Fear. Panic. Uncertainty. All feelings that surround us when we think about how to pay taxes as a freelancer.
What’s with all the dread? Honestly, I think it’s just that we as a nation don’t truly understand taxes. That’s understandable. The tax code is crazy complicated and varies from state to state (and we have 50 of them!). But once you understand the basics of paying taxes as a freelancer and hire professional help from an accountant, you’ll breathe easy!
This blog post was inspired by my Ask Me Anything (AMA). A reader, Jenna, submitted this question to me:
“I quit my full-time job to pursue freelance last February (almost hitting my one year anniversary!), but as tax season approaches, I am starting to stress out and don’t know where to begin. Any big do’s or don’ts for tax filing? I’d appreciate any feedback!”
First of all, let me congratulate you, Jenna! I’m so proud of you for taking the leap into entrepreneurship! 🙌🏼
Second, before diving into my answers, let me say that:
- I am not an accountant or tax professional, so this is not tax advice and should not be a substitute for seeking professional tax help.
- Everything I talk about below is in reference to the American tax system as that is the only one I’m familiar with. Tax law is extremely complex and varies country to country.
- I will speak from the point of view of a freelancer who is a sole proprietor. You can be a freelancer who’s an LLC, too, but taxes are slightly different for you. Basics are the same, though.
Filing taxes for your first year as a freelancer is tricky. That’s because, as a freelancer, you are supposed to pay your income taxes every quarter. These are known as quarterly estimated taxes. But most freelancers either don’t know this or don’t understand how to calculate this.
But I’m getting ahead of myself. Let’s start with the basics:
Do I have to pay taxes on my freelance income?
Yes. You are required by law to pay taxes on all income, even the 20 bucks your neighbor paid you to mow his lawn.
Now, the question becomes this: Is your freelancing a hobby or a business? The answer to that question determines how and if you can deduct certain expenses on your tax return. The IRS lays out some guidelines on how to determine whether what you’re doing is seen by them as a hobby or a business, but here’s the gist of it, taken from the IRS website:
“The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year — at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.”
I’m assuming the last bit about horses probably doesn’t apply to any freelancers reading this post. But there you have it: if your freelancing made a profit during at least three of the last five tax years, you are a business! But that’s not the only guideline to go by, as maybe you haven’t even been in business for the past five years.
How do freelancers pay taxes anyway?
Unlike an employee, freelancers must pay Self-Employment Tax. Employees have income taxes taken out automatically from every paycheck by their employer. Most people are employees and never even notice this money is being taken out.
Unfortunately, freelancers don’t have that luxury. We must take that money out ourselves and pay the government. Freelancers are supposed to pay their income taxes every quarter (four times a year)
As a freelancer (sole proprietor), you have a new form attached to your April 15 tax return: the Schedule C. This is where you list your income and all your expenses and will arrive at your net income (profit or loss).
What if I haven’t been paying quarterly estimated taxes?
While this isn’t ideal, you’re gonna be fine! Basically what happens is if you haven’t been paying your income taxes in four separate installments (once a quarter) throughout the year, you’ll wind up paying them all in one lump sum come Tax Day (April 15). On top of that large tax bill, you will pay a relatively small penalty for paying late.
How do I calculate quarterly estimated taxes?
Ooph, this one’s complicated. Technically speaking, there’s this really complicated form called the 1040-ES that you can fill out to figure it out down to the last cent.
Or … you can do the easy way.
Here’s what you need to understand about quarterly estimated taxes: You’re paying taxes on your taxable income for the past 3 months.
So pull up your business bank account online and look at the last 3 months. Add up all income earned those last 3 months. Then add up all business expenses spent those last 3 months. Subtract the two. Then take about 25% out of that. That’s your rough quarterly estimated tax payment. Wanna be super safe? Take 30%. Again, the percentage varies widely depending on your income and other factors, but 30% typically should be more than enough.
The best way is to hire an accountant to help you calculate your quarterly taxes.
What happens if I overpaid in my quarterly estimated taxes?
I’ve done this before! No sweat. If you paid too much in quarterly estimated taxes, you’ll get a refund in April the following year (yay!) when you file your income tax return. Essentially, you gave the government an interest-free loan, and now they’re gonna pay you back. :)
What happens if I underpaid in my quarterly estimated taxes?
If you paid too little in quarterly estimated taxes, you’ll owe the remaining taxes (plus a small penalty) in April the following year when you file your income tax return.
What if I haven’t been paying taxes on my freelance income?
Ruh-roh. If you haven’t been paying taxes on your freelance income, there’s this thing called “back taxes,” which essentially means paying taxes late. I don’t know much about this, but a qualified accountant can help you file your back taxes.
What if I can’t afford to pay the taxes I owe to the IRS?
I’ve been there! Don’t worry. Here are two main options:
- Work out an installment plan with the IRS
- File for a short-term extension to pay – This is what I did. I think I ended up paying the taxes owed by August that same year.
Note: Even if you can’t pay your taxes owed, you STILL must file your tax return by April 15. You should also pay as much as you can to offset the penalties.
To learn more about your options, visit the IRS webpage about “What if I can’t pay my taxes?”
Do I need to open a business bank account?
While you don’t need to open a technical “business bank account,” YOU DO need to AT LEAST open a separate personal checking account that you use STRICTLY FOR BUSINESS.
While this is NOT required by any law, it will save you so much time later one. Just trust me on this one.
What are 1099s?
It’s basically a form that tells the IRS how much money a contractor was paid for the year. If a client paid you more than $600 in one calendar year, they should send you a 1099 form by Jan. 31st of the following year.
What if a client didn’t send me a 1099?
Even if a client fails to you send you a 1099, you still must report that income on your tax return.
What can I deduct as a business expense?
You need to know what is (and isn’t) deductible as a business expense.
Common Business Expenses for Freelancers
- Accounting software – QuickBooks, Xero, FreshBooks, etc.
- Tax help – Hiring an accountant to file your income tax return, for example
- Office supplies – pens, notebooks, paper clips, etc.
- Social media software – Buffer, HootSuite, etc
- Education – Online courses, ebooks, etc.
- Professional services – Business strategists, coaches, etc.
Contrary to popular belief, these are NOT deductible:
- Paying for a latte at the coffee shop you work from. Nope, that’s not a business expense. Now, if you meet a client at the coffee shop to discuss business matters, and you treat that client to a latte, THAT is tax deductible.
- The clothes you buy to dress up for client meetings. While it could be argued that you need the professional clothes in order to do business, sadly, clothes are not tax deductible.
Do I have to keep receipts as proof of business expenses?
Yes. You must have receipts for every item you claim as a deduction. It’s not that you need to show the receipts when you file your taxes, it’s in case you get audited by the IRS. If that happens, you’re going to have to show them the proof for everything, so you better hope you have it.
Do I have to hire an accountant or CPA to do my taxes as a freelancer?
Nope, it’s not required. You most certainly are allowed to complete your own tax return as a freelancer. But … personally, I wouldn’t recommend it, especially if the previous tax year was your first year as a freelancer. Filing as a freelance business owner is SO different from filing as an employee.
I would recommend hiring a tax preparer. I’ve done it every year for my freelance business.
What do I need to have to prepare my tax return?
These are the main items you need to have in order to complete your tax return:
- Your business income for the year. Often, this is pulled from your accounting software.
- Your business expenses for the year PLUS receipts for them
- Your Social Security Number or Employer Identification Number (EIN)
- Proof that you had health insurance for that tax year
- 1099 forms
- W-2 forms (if applicable)
- Any forms for interest and dividends you earned on savings accounts or investments
Do you know any good accountants who specialize in freelancers?
Yes! I have worked with and can recommend these two CPAs:
- Eric Bisignano, CPA, of Charitax
- Winnie Tam, CPA – She has the added bonus of specializing in American expat taxes for you long-term travelers out there!
*And one last time, for good measure, a disclaimer: I am not an accountant or tax professional, so this blog post is not tax advice and should not be a substitute for seeking professional tax help. Thanks!
You might want to read these posts next:
- The Freelancer’s Guide to Quarterly Estimated Taxes
- Digital Nomad Tax Questions Answered by a U.S. Tax Attorney
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