This is a collaborative post on Tax On Freelance work by Caroline.
What is Freelancing?
Freelancing has exploded in popularity in recent years for a variety of reasons. Everyone is good at something. Historically freelancing has been difficult because it’s hard to let people know you exist. It’s also expensive and time consuming to find a freelancer. Platforms like Fiverr have removed those hurdles. Fiverr makes it very easy to post your services online. It also make it very easy to find freelance work. If there is something you can do, or need done, checkout Fiverr. It’s one of the major drivers to the Great Resignation. You can work on your terms and your hours on platforms like Fiverr.
Do Freelancers Pay Taxes?
Do Freelancers pay taxes. Yes. Unfortunately, many freelancers get an unexpected tax bill that can take their breath away, especially if it’s their first time not receiving a W-2 employee paycheck. If you’re a new freelancer or have been self-employed for a while and just need a refresher, here are the ways your taxes can be affected by freelance income.
Things You Need To Consider Before Becoming A Freelancer
Freelancers Have An Unstable Income
Even when your freelance business takes off, it’s best to assume your income will rarely be stable. The added stress of your debt burden and irregular income will make it much more challenging to stay self-employed or ensure there’s enough money to pay your taxes. Consequently, before making the jump to freelance, you need to get your budget and debt under control. Use helpful tools like this loan payoff calculator to figure out what it will take to become debt-free before quitting your day job.
Freelancers Are Considered Small Business Owners
Freelance and side gigs are considered small businesses once they generate revenue. Expect to be considered an entrepreneur or small business owner. You’ll be the one responsible for daily operations. You are also responsible for everything to keep your business afloat, like being compliant with local, state, and federal business laws. Freelancers are self-employed people. Often treated like a sole proprietor and independent contractor.
The Difference Between 1099 and W-2 taxes
The biggest thing to realize is that any burden covered by an employer is now your responsibility. W-2 employees typically have a portion of their Social Security and Medicare taxes taken care of by their employer. 1099 or W-9 freelancers are responsible for 100% of these fees.
The taxes you’ll need to pay will vary based on whether or not your state charges income tax. That said, there are a few taxes all freelancers in the United States will be responsible for paying (in 2021):
- Self-employment tax: Self-employment taxes are a combination of Social Security (12.4%) and Medicare (2.9%) taxes. This will equal 15.3% of your income. If you earn more than $400 as a freelancer, you’ll be required to pay this tax.
- Estimated taxes (federal): Federal taxes vary. Not making quarterly payments will subject your income to an additional penalty with your yearly payment. Quarterly payments are only required if you expect to owe more than $1,000 in taxes. We recommend having a bank account just to save for your quarterly taxes. Don’t wait for the filing deadlines to set money aside.
- Income tax (state): State income taxes vary by state from 0-13.3%.
How To Reduce Your Tax Burden As A Freelancer
- Keep track of your finances – Tracking your finances won’t reduce your tax liability but may prevent you getting penalized during an audit. Ensure you keep detailed records of your income and expenses for a few years. Expenses often can include utilities, internet bills, and rent on office space. You can use a spreadsheet of costs with an accompanying folder (digital or real) that has your receipts or budget tracking software like Quicken. Keep track of your business expenses because tax payments are based on earnings net of business expenses.
- Consider setting up an S-Corp, C-Corp, or LLC – Depending on your income level it may be advantageous to set up a corporate entity and draw a salary from the corporation rather than running your business as a Sole Proprietorship. Talk with your accountant to see if this would be best as a corporation could be either a way to reduce taxes or increase your liability.
- Understand how deductibles work – Deductible expenses are costs for your business that directly contribute to your freelancing business’s daily operations or growth (the actual term is “ordinary and necessary”). There are very specific deductibles that freelancers can use listed on the IRS’ website, so don’t automatically think that a new luxury bag is a tax-deductible marketing expense. However, the IRS is generous when it comes to allowing the deduction of a portion of your home expenses and considering the square footage of your workspace or home office as a deductible cost. Talk to a tax expert about the home office deduction.
- Contribute to your retirement – Contributions to pre-tax retirement accounts such as Solo 401(k)s, SEP IRAs, and DB Pension Plans can both reduce your tax liability and help you save for retirement.
- Pay for healthcare – If your healthcare expenses account for more than 7.5% of your Adjusted Gross Income (AGI), then the IRS allows you to deduct them from your taxable income. Keep track of any payments made to medical professionals, hospitals, health insurance premiums, and costs for your prescriptions.
The Bottom Line With Freelancer Taxes
How you make money in the gig economy impacts your taxes. Understanding how these income sources affect your taxes and planning to minimize your tax liability is essential. Keep this guide handy come tax time. Whether you are a full time freelancers or part time, make it a priority to set aside money from every paid invoice for taxes so that you’ll never worry about going into credit card debt just to pay the IRS.
Interested in learning more about Freelancing, or becoming a Freelancer? Go to Fiverr and sign up.
We are not tax professionals. Please discuss your situation with the appropriate tax professionals.