How to manage freelance taxes: A guide
Being your own boss always sounds good on paper, but as a freelancer, when you actually have to deal with paper – including freelance taxes – understanding all your legal and fiscal obligations is crucial.
In order to help you budget accordingly, manage your expenses, and plan for tax season, we’ve created this guide to provide freelancers with tips, resources, and answers to some of the most common tax-related questions. So, let’s dive into the steps and strategies for how you can take control of your freelance tax obligations.
Understanding your tax obligations as a freelancer
As a freelancer, understanding and properly managing your finances – in addition to staying compliant with IRS regulations – is tantamount to creating a successful and sustainable business. Unlike employees whose employers withhold taxes on their behalf, freelancers are considered self-employed individuals, making them responsible for their own tax payments.
This even includes paying Social Security and Medicare taxes, which, for those who are self-employed, come bundled together as the self-employment tax. Here’s a quick breakdown of how much the self-employment tax is:
| Tax Category | Tax Rate | Note |
| Social Security Tax | 12.4% | Only applies to the first $142,800 of your net earnings (for 2021) |
| Medicare Tax | 2.9% | Applies to all your net earnings, with an additional 0.9% for income above $200,000 ($250,000 for married couples filing jointly) |
It’s crucial to calculate your freelance taxes and set aside a portion of your income – which we’ll get into in a bit. Not only will this help you to avoid a surprise (or horrifying) tax bill, but also potential underpayment penalties. Keep comprehensive records of your earnings and expenses to accurately estimate your freelance taxes and file the correct freelance tax form when tax season arrives.
Know your business structure
When preparing your freelance taxes, you need to know your business structure and what it implies. For example, an individual freelancer operating without a legal business entity is treated as a sole proprietor by default. This means that their freelance income is subject to self-employment taxes, and they must use a freelance tax form like a Schedule C to report profits or losses.
Tax obligations tend to differ if you’re a freelancer who establishes a legal business entity like an LLC or corporation. An LLC can choose to be taxed as a sole proprietor, a partnership, or a corporation. This offers flexibility in managing tax responsibilities.
A corporation, on the other hand, is considered a separate tax entity and could lead to a different tax treatment that’s known as “double taxation” – once at the corporate level and once on the individual shareholder’s income.
Knowing and understanding what type of structure you have is important because it’s what influences your overall tax strategy and how much you’ll need to set aside for taxes on freelance work.
Keeping track of income and expenses
Factors like your income level, the type of freelance work you do, and your business expenses all come into play when managing your tax obligations. Knowing the ins and outs of your obligations – including which freelance tax form to use, how to estimate freelance taxes, and understanding the rate of the self-employment tax – is crucial for financial stability and legal compliance.
Tracking income and expenses is especially necessary for every freelancer who wants to stay on Uncle Sam’s good side. Expensify simplifies this process by helping freelancers streamline expense documentation and categorization, which is critical when it comes time to calculate your taxes. Expensify lets you capture receipts via SmartScan, invoice your clients, directly link to bank accounts for realtime transaction tracking, and categorize expenses according to IRS requirements, to ensure you’re maximizing deductions and staying prepared for tax time.
Deductions and credits available to freelancers
When you have your own business, every dollar counts, which is why it’s to your advantage to understand what deductions and credits are available to freelancers. This helpful knowledge can significantly reduce your taxable income and potentially lower your tax liability.
The IRS allows independent contractors to subtract various business expenses from their income to reflect the costs incurred in generating that income. Common deductions include things like:
Travel and Entertainment (T&E)
Home office use
Continuing education
Equipment or supplies
Additionally, some tax credits may be directly subtracted from your tax bill, providing even more savings. When you understand these benefits, you can appropriately apply them when filing your taxes. Let’s look at some of the most common deductions in depth.
T&E
Travel and Entertainment expenses, also known as Travel and Expense (T&E), are often a huge part of freelancing, especially for those who meet with clients or perform services at various locations. Deductible costs in this category can include transportation, lodging for business travel, and 50% of business-related meal expenses. When it comes to T&E deductions, freelancers must keep meticulous records that detail the amount of each expense, the date and location of the travel or meal, and the business purpose.
Home office
A lot more people, including freelancers, work from home today and may qualify for the home office deduction if they use part of their home regularly and exclusively for their business. Two methods are available for calculating the deduction: the regular method, based on actual expenses and proportion of your home used for business; or the simplified option, which allows a standard deduction per square foot of home office space, up to 300 square feet.
Continuing education
Investing in your professional development can pay off at tax time, too. Freelancers can deduct the cost of courses, seminars, workshops, and multi-day conventions that maintain or improve skills required in their current business. This includes registration fees, related books, and materials – and in some cases, travel costs to get to an educational event.
Equipment/supplies
Freelancers typically require certain equipment or supplies to perform their work. This can include computers, software, office supplies, and specialized tools unique to their trade. The cost of these items can be deducted as business expenses, provided they are ordinary and necessary for your freelance work.
Other categories that are deductions for freelancers
Here are other potential deduction categories for freelance taxes:
Internet and phone expenses proportionate to business use
Business insurance premiums
Marketing and advertising costs
Bank fees related to your business account or transactions
Professional service fees (attorneys, accountants, consultants)
Tax credits available to freelancers
In addition to deductions, freelancers may qualify for tax credits, which reduce tax liability dollar for dollar. Examples include Earned Income Tax Credit (EITC) for low- to moderate-income individuals or families, the Child and Dependent Care Credit, and in some cases, educational tax credits like the Lifetime Learning Credit. To qualify for these credits, freelancers must meet specific criteria based on income levels and other tax filing requirements.
Quarterly estimated tax payments
How are self-employment taxes calculated? To estimate your quarterly tax payments, consider using the Form 1040-ES, “Estimated Tax for Individuals,” which provides a worksheet to help you figure out how much to pay. This involves estimating your adjusted gross income, taxable income, taxes, deductions, and credits for the year.
Here’s a simplified process to follow:
Estimate annual income.
Subtract deductions to find taxable income.
Calculate income tax plus self-employment tax.
Divide by four to find the quarterly payment.
Hiring a tax professional vs. DIY tax filing
When it’s tax time, there are typically two options you can choose from: hiring a tax professional or opting for DIY tax filing. Each has its benefits and drawbacks, and your decision will most likely be influenced by factors like cost, time, accuracy, and the complexity of your tax situation.
While hiring a professional adds a layer of assurance, DIY filing can be cost-effective for simpler tax situations. If you choose to go the latter route, be sure that whatever software you’re using is reputable. When you use Expensify to track your freelance expenses, you can take advantage of one of the many automated accounting integrations, which streamlines the DIY process. Ultimately, the choice rests on your personal comfort with tax matters, how complex your freelance finances are, and how much you value your time vs. potential savings.
Resources for freelancers to stay informed on tax laws and changes
Staying current with tax laws and changes is important when it comes to effectively managing your freelance finances. Note that there are several key forms and resources for accurate tax filings:
IRS Form 1099-NEC: this document reports your non-employee compensation if you’ve been paid $600 or more by a client.
IRS Form 1099-K: issued by payment settlement entities, it details your transactions if they exceed a specific threshold.
Schedule C: used to report income or loss from a business you operated or a profession you practiced as a sole proprietor.
Form 1040: the standard federal income tax form used to report your total income, including freelance earnings.
Form 8995: pertains to qualified business income deductions for freelancers who are eligible.
Freelance taxes FAQs
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Yes, income from freelance work is taxable and should be reported to the IRS. Freelancers are considered self-employed and are thus responsible for paying self-employment taxes (covers Social Security and Medicare) in addition to income taxes.
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The IRS allows a certain amount of income to be earned without requiring federal income tax payment. This is often referred to as the standard deduction. If you’re single, under 65, and made at least $12,950, then you need to file. Same goes if you’re married and filing jointly and made at least $25,900. As a self-employed person, regardless of the standard deduction amount, you need to file an income tax return if you earned $400 or more.
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Typically, you’ll need to make quarterly estimated tax payments to the IRS using Form 1040-ES. The amount to set aside for taxes varies depending on your income, location, and the current tax rates. A general rule of thumb to follow for saving is to set aside 25%-30% of your freelance income for taxes. As a precaution, it’s always a good idea to consult with a tax professional to determine accurate tax obligations.
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Use Schedule C (Profit or Loss from Business) to document your earnings and costs incurred throughout the year. Attach it to your personal tax return (Form 1040). Be sure to include any 1099-NEC forms for freelance income you’ve received if you earned $600 or more from a client. Additionally, claim your calculated estimated tax payments on your tax return.
Ready to make managing your freelance taxes simpler than ever? Give Expensify a try today by filling out the form below, and we’ll take it from there.
