What Freelancers Need to Know About Income Taxes

If you’re a freelancer in the United States, it’s time to think about income taxes again.

There are some major differences between filing U.S. income taxes as an employee and filing them as a freelancer. Often, these differences take new freelancers by surprise–but it doesn’t have to be that way.

If you’re a new to freelancing this year, or if you just need a reminder about some of the tax differences–this post is for you. I’ll outline some of the major tax differences for freelancers.

(Note: This post is not specific income tax advice for your situation. Rather, consider it to be a very general overview of some tax issues that many freelancers faced when this post was written.)

Different Forms for Freelancers

The first thing that you’ll notice is that you’ll be receiving different tax forms as a freelancer than you did as an employee. As an employee, you likely received a W-2 form from your employer each year. The form outlined how much you earned as an employee, detailed any other type of compensation that you received, and also listed the amount of income and social security taxes that the employer withheld on your behalf.

Getting a W-2 form each year made filling out your taxes fairly easy. However, as a freelancer, you’ll find that things are different.

Most freelancers do not receive W-2 forms from their clients. Nor do clients withhold taxes on your behalf. But you are still responsible for paying taxes. And if you’re not prepared, your tax bill could be a shock.

Instead of a W-2, you’ll receive a 1099-Misc form from any U.S. client who paid you more than $600 during the tax year. But even if you don’t receive a 1099 form (either because the client was not in the U.S. or because you received less than $600), you still must report the income. That’s why it’s important to have very good records when you’re freelancing.

Different Information You Need to Collect

If you’ve been keeping good records during the year, then you’ll have a much easier time doing taxes. As a freelancer, your records are more important than ever. You’ll need to collect back-up details for the following information:

  • Expenses–Freelancers can deduct legitimate business expenses. To do this, you must keep receipts and other documentation to show that amount and purpose of each expense. Some business expenses that you may be able to deduct include business phone costs, utilities for your business, bank service charges, business cards and other business stationery, Internet hosting charges, home office expenses, business travel, the cost of retirement plans, and more. Basically, you incur a business expense when you purchase a product or service for use in your business.
  • Income receipts–While many of your clients will send you a 1099 form, you are responsible for reporting every bit of income that you received during the tax year. This is why accurate bookkeeping is so very important. For most freelancers who operate on a cash basis, income is recognized for the year in which it is received. That means that if you bill a client on December 31st and they pay you on January 5th, the income is recognized in the new year. Make sure that you record the exact date when you receive payments.

Keeping accurate records of your income and expenses will help you to fill out your Schedule C.

Different Schedules for Freelancers

Most freelancers who operate as sole proprietors will have some additional income tax schedules to fill out, Schedule C and Schedule SE.

Schedule C is used to calculate whether your freelancing business made a profit or a loss during the taxable year. Basically, list the total income that you received during the year. Next, you list the total expenses that you paid during the year. You’ll notice the home office expense is included separately.

Basically, the difference between your income and your expenses is your profit or loss for the year. If you made a profit, you will likely owe taxes on it.

You also need to fill out Schedule SE to calculate your self-employment tax.

What Is Self-Employment Tax?

Freelancers often ask what self-employment tax is. Basically, it is the amount of Social Security Taxes and Medicare Taxes that an employer would have withheld from your pay plus the amount of these taxes that an employer would have paid on your behalf.

The percentage has changed over the years, and will likely change again. The important concept to realize is that, as a freelancer, you do have this tax responsibility.

A Word About Estimated Taxes

Freelancers who don’t plan ahead and prepare for income taxes are often surprised when they owe a huge amount at tax time. Fortunately, making estimated tax payments during the year can protect you from the rather unpleasant surprise of a large unexpected tax bill.

Most freelancers pay estimated taxes. When you pay estimated taxes, you make quarterly payments towards the year’s tax liability during the year. Usually, the amount of estimated taxes that you pay is based on your previous year’s tax liability. If you do not pay estimated taxes during the year, you run the risk of being charged a penalty for under withholding.

Use Form 1040-ES to make estimated tax payments.

Getting Help

If you’ve read this far, you’re probably thinking something along the lines of, “Wow, my taxes as a freelancer are way more complex than they were when I was an employee. I need help.

If that’s what you’re thinking, you’re right. While many freelancers are able to complete their own taxes, there’s nothing wrong with getting help from a professional.

Professional help can be especially helpful the first time that you complete your tax form as a freelancer instead of an employee. A tax professional can provide tips that will help you in the future and also make sure that you didn’t miss anything.

And while hiring a tax expert doesn’t come cheap, in the long run they may actually save you money by ensuring that your tax reporting is correct.

Your Turn

Do you do your own taxes, or do you get help? What advice have I missed?

Share your thoughts in the comments.

Image by 401(K) 2012

How To Get More Clients

Get More Clients

Tired of struggling every month to find new clients?

Join us for our latest workshop and build your own custom marketing plan. Conrad Feagin - the Chief Executive Freelancer at FreelanceFolder - will guide you step-by-step.

The workshop includes live classes, expert support and one-on-one coaching.
Learn more here.

Comments

  1. Vincent says

    Tax is one of my biggest headaches. The freelancer website which I work on takes (i.e 10% Tax) which is huge & plus another dollar (i.e $1) on withdrawal. That means If I were to recieve $40 from my client, I lose $4 (10%) on recieving the money & $1 on withdrawal so, a total of $5.To add more salt to the wound money transfer companies such as (i.e paypal or moneybookers) do have certain tax for wire transfer since, niether of them pocess Cheque’s these days. so another hefty $5 is lost on wire transfer & I finally end up with $30 in my Bank Account.

  2. says

    Hi Vincent,

    Thanks for your comment. Are you a U.S. based freelancer? If so, it’s likely that the fees being withheld from your pay are not taxes but charges for doing business with the site. Look over your agreement with the sites where you do business carefully.

  3. says

    Great post, but it brings up a nagging question I have. How are reimbursed costs figured into taxes? In other words. If I pay website hosting fees for a client and charge them back for that cost, is that an expense I can deduct? I hope you don’t mind fielding a tax question on here. Thanks!

  4. says

    For freelancers in the UK, pretty much all the same types of records / receipts are required to complete the annual Self-Assessment Tax Return (SATR) process… the deadline just expired for the 2011/12 tax year on 31st Jan 2013.

    If you work via your own limited company, you’ll need an accountant to complete your company accounts, and as a director – you’ll also need to fill in a SATR.

    As a freelancer site editor / writer myself, from my experience, I would recommend freelancers don’t shy away from seeking tax advice early on (even at a very basic level). By the end of the year, there can be a lot of paperwork to complete, and this can be a bit overwhelming!

  5. says

    Thanks for taking that the time to discuss this, I actually feel strongly about it and love
    learning extra on this topic. If attainable, because you
    achieve experience, would you thoughts updating your blog with additional data?
    It can be extremely useful for me.

  6. Aven says

    I’m from the UK and I just finished Uni. I’m thinking of being a freelance web designer while trying to find a permanent job. What do I need to know more about freelancing in the UK?

Trackbacks

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>