As we round out 2019, more than one-third of U.S. workers now earn a living freelancing. If market reports are anything to go by, this number — and the rate of people filing freelance taxes — will only continue to rise.
This trend says a lot about our current economic and labor climates. Like, how more and more workers are growing tired of working for a larger corporation and would rather strike out on their own.
However, it also means the way many professionals handle their personal finances needs to change. Mainly, in how they approach their tax obligations.
Filing your first year of freelance taxes is, simultaneously, the most exciting and most gut-wrenching part of entering into the entrepreneurial world. At the same time, though, it’s one of the most discussed aspects of freelancing.
In this case, though, more information isn’t necessarily better.
Separating Fact from Fiction in the World of Freelance Taxes
A personal anecdote:
Since starting my freelance career, the ins-and-outs of self-employment tax are all distant relatives want to discuss at holiday get-togethers.
No one wants to know about my newest client or current projects. The only topic of interest is how I plan to navigate the mysterious, scary world of freelance taxes.
If that doesn’t show how hyper-focused we all are on our taxes (and doing them right), I don’t know what does!
Of course, these conversations are almost always laced with misinformation and unwarranted concern. And, unfortunately, my older relatives aren’t the only ones confused by freelance taxes.
If you need even more proof that freelancers are being inundated with tax advice, a simple Google search for “freelance taxes” brings up over 13 million results. That’s a whole lot of (often conflicting) advice!
So, how do you navigate the world of self-employment taxes without becoming completely overwhelmed?
7 Tips for a Stress-Free Tax Season This Year
When it comes to understanding your taxes, the first step is always the hardest. Fortunately, you’re not alone on this journey.
As freelancers, we’re not just hustling to earn a steady income on our own. We’re also learning to manage a business single-handedly along the way.
And, honestly, there will always be bumps in the road.
So, whether this is your very first year filing freelance taxes or you’ve been winging it for the past decade, there’s no wrong time to learn how to do things the right way.
1. Understand your new tax rates
If your goal is to face tax season with confidence, you need to learn what to expect. More specifically, how your tax liability differs from a traditional employee.
When the average employee receives a paycheck, they see a portion of income taken out for taxes. What they don’t see, however, is the equivalent tax payment made by their employer. These are called payroll taxes.
Put simply, freelancers are responsible for not just the employee’s side of income taxes, but also the employer’s. You now fill both roles functionally and, in the eyes of the IRS, financially.
Although tax rates vary from year to year, this typically means freelancers pay double the income tax rate of traditional employees.
2. Don’t skip those estimated payments
Not only are you now responsible for double the tax payments, but no one is going to be taking those payments out of your day-to-day income.
Instead, businesses (including the self-employed) make quarterly estimated payments throughout the year. These payments take the place of traditional paycheck withholdings, and you may or may not owe more at the fiscal year’s end.
Again, there’s no higher authority, employer or otherwise, taking these payments from your quarterly income. You are entirely responsible for tracking your estimated payment totals and making them each quarter.
In other words, it’s 100 percent possible to skip these payments altogether. But don’t!
Businesses and freelancers who skip these estimated payments pay the price in several ways:
- You now owe a major chunk of your yearly income as one lump sum
- Any missed payments can accrue penalties or interest
- Poor tracking can mean missed write-off opportunities
Unfortunately, failing to make estimated payments throughout the year is one of the most frequent mistakes made by new freelancers.
3. Communicate with your clients
You would think the inherent nature of freelancing would mean less time and energy spent on people management. Often, though, our clients ensure that’s not the case.
At the end of the tax year, employees expect to receive a form from their employer called a W-2. This form offers a detailed summary of their income and tax withholdings from the previous year.
Now, freelancers obviously don’t have a traditional employer to track this information. Instead, you need to rely on something called a Form 1099.
A Form 1099 helps track income taken in by all types of businesses. It is an official, IRS-approved record of your income from non-employment sources.
The tricky part, though, can be actually getting this form from your clients.
Many clients will send a Form 1099 promptly and with zero issues. If they don’t, however, it might be best to just report the income without the form.
Whatever you do, avoid filing any tax forms on your client’s behalf. Doing so can quickly lead to duplicate filings and double your reported tax liability on that income.
Keep in mind, clients are only required to submit a Form 1099 if they pay you over $600 in a single fiscal year.
Of course, you must still report any income below this limit on your taxes.
4. Keep records of everything
If until this point you’ve been keeping your financial records in old shoeboxes, you’re in for a bumpy ride.
Not only can this practice be a headache for clients (no one wants to deal with a business that can’t keep track of its own bookkeeping), but it can also cost you money when it comes time to file your freelance taxes.
You might file away those receipts and invoices with the best of intentions, but what’s the chance you’ll remember them at the end of the year? Pretty slim.
Plus, stockpiling paperwork in your closet deprives you of seeing the big picture of your business finances until the year’s end.
Yes, old habits die hard, but after you see how easy digital bookkeeping really is, you’ll never go back. Platforms like invoicely give you access to all of your business finances, from expenses to client payments, at any time and on practically any device.
Doesn’t that sound like a better solution than a dusty, old shoebox?
5. Take advantage of write-offs
One of the biggest reasons to keep track of every cent of your earning and spending is to cash in on tax write-offs.
Although freelancers are subject to much higher tax rates than their employed peers, we also get to take advantage of the same tax write-offs as other businesses.
In very simple terms, this means you don’t need to pay taxes on money spent on your business.
While there are numerous potential write-offs out there, here are some of the most common examples:
- Equipment and software
- Phone and internet
- Work-related mileage and travel
- Health insurance
Sooner rather than later, you need to determine which of these write-offs apply to you and your business. If you don’t, you’ll be losing out on valuable tax savings.
6. Stay honest
Speaking of tax write-offs, don’t be that person.
Who is that person? We all know at least one:
The business owner who pays for every night out with their company card, calls their family vacation a work trip, and tries to count their basement gym as a tax-deductible home office.
That person might brag about how much they save on taxes each year. But when they’re subject to an official audit and can’t back up any of those claims, you’re going to be glad you took the honest route.
Because guess what? The IRS isn’t dumb, and strange business expenses and deductions will quickly trigger an investigation.
7. Swallow your pride
Why are you a freelancer? Chances are, because you’re really, really good at something.
But being skilled in one area doesn’t equal knowledge or experience in another.
At the end of the day, we’re not always the best person for the job — our own finances included.
Instead of wasting valuable time and money trying to navigate the confusing world of freelance taxes by yourself, consider asking for help.
Despite what many business owners believe, meeting with a tax professional doesn’t need to be expensive, stressful, or time-consuming. Actually, working with a tax consultant can be one of the best investments of your entrepreneurial career.
It’s Almost That Time of Year Again
We can’t promise to make filing your freelance taxes easy, or even pleasant. However, we can tell you that following these tips will make facing tax season just a little bit less stressful.
As long as you stay on top of your finances by tracking income and business expenses with a program like invoicely, you can feel confident knowing you’re getting the most from your tax filing each year.
Plus, you can rest a little easier at night knowing the IRS has nothing on you in case of an audit!
(Just kidding! Well, maybe.)