL of your income?
If your head is currently swimming with questions, don’t fret. Here are some quick tips for making your tax season as painless as possible.
Understanding Self-Employment Tax
The first step to handling your finances as a freelancer is to start thinking of yourself as two entities: you, the person, and you, the company.
When you work for an employer, that employer withholds taxes for you and also contributes toward Medicare and Social Security on your behalf. When you work for yourself, you have to withhold your own taxes and cover the entirety of those Medicare and Social Security taxes – often referred to as “self-employment tax.” This self-employment tax accounts for 15.3% of your net business profit up to $132,900, and it’s added to your actual income tax. So for example, if your income falls in the 12% tax bracket, you should be prepared to pay 27.3% in total federal taxes.
The good news is that, since you’re a business owner, you can claim deductions not available to employees. These deductible expenses come out of your income before the self-employment tax is applied, reducing the overall amount you owe to the IRS.
Tips for Minimizing Your Tax Burden
There are a lot of available tax deductions out there, and it’s a good idea to consult with a professional accountant or tax preparer to see what can best apply to your situation. Tax law is incredibly complex, and you’re likely to leave money on the table – or risk an audit – if you wade into it without a bit of professional help. However, here are a few deductions that most freelancers are able to claim:
- Home office deductions. If you have a dedicated space in your home that’s set aside for work, you can claim deductions for portions of your mortgage and utility costs. The IRS offers a simplified method for claiming these expenses based on the square footage of the space.
- Office supplies. Computers, paper, staples, business cards, and all sorts of other supplies used for business purposes can qualify for deductions.
- Advertising and self-promotion costs directly related to your business.
- Work-related travel expenses, such as gas and mileage for meeting with clients or traveling to industry conferences.
Remember: When the IRS is concerned, you are an employer first and an individual second. This means that all of your business expenses are deducted from the front end of your earnings, dropping your net income accordingly. And these business expenses are separate from whatever standard deduction you qualify for as an individual; it’s not an either-or proposition!
To make it easier to keep track of your business expenses to ensure your taxes are being calculated correctly (and prevent headaches if you do get audited), it’s a good idea to keep your freelancing expenses separate from your household budget whenever possible. Maintain separate bank accounts for business and personal use, or put all business-related expenses on a credit card. This makes it a lot easier to tell at a glance where the cash is flowing.
Mythbusting: Do I Still Owe Taxes If…?
Whether freelancing is your full-time business or a side hustle, you still owe taxes on the income you earn. You may have heard the common myth that you don’t owe taxes on work under $300 or $600 per year, but this is a misunderstanding. The fact is that your clients are only required to send a 1099-MISC form showing how much they paid you if it meets a certain threshold – but you are responsible for 100% of your income whether it shows up on a 1099-MISC or not.
There is one spot of good fortune for low-earners, though: If you earn less than $400 per year as an independent contractor, you may not have to pay self-employment tax. Instead, that $400 would just be added to your regular income and taxed at your regular income tax rate.
Similarly, if you report a loss on Schedule C of your taxes (meaning that your expenses are higher than what you earned), the loss deduction will cancel out any tax you owe.
All the same, it’s always best to err on the side of caution and set aside money for taxes. It’s better to be prepared and end up with some extra money if you over-estimated your tax burden than to under-estimate and scramble to pay later.
How Do I Pay My Taxes?
Now that you have a clearer idea of what you might owe and how you can reduce that figure, how do you go about keeping up with your tax payments?
When you work for an employer, that employer will routinely set aside some of each paycheck and send it to the IRS on your behalf, so your only concern is filing your return once a year. As a freelancer, you’ll need to make these payments on your own.
The IRS requires self-employed individuals to send quarterly estimated tax payments for both your self-employment tax and income tax. Depending on your overall income, this will probably balance out to around 25-35% of your net profits. Since this can represent a hefty chunk of change, it’s smart to put a little bit aside from each project or paycheck. Set up separate bank accounts and get in the habit of moving a third of each check into savings.
If you overpay on your estimated taxes, you can get a tax refund after filing your return. If you underpay, you have to make up the difference and may be liable for some penalties depending on the situation. Payments are due in January, April, June, and September, and you can pay by mail or online through the IRS website. You can find the appropriate tax forms and lots of other valuable information at the IRS Self-Employed Tax Center website.
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