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.
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.
Do you do your own taxes, or do you get help? What advice have I missed?
Share your thoughts in the comments.
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