Becoming a freelancer changes many things for you; it changes how you work and manage your money. One crucial area that requires keen attention when you’re self-employed is tax filing. To become successful as a freelancer, you want to treat it like a business based on how you market yourself and treat clients.
The same concept applies to your taxes. You’re responsible for ensuring the IRS receives the correct information. Look, we get it; being accountable for your taxes can be difficult. Sometimes, your situation might also be slightly different from most freelancers.
The truth is – taxes for freelancers are not an easy thing to comprehend when you’re first starting.
But to help you navigate this “tax quagmire,” here are seven rules you need to understand as a freelancer.
1. Keep Track of Your Income
Let’s say you’re working for an organization as an employee. Ideally, what happens is that your employer is responsible for calculating your earnings for the year. These are added, along with the amount of taxes you’ve paid, on your W-2.
When you work as a freelancer, the government considers you as an independent contractor. This means for your work from home tax deduction; you’ll be issued 1099 at the close of the year. First, you want to avoid relying on your 1099 to assess how much income you made.
Why? Sometimes, a client could leave out a payment or make a miscalculation. Should you file your taxes based on incorrect data, you’re in for an unpleasant surprise if the IRS discovers that you owe more money.
So it’s always better to use software calculators like https://www.taxfyle.com/tax-bracket-calculator to estimate your federal income tax bracket and total tax.
2. Consider Quarterly Payments
Sure, it sounds hectic paying taxes four times a year! But, making smaller tax payments can save you a considerable amount of money. As a freelancer, when you don’t pay quarterly taxes, the cash drain can add up: the penalty is up to 6 percent every month.
You can also encounter additional extra penalties for late-payments and underpayments. Even with penalties sounding like a big scare, there are challenges surrounding quarterlies.
First, you are calculating an estimate of your earnings in real-time. Secondly, you also want to have enough cash to cover your quarterlies.
With such challenges, it’s in your best interests to manage and automate your finances. Consider having software that will help you track your income and calculate the needed estimates and tax deductions.
3. What If I Was Paid in Cash?
Keep a record of cash receipts. You also want to make a habit of requesting printed receipts for any cash transactions. If the client or entity paying you cash doesn’t want to issue you an invoice or receipt, prepare your receipt to reflect the payment and have the entity or person you’re paying sign it.
In most cases, the person or entity giving you cash may have their business records. This means they could be deducting their payments to you as a genuine business expense and recording it simultaneously.
In cases where no history of payment is being given to you, nothing is preventing the entity paying you from increasing the amount they claim to pay you.
4. Separate your Business and Personal Accounts
If you’ve been freelancing for some time, ensure you set up separate bank accounts for personal and business spending. If you’re yet to do this, it should be at the top of your to-do list. Setting up these accounts simplifies your record keeping. You can easily view your income for the year.
Additionally, you can track expenses you incurred for your business without having to remove what you spent on groceries or other expenses. Splitting things up also keeps you protected if an audit happens.
If any issue on your taxes raises a red flag with the IRS, having a separate bank statement for your business makes it easier to back up the information.
5. Focus on Tax-Related Information
Tax experts advise freelancers and self-employed individuals to spend time every day focusing on tax information. This also includes updating income and expenditures as they happen. If you stay updated with your financials, your records are more accurate and easy to track.
You won’t have to panic anytime the IRS calls or when you’re meeting your accountant. As a self-employed person, consider using a tool like QuickBooks or an accounting app. These will help you track everything from expenses to scanning receipts.
“Freelancers need to understand that even though they’re freelancing, to the IRS, it’s still a business,” explains Alexis Krystina, a CPA and the founder of Advance Accounting, LLC. “You need to keep detailed and accurate records as this is vital during tax filing,” adds Krystina.
6. Income and Self-Employment Tax: Which is Which?
As a freelancer, if your freelance venture generates over $400 annually, you must pay self-employment tax coupled with income tax.
This comes as a nasty surprise to many freelancers. If you are self-employed or as a 1099 contractor, you’re usually double-taxed as both an employee and employer.
The figure subject to self-employment tax is 92.35% of your net earnings from freelancing. So, how do you calculate net earnings? You only need to subtract the necessary business expenses from the gross income you received from your business.
7. What to Deduct
The IRS is clear on what you can and cannot include as a deduction on your taxes. Calling the corner of your bedroom where your computer is located a home office isn’t going to cut it. For something to be considered a deductible business expense, it needs to be both necessary and realistic.
This can apply to items like a new computer, business cards, or travel expenses. You only need to ensure they’re incurred as a direct result of your freelance work. If you’re unsure whether some qualify, it’s in your best interest to seek advice from a tax professional.
Remember, the government doesn’t care if you also have a W-2 job or are otherwise just part-time freelancing. Whatever the case, your self-employment income will be taxed at the close of the year.
The bottom line is, ensure you stay on top of your tax information. If the information is too much to tabulate, consider hiring a tax expert. Paying a professional to handle things for you is a wise investment.