Freelancing isn’t easy. It’s not all working outside on your laptop or digital nomading your way around the world. Sure, there’s that, but you’re also constantly working to win over new clients, deal with demands from current ones, budget with an irregular income, and so on. It’s a constant hustle toward success, and if you want to make a decent, sustainable income, freelancing is not for the faint of heart.
Oh, and then there’s the completely unsexy side of freelancing: taxes.
Doing taxes as a freelancer isn’t pretty, but hey, the sausage has to get made. When you’re a full-time worker, your employer takes care of taxes for you. All you have to do is file in April. As a freelancer, you own the responsibility entirely.
I learned this the hard way when I completely depleted my savings during my first year as a full-time freelancer. To avoid the same mistake, here are a few tax-related issues you should know about freelancing, independent contracting, or self-employment.
You Have to Pay Throughout the Year
My first full year as a freelancer was a disaster. This was mostly because I had no idea I was a freelancer. I went into work every day, stayed late often, and received a regular paycheck. Sounds like a standard 9-5, right? It wasn’t.
Technically, I was a freelancer, an independent contractor. When I started, I signed a W9 instead of a W4. Independent contractors sign the former, employees sign the latter. Now, this is 100% on me. I should’ve snapped to it, but I was naive and eager for the job.
Freelance Vs. Full-Time Employee
In a standard full-time employment situation, your employer takes money out of your paycheck for taxes, paying the IRS on your behalf throughout the year. This is called withholding. As a self-employed freelancer, it’s up to you to make sure these taxes are paid. They’re called Estimated Quarterly Taxes, and as you can probably guess, they’re an estimate of the taxes you owe every quarter.
Since I was clueless about my freelancing status, I was shocked to discover I owed over $5,000 in April (including late fees) during my first full year of employment at this job. The tax bill obliterated my emergency fund. On the plus side, at least I had an emergency fund in place to pay for this. Still, you don’t want to make the same mistake. Once you start freelancing full-time (meaning you don’t have an employer taking out taxes on your behalf), you should start paying estimated quarterly taxes throughout the year. You can do this via Direct Pay on the IRS website. You enter your bank details, select Estimated Payments, then calculate the amount you want to pay. At the end of the year, you’ll get 1099s from your employer, and they’re what you use to do your taxes.
After your first year freelancing, the IRS will send you 1040-ES vouchers. These are basically a series of four tax bills, envelope included, for you to easily mail in your estimated tax payments. The amount for each quarter is pre-calculated based on your total earnings for the previous tax year. And each quarter, you owe three months’ worth of taxes.
So how do you figure out how much you owe? The IRS has a form (PDF) that helps you break it all down and online calculators can give you a general idea. But keep in mind: “estimated” is not a loose definition. If you don’t pay enough estimated taxes, you could pay a penalty.
What “Estimated” Means, Exactly
If your tax estimates aren’t high enough each quarter, the IRS will penalize you. Worse, they’ll apply next quarter’s payment to the first quarter, which means you’ll likely underpay for that quarter, which means you’re penalized again. In short, you’re basically paying a series of late fees if your first estimated payment isn’t enough. The penalties aren’t outrageous. Last year, I underpaid by thousands (this time I had healthy savings) and I think I owed something like $100 in fees. It didn’t ruin me, but it’s still $100 you shouldn’t have to give the IRS.
The IRS has a very straightforward definition of how close your estimates have to be. You either have to pay taxes on 100% of your income from the previous year or 90% for the current year. Here’s how they explain it:
“If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller.”
Your best bet is to pay taxes for 100% of last year’s income. This is the easiest option and, especially if your income varies, it’s the safest bet.
You Can Deduct a Lot of Stuff
You have to take care of taxes on your own when you’re a freelancer, which sucks, but there’s a silver lining: deductions. Freelancers can deduct quite a few expenses, basically any expenses related to their business. The IRS has guidelines for what counts as a business expense, of course, but for the most part, if it’s a common expense for your industry that benefits your business, it’s deductible. These might include:
- Camera equipment if you have a freelance video business
- Photo editing software if you make money as a photographer
- Business-related trips
- Meals with potential clients or colleagues
Your home office is one big deduction you don’t want to miss. You get to deduct a portion of your home that you use as an office, and that includes utilities, improvements, and supplies. Office equipment is deductible, too. So if you bought a laptop for work, a printer, scanner, or any other equipment, make sure you deduct it.
Note: The SEP-IRA is my favorite deduction. It’s a self-employed Individual Retirement Account. After I max out my IRA every year, I save any extra money I’ve made from my freelancing business into the SEP-IRA. And best of all, I can deduct this savings from my taxes in April. Of course, I’ll have to pay taxes on that money when I retire, though. I realize this might not be an option for everyone, it’s hard enough to max out your IRA, but once your business starts growing, you’ll want to look into it.
If you paid people to help you out with work–typically called subcontracting–that’s also deductible. Keep in mind, though, if you paid them more than $600, you’ll have to order and file a 1099 for them by January 31st. It’s complicated, but the IRS explains the process here.
In fact, all of this can be pretty complicated. If you’re at all unsure about how to handle it, I would highly recommend talking to a Certified Financial Planner® during your first year as a full-time freelancer. (Since I write about money, I have to research this stuff anyway, so I go at it alone.) Just make sure your CFP is an actual CFP with the little logo behind their name. This means they take an oath to work in your best interest instead of just selling you investments. You can look up legit CFPs here. When I started hiring subcontractors for my own business, I consulted a CFP myself. It was a quick phone call just to verify some questions, but he told me everything I needed to know in less than five minutes.
You can certainly navigate the tax world on your own, though. Like a lot of subjects, it’s not nearly as intimidating as it seems. It just takes some research, and these basics should put you in the right direction. Taxes are the less exciting side of freelancing, but once you get them in order, those work-by-the-beach days are all the more satisfying.