As a freelancer, you must be aware of your tax situation. Freelancers have unique tax requirements, and if you're not careful, you could lose a lot of money at the end of the year.
In this article, we'll go over the basics of freelance taxes so that you can make sure you're doing everything correctly. We'll also discuss some tips for reducing your tax bill to keep more of your hard-earned money.
What is the Tax Rate for Freelancers?
In 2020, approximately 59 million Americans were doing freelance work in the United States, an increase from 2014, when an estimated 53 million were freelancers. Being a freelancer is a desirable way of working for many people as it offers a high degree of flexibility and freedom. There are many reasons why being a freelancer is a great option.
- You can set your schedule
- Be your boss
- Choose where you work
- Choose the work you want
Even if you have a full-time job, freelance income is a great way to pay down debt or save for a rainy day. Findings reveal that freelancers are better prepared for the future, and half the workforce doesn't believe their job will exist in 20 years.
Therefore, acquiring new skills is critical; people are increasing the prevalence of freelance work by choice. Most U.S. workforce will soon freelance at the current rate, achieving the milestone by 2027.
What freelance workers may not realize, however, is that there is a self-employment tax that they may be required to pay. If you aren't careful, you could owe a lot of money at the end of the year.
While paying taxes is never fun, it's essential to understand the tax requirements for freelancers to stay compliant and avoid any penalties. Let's dig in.
Freelancer Basics
To prepare for your Federal tax obligation, you need to be aware of three main points:
- The minimum you have to earn to pay taxes
- The self-employment tax rate
- When you have to pay freelance estimated taxes
- Federal and state income taxes
If you earn $400 or more from freelance work during the year, you are responsible for paying taxes on that income. You will receive a Form 1099 from anyone who paid you $600, but you must pay taxes on $400 or more. You need to prepare and file a freelance tax return just like you would if employed by someone else.
Self-employment is the term used by the IRS for freelance work. The income tax rate for self-employment is 15.3%, including 12.4% for social security and 2.9% for Medicare.
As a freelancer, you are required to pay your own income taxes. You don't have an employer who withholds these taxes from your paycheck – instead, you're responsible for setting aside money each month. Your next question may be, Why?
According to the IRS, you are considered both an employee and an employer when you freelance. This means you are responsible for paying the employee and employer portion of Social Security and Medicare taxes.
If you remember to set aside 25%-30% of every freelance check you receive, you should be in good shape at tax time.
You must make estimated tax payments every quarter if you owe at least $1,000 or more in taxes. Since an employer doesn’t withhold taxes throughout the year, estimating and paying your tax obligation quarterly is standard practice. Generally, quarterly tax payments work like this.
- Quarter 1: April 15 of the current year (April 17, 2023)
- Quarter 2: June 15 of the current year
- Quarter 3: September 15 of the current year
- Quarter 4: January 17 of the next year (2023)
To make payments, you can physically mail a check and accompanying estimated tax stub provided by your accountant, or you can pay quarterly estimated taxes online via the IRS portal.
You also should make yourself aware of your state's tax rate, as that can add a burden to your end-of-year planning if you don't save appropriately to pay state taxes. Unless you live in one of the following states, you'll want to look up your state's income tax rate.
States w/ no income tax:
- Alaska
- Florida
- Nevada
- New Hampshire*
- Tennessee
- Texas
- South Dakota
- Washington
- Wyoming
*New Hampshire limits its tax to interest and dividend income, not income from wages.
Understanding Business Expenses and How to Track Them
As a freelancer, you can deduct certain business expenses from your taxes. This can help reduce the taxes you owe at the end of the year. The key is to track your expenses throughout the year to have a good record come tax time.
What are Business Expenses?
Business expenses are those types of expenses that are directly related to starting and maintaining your business. Defining business expenses this way is broad and doesn't reasonably address the idea of business expenses. So, let's break down the types of business expenses.
- Cost of Goods Sold – This includes the direct costs of producing your product or service. For example, if you freelance as a web designer, the cost of goods sold would consist of website hosting, domain name registration, and any software or tools you need to do your job.
- Operating Expenses – The day-to-day expenses you incur to keep your business running. Operating expenses include office supplies, internet, rent, salaries, business licenses, etc.
For the sake of discussion, we can refine the types of business expenses into the categories that help classify them and prioritize them when budgeting.
- Fixed – These expenses stay relatively constant from month to month. They don't fluctuate much, and you can predict them with some accuracy. These expenses include mortgages, leases, salaries, and office supplies.
- Variable – These expenses fluctuate monthly and are often more challenging to predict. They are necessary expenses, but the cost varies every billing cycle. These expenses can include utilities, inventory, and credit card fees.
- Period – These are expenses that you only incur periodically. They don't happen every month, but they do occur regularly. These expenses can be fixed or variable.
- Interest – This is the expense of borrowing money. The amount you pay in interest will be based on the terms of your loan, the principal, and the current interest rate.
- Depreciation – The expense of using an asset over time; depreciation is necessary to determine the ROI of replacing the item. This expense is often associated with business equipment or vehicles. This is usually tax-deductible, so it is essential to track.
How to Track Business Expenses
Now that you know what types of expenses to track, you must know how to track them. Knowing or monitoring your business expenses regularly will help you determine what tax deductions you're eligible for according to the law. The absolute first step should be to separate your business expenses from your expenses and establish a dedicated account.
There are a few methods that you can use to track your expenses. You can use a physical ledger, an Excel spreadsheet, or accounting software like FreshBooks.
Physical Ledger
A physical ledger allows you to track your expenses with pen and paper. This can be helpful if you don't want to use software or if you want a low-tech system. The downside to using a physical ledger is that it can be easy to lose receipts and time-consuming to input the data into your taxes.
Excel Spreadsheet
An Excel spreadsheet is a digital way to track your expenses. This can be helpful because it's accessible to input data, and you can access it anywhere. The downside to using an Excel spreadsheet is that it can easily make mistakes when inputting data and is not as user-friendly as accounting software.
Accounting Software
Accounting software is the best way to track your expenses. The software is designed to track the costs and is easy to use. Cloud software allows many businesses to add their costs while on the go. The downside to using accounting software is that it can be expensive if you have a lot of expenses to track. Fortunately, with a cloud-based accounting system, tax records are secure and auditable and can be stored indefinitely.
We prefer FreshBooks cloud-based accounting software
What's a Business Tax Deduction?
A tax deduction is an expense you can subtract from your taxable income; this lowers the amount of taxes you owe. The IRS allows businesses to deduct certain expenses so that they don't have to pay taxes on the entire amount of their income.
Deducting an expense must be considered “ordinary and necessary.” This means that the expense must be ordinary, accepted in your industry, and necessary for your business. Businesses can qualify for many tax deductions, but many freelancers leave valuable tax deductions behind each April despite being eligible for them.
Usually, freelancers leave behind these deductions because they aren't sure what they can and can't deduct. In addition, as much as 35% of freelancers have difficulty understanding and paying their taxes.
While it's best to speak to a tax professional that specializes in 1099 contractors, most freelancers will qualify for these standard deductions.
- Home office space – If you have an area in your home that is dedicated to your freelance business, you can deduct a portion of your utilities, mortgage interest, insurance, and repairs.
- Vehicle expenses – If you use your vehicle for freelance business, you can deduct a portion of your gas, oil changes, repairs, and insurance. Or you can deduct mileage used for business purposes at the standard mileage deduction rate, which for 2022 was raised to 62.5 cents per mile as of July 1st. You must retain records of your miles driven for business purposes to help determine the amount you can deduct. You can sign up for several good apps to track those miles that are driven automatically and calculate your deduction at the end of the year.
- Try: Zoho Expense, Rydoo, Everlance, or the built-in mileage tracking for FreshBooks
- Travel expenses – If you travel for freelance work, you can remove your travel expenses. This includes plane tickets, car rental, ground transportation, baggage fees, tolls, and fees.
- Internet and phone bills – A portion of your monthly internet and phone bills can be deducted as a freelance expense.
- Health insurance – You can deduct the amount you pay for health, dental, and long-term care insurance.
- Meals and entertainment – Meals and entertainment is tricky but can be navigated relatively easily if you track each one, keep the receipt, and write on the receipt the following information. The client or vendor name and the purpose of the event. You can deduct 50% of all meals related to business income and 100% for restaurants for 2022 and 2023 due to Covid-19.
- Office supplies – The cost of printer paper, pens, ink cartridges, and other office supplies can be deducted as freelance expenses.
- General supplies – Coffee, water, cleaning supplies, and other general supplies used in your business's day-to-day operations.
- Hardware and software – If you need specific hardware or software for freelance work, you can deduct the cost of these items as business expenses. Online services are also deductible as most software is now SaaS.
- Licenses and fees – Businesses must pay taxes and fees to the government; these freelance expenses can be deducted from your taxes. You may also have state and local licensing requirements, fees for organizations to run your business or fees for organizations to classify your business.
- Advertising materials -Any freelance business can deduct the cost of advertising, including business cards, website design, and online ads.
- Memberships and dues – If you belong to any professional organizations that charge annual fees, those are deductible.
Freelancers Can't Deduct it All
As we mentioned earlier, all deductions must be reasonable business expenses to be deducted from your taxes. Personal, lifestyle and non-business costs cannot be included. False information can result in an audit from the IRS, so it's crucial that you only deduct business-related expenses.
Any freelance expenses considered “luxuries” or “hobbies” cannot be deducted. For example, you can remove this cost if you're a freelance writer and purchase a new laptop to help with work.
However, you cannot deduct this cost if you're a hobbyist photographer and buy a new camera to add to your collection. The key factor is if you are being hired to perform a service and receive payment for that service.
Even if an expense is considered a business necessity, some costs cannot be deducted in full. For example, you can only deduct a car payment or other expense under certain conditions, such as using that car as your business, being an Uber or Lyft driver, or being a delivery driver for DoorDash or another service.
For freelance taxes, keeping detailed records of all business-related expenses throughout the year is essential. This will make tax time much more manageable and help you get the most deductions possible.
Also, filing your taxes while working for another employer can entitle you to a refund for overpayment of taxes; it's unlikely to happen with freelance taxes. Most freelancers are self-employed and responsible for paying their taxes throughout the year. If you moonlight as a freelancer but have a full-time 9-5 job, you'll want to see if your regular taxes cover your freelancing or side income, and you don't have to pay quarterly estimated taxes in this scenario.
The Importance of Receipts and Invoices Related to Your Freelance Work
The freelance community has been growing rapidly in recent years. As the freelance community grows, accurate information involving the tax law that applies to freelancers is vital. This means keeping all documentation, including applicable receipts and invoices, in an easily accessible place.
As a freelancer, you juggle many tasks, including work or bookkeeping, such as tracking expenses. Regarding freelance taxes, it's crucial to stay organized and keep track of all business-related costs by knowing when and where to utilize invoices and receipts.
This will help you ensure you get the most deductions possible, avoid any penalties from the IRS, and understand the flow of finances through your business. In short, you can't do business without paperwork.
What is an Invoice?
An invoice is a document freelance businesses send to their clients that outline the completed work and the amount owed for those services. An accurate and up-to-date invoice is essential for a few reasons:
- It helps freelance businesses keep track of the work they've completed and the payments they are owed.
- It provides freelance businesses with a record of their earnings, which is essential come tax time. For freelance taxes, invoices serve as proof of income.
- It helps freelance businesses keep track of expenses. This is important because some business expenses can be deducted from taxes.
What is a Receipt?
A receipt is a document that freelance businesses receive from vendors after purchasing or performing a service and receiving payment.
Like invoices, receipts are essential for freelance businesses because they can be used to track expenses. For freelance taxes, receipts provide proof of business-related expenses. They help freelance businesses keep track of the work and income received. As a freelance business owner, it's essential to keep track of all receipts for two reasons:
- Receipts act as proof of purchase for business-related expenses. This is important because some business expenses can be deducted from taxes.
- Receipts help freelance businesses keep track of the money they've earned and spent.
Freelancers need to know how much money they're spending to stay within their budget, and freelance businesses need to know how much they've spent so they can keep track of their expenses come tax time. Utilizing invoicing software can help freelance enterprises keep track of their finances and fees, generate accurate invoices and receipts, and see the bigger picture for their business.
While freelance businesses must utilize invoicing and receipt-tracking software for taxation, freelancers need to account for any Pre-Tax deductions they may incur.
Pre-Tax Deductions for Self-Employed (Simple IRA, HSAs)
Often, freelancers are so hyper-focused on growing their business and meeting new clients that they don't consider the importance of other areas of their freelance business – like their pre-tax deductions. Pre-tax deductions are essential things for freelance firms to consider come tax time. Pre-tax deductions lower the amount of taxes freelance companies owe.
There are a few different types of pre-tax deductions that freelance businesses can take advantage of:
- Simple IRA – The Simple IRA is a retirement savings plan that freelance businesses can set up for themselves. With a Simple IRA, freelance businesses can deduct money from their taxes to put into a retirement account.
- HSA – A Health Savings Account (HSA) is tax-advantaged medical savings account for freelance business owners enrolled in a High Deductible Health Plan (HDHP). With an HSA, freelance businesses can set aside money to pay for qualified medical expenses, and the money in the account can be used tax-free.
- SEP-IRA – A Simplified Employee Pension Individual Retirement Account allows you to save for retirement and benefit from significant tax savings.
For freelance businesses, taking advantage of pre-tax deductions can help lower the taxes they owe come tax time. When freelancers know the different pre-tax deductions available, they can make informed decisions about what will benefit their business the most.
We encourage you to speak with your accountant or financial planner to understand all the rules and benefits associated with retirement savings for self-employed individuals.
How to file your taxes
Paying your freelance taxes doesn't have to be a headache, but freelance taxes are a little different than everyone else's. It can be easy to make mistakes when doing your taxes and even easier to lose money if you do them wrong.
As mentioned, freelancers are responsible for two types of taxes: income and self-employment tax. You are also responsible for those at the federal and state level unless you reside in a state without an income tax.
If you plan to file your taxes, you'll need to ensure that you understand your taxable income and the IRS forms you must fill out.
Potential Forms You'll Need
As a freelancer filing your taxes, you may or may not need to file a few different IRS forms. We will discuss these forms below:
- 1099-NEC – non-employee compensation documentation for freelance income; you would not need to file this form if you earned less than $600 from a client.
- 1040-ES – the individual tax return you'll need on tax day regardless of your status as a freelancer.
- Schedule C – this is where you'll report your freelance income and any business expenses incurred. This form will calculate your net profit or loss from your freelance business.
- Schedule SE – this is the form you'll use to calculate your self-employment tax.
When filing your taxes, ensure that you have all your 1099-NEC forms; if you render payments through services like Square, Paypal, or Stripe, they will send you 1099-Ks, providing all the information you'll need for taxes.
You'll also be looking for 1099-INT if you have any interest-bearing accounts that need to be filed as part of your return.
How to File Freelance Taxes Without a Form 1099
If you didn't earn $600 from a client, you would not receive a Form 1099; however, if you did receive $600 or more from a client, they should be sending you documentation. If they didn't, they likely forgot.
It's important to remember that even if you don't receive a form from a client, you're still required to report the income. Thus, you will use your standard 1040 and Schedule C to report your profit or loss from your business.
Should You Have a Professional File Your Freelance Taxes?
While trying and do your freelance taxes on your own might be tempting, it's not always the best idea – especially if you're starting out. Unless you're confident in your abilities and knowledge, it's best to have a professional do it for you.
This way, you can avoid any costly mistakes, and rest assured that your taxes are being done correctly. Fortunately, your accountant will understand how to file freelance taxes properly and can help you maximize your deductions.
If you do decide to go it alone, the best tax return software will be needed. The following tax return software is what we recommend.
TurboTax
Why we like it: Easy to use, tax assistance, power of Intuit's other products, audit defense, etc.
Starting price: $119 for self-employment taxes + filing State income taxes
Rakuten discount: up to 7.5% cash back
Read our complete TurboTax review to see if TurboTax is your best tax prep option
TaxSlayer
Why we like it: Low baseline prices, easy to use, ask a tax pro feature, audit defense, etc.
Starting price: $59.95 for self-employment taxes + filing State income taxes
Rakuten discount: 5% cash back
TaxAct
Why we like it: Start for free, free unlimited tax advice, prior year import, tax resources, etc.
Starting price: $94.95 for self-employment taxes + filing State income taxes
Rakuten discount: 5% cash back
Freelance Taxes Wrap-up
The freelance tax landscape can be confusing, but with some knowledge, it doesn't have to be. The best way to avoid freelance tax problems is to stay organized and on top of your finances throughout the year.
This means setting aside money for taxes, keeping track of all business-related expenses, and knowing which deductions you qualify for. By taking these steps, you can ensure that your freelance business is profitable – even after tax season.
