Everything you need to know.
It’s the dreaded ‘T’ word that every freelancer avoids like the plague: taxes. When you elect to leave a salaried job where taxes are withheld from biweekly paychecks, the idea that tax management is a scary, complex, and the overwhelming process can deter too many people from making the jump into freelancing.
The reality is that paying taxes as a freelancer is a standard process, one that imitates how many other professionals manage their taxes and finances every year. With the information we are going to provide you in this guide, you will know everything you need to know to pay your taxes accurately, regularly, and timely, year-over-year. In fact, you will soon realize that managing your taxes as a freelancer is one of the least stressful things you will do while scaling your business.
Let’s first get some basic information out of the way.
As a freelancer, you are considered to be self-employed by the Internal Revenue Service. If you earn income as a freelancer, you must file your taxes as a business owner. This ensures you can take deductions as a self-employed individual, but it’s worth noting that you will face additional taxes in the form of self-employment tax, etc.
What does all of this mean? We’re glad you asked!
A Step-by-Step to Filing Taxes as a Freelancer
Step 1: Tracking Your Income
Your first step as a freelancer is to gather the amount of money you made as a freelancer throughout the calendar year. Tracking your sources of income is an important part of being accurate on your tax return, and can be, at times, stressful if you are working with 100+ clients throughout the year.
Whereas a traditional employee would get a single W2 for income reporting purposes, as a freelancer, you’re likely to get a number of 1099-NEC forms from your clients.
How does this differ between freelancing marketplaces vs. working on your own?
If you are using a site like Fiverr or Upwork, you will be able to claim the income as one monetary expense since you used their platform to make the money. Fiverr/Upwork will send you a W9 and the process will be overall, rather painless.
If you are managing your own business off of a site like Fiverr, you will need to track the clients you work with and the money earned throughout the year. But, with Continuum, we make it easy to count the exact number of clients, transactions, and money earned so taxes are a breeze. Both options will keep you compliant with income reporting requirements.
Step 2: Self-Employment Tax
If you are a self-employed individual and function as your own boss, you will be required to pay the self-employment tax of 15.3% (as of 2020). This tax includes the Social Security and Medicare taxes that ordinary employees would have had taken out of their paychecks automatically.
This amount also includes the employer portion of those taxes, since a freelancer is considered an employee and employer at the same time. Knowing this percentage ahead of time will help you better prepare and/or budget your funds throughout the year.
Step 3: Managing Your Tax Liability
The goal is to reduce your liability to the lowest amount possible when you are working for yourself. As a freelancer, you will be able to deduct things like WiFi, a portion of the space you work out of, laptop accessories, and so forth, which will make your tax burden lighter than someone working for an employer. However, you can only take deductions for things related to the ‘ordinary and necessary’ operation of your business. No, you cannot claim that a new shirt you bought at the mall helped you create logos as a freelancer.
Here are some categories from which you can claim the deductions:
- Business-related food: food/drink if you met with clients and/or used the meal to advance your business. Business meals are deductible at a 55% rate.
- Lodging: traveling for work, digital nomadism, or using travel for social media content/payment.
- Office expenses: buying laptops, phones, etc.
- Required equipment: buying a camera, lights for a YouTube studio, etc.
- Educational costs: if you are learning about your skill or how to be better at what you do, these costs are tax-deductible. If you take classes to earn certificates, these costs are deductible. The same thing holds true for licensing, registration, and any other certifications that you must pay to renew.
The IRS makes it very clear that the expenses must be ordinary and necessary to the function of the business.
The Home Office Deduction: thanks to the pandemic, the majority of freelancers are working from home or their apartment while they do their work. That’s where the home office deduction comes into the picture. The IRS states that you can write off everything from rent to utilities for portions of your home that are used in the functioning of your business.
But the office space must be used specifically for self-employment work. It can’t be your spouse’s room that you borrow from 9-to-5 and consider it to be your full-time office. It needs to be ‘provable’ that you use that space daily to operate your freelancing business.
Step 4: Keeping it All Separate
In order to avoid any tax mishaps or problems with the IRS, it is strongly advised that you open a business bank account where all business-related expenses are managed. This will make it easier for you (if you are filing your taxes on your own using TurboTax software), or your CPA, to compile an accurate tax return during tax season. Business bank accounts are typically free (some banks have $5-$50 fees for opening them) and can be opened at all banks and credit unions.
Don’t let the fear of taxes stop you from achieving personal and professional autonomy as a freelancer. If you take the time now to set up a system for invoicing, payment tracking, and a business bank account, preparing your taxes will be easier than ever before.