Freelancing is an exciting adventure, but it’s rarely an easy one.
Without the security of a regular paycheck, attracting customers and clients will take up a large proportion of your time. And apart from the billable hours you spend working, you also have to find space in your day to deal with suppliers, address any staff issues, keep your office space and IT functioning properly and maybe, just maybe, do a little planning for future growth.
Little wonder if apparently mundane tasks such as taking care of taxes are all too often pushed to the bottom of that ever-lengthening “to do” list.
But for any new venture one of the most difficult and important things is to maintain a positive cash flow. Getting hit with a large and unexpected tax bill is the last thing you need when you’re just getting established.
So it makes sense to pay attention to your taxes from day one. And taking just a few simple steps will help you to reduce your liabilities and meet your tax obligations on time with a minimum of stress.
What Taxes Will I Have to Pay?
The first thing is to be aware of the taxes you may be required to pay.
The Self-Employment Tax
No matter how much or little you may earn, if you’re a full-time freelancer the IRS regards you as self-employed. You will therefore be liable to pay the so-called “self-employment tax”. This levy is in addition to your regular income tax and is intended to cover the Social Security and Medicare contributions that are automatically withheld from the pay of traditional employees.
The bad news is that self-employed people are required to pay as both employer and employee, giving a total liability of 15.3% which you will need to budget for from the very first client payment you receive.
One of the advantages of employment is that your taxes are calculated by your employer and automatically withheld from your paychecks.
But as a freelancer you will need to calculate your own federal (and possibly state) tax liabilities and, ideally, put aside sufficient funds through the year to cover them. This is not as straightforward as it might sound, especially for new businesses, and it’s vital to keep full and accurate records from day one.
You should receive either a form 1099-MISC or 1099-K from clients who paid you more than $600, but regardless of whether you receive this form, all income streams must be reported.
You will detail all your freelance income for the relevant year on your tax return using IRS Schedule C, which will show total income earned including any amounts listed on Form 1099s sent to you.
That’s the bad news.
The good news is that Schedule C is also where you’ll have the opportunity to reduce your tax bill by claiming all the allowable deductions from your taxable income.
As a freelancer you are generally entitled to deduct business expenses, but determining exactly what is and is not allowable in the eyes of the IRS can be a complex matter.
The basic rule is that the expenses claimed must be incurred solely in connection with the running of the business. That might sounds simple, but some research suggests that almost 75% of freelancers are not claiming any deductions at all. These people may be leaving thousands of dollars of revenue on the table for expenses such as purchasing a computer for work or traveling to meet with clients.
There are two essential ingredients to maximizing your deductions: accounting software and the advice of a tax professional. That’s why Visor has partnered up with AND CO from Fiverr. AND CO tracks all your income and expenses so you don’t miss any deductions. And the integration with Visor shares that data seamlessly with your tax advisor, who is available to you year-round for advice and to file your tax return.
Do I Need to Incorporate for Tax Purposes?
“Sole proprietor” is the default status for individuals carrying on freelance businesses without forming a legal entity. For tax purposes, your net freelancing income is reported on your personal tax return and combined with any other income earned and deductions taken (as well as your spouse’s if filing jointly).
Some freelancers will incorporate as a single member LLC for liability protection, but from the point of view of tax filing, a single member LLC is treated in just the same way as a sole proprietor. The only financial difference is that you will likely owe an annual registration fee to the state where your LLC is incorporated.
The other (less common) options for freelancers are to (1) elect to be treated as an S-Corp or (2) incorporate as a C-corp. If you choose to become either a C- or S-corporation, your taxes will get more complicated as you’ll separately file a business tax return in addition to your personal tax return. Income and expenses no longer flow directly onto your individual tax filing. The tax implications of incorporating are complex, so it’s worth consulting a tax advisor who can help you determine the tradeoffs. But for most average earning ‘solopreneurs’, the sole proprietor or single member LLC route is most typical.
One last item to note is that the Tax Cuts and Jobs Act of 2017 introduced a 20% tax deduction for most freelancers. However, C-corporations will not be eligible (although corporate tax rates were also lowered in the new law). The details of the 20% deduction are complex, and beyond the scope of this article, but you can find out more here. It’s a big enough tax deduction that it should absolutely be factored into your final decision on the best legal entity to choose for your freelancing business.
When Do I Have to Pay My Taxes?
For traditional employees, it’s straightforward enough. Simply file your tax return for a given year by April 15th of the following year assuming your employer withheld taxes correctly from each paycheck.
But as a freelancer, the IRS also expects you to make quarterly tax payments in April, June, September and January; doing so on the basis of estimated income if necessary. That’s because the U.S. has a pay-as-you-go tax system, and quarterly payments are how freelancers mimic a traditional employee’s payroll withholding. Quarterly tax payments might seem onerous, but you will at least avoid some of the psychological trauma of writing a single large check at the end of the year.
Getting these estimates right is not easy, particularly in the early days of a business, but the process will help you focus on cash flow and on the need to be putting aside a proportion of your revenues for tax purposes. Most experts advise a set aside of around 30% of your revenues, though this will vary according to your particular circumstances, which is why working with a year-round tax service such as Visor can be really beneficial.
Find Out More
Managing business taxes can be a major headache even for the seasoned freelancer. When you’re just starting out, it can seem as though you’re sinking into a morass of bureaucratic rules, regulations and conflicting advice.
Getting the advice of a tax professional as soon as you get your first paying client, and preferably even before, is an investment which will repay you many times over both in hard cash and peace of mind.
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