Being self-employed isn’t for the faint of heart. In addition to the actual work you’re performing, it requires you to deal with uncertainty and assume risks and responsibilities that traditional employees never have to consider. A few of these extra responsibilities are shouldered during tax season.
Here’s a quick guide to some things you’ll need to consider when filing taxes as a freelancer. This is just a starting point for you, and by no means a comprehensive step-by-step walkthrough. I’ll cover some terminology that affects self-employed filers, the tax forms you’ll likely use, common self-employment business deductions you can take, and finally how you can actually use your tax bill to make some money when you pay.
Understand What Kind of Self-Employed You Are
In order to correctly research and fulfill your tax obligations, you must understand what kind of self-employed you actually are. Here are the most relevant terms. (Note that for the purposes of this article, I’m only discussing one-person enterprises, not partnerships or corporations.)
Independent contractors: Most freelancers fall into this category. They’re not employees of a company or client, but complete work for that company or client on a contract basis.
Sole proprietors: These are people who own a business that is not officially registered/incorporated as a business entity. In other words, it’s the default business type for single-person entities.
Note that you CAN be both an independent contractor and a sole proprietor. In some ways, the difference is just semantic, since both file taxes the same way. The only distinction is that if you own a business but don’t do contract work for others, you’re only a sole proprietor, not an independent contractor as well.
Tax Forms That Affect You as a Freelancer
Here’s a quick overview of the forms you should be familiar with.
W-9: This is the form a client will request from you earlier in the year. They will use the information on the W-9 to issue you the appropriate forms come tax time.
1099: This is the most common freelance tax form. When you receive a 1099 from a client, box 7, titled “non-employee compensation,” should contain all of your earnings from that company or person. This is what indicates that you are self-employed: you’re not an employee of the company, but an independent contractor.
1040: Just like other individuals, you’ll use a 1040 form to file your income taxes.
Schedule C: This form concerns business income and expenses, so it’s used by independent contractors and sole proprietors.
Schedule SE: This form has to do with self-employment taxes.
Don’t Forget the Self-Employment Tax–Or Its Deduction Eligibility
Anyone who’s been self-employed for more than a year in the U.S. already knows the drill here (and hates it!). But if you’re new to filing taxes as a freelancer or are considering starting up your own one-person business, the self-employment tax might just surprise you like a punch to the face.
Essentially, when you work for a company as a typical employee and receive a W-2, they will pay half of your Social Security and Medicare taxes, and likely withhold the rest on your behalf. When you’re self-employed, you’re still on the hook for those taxes, but you don’t have an employer contributing or withholding for you.
This means that when you’re filing taxes as a freelancer or business owner, you’re responsible for the entire amount of SS and Medicare taxes, which amounts to 15.3% of your net self-employment income. And yes, that’s on top of your regular federal and state liability. When all is said and done, you might only get to keep about 60% of what you earned during the year. Be aware of this and try to factor it into your rates when quoting clients or customers.
However, something that self-employed tax filers may overlook is that half of your self-employed tax liability actually qualifies as a business expense. Since normally an employer contributes half for you, the “employer” half (7.65%) can be deducted, which helps level the playing field a little.
So, here’s a quick overview of how to calculate your self-employment tax and eligible deduction:
- Fill out the rest of your taxes using your tax software of choice. Input all other business expenses so they can be appropriately subtracted from your net income first.
- Once you have an accurate number, multiply that number x 92.35% (plug in X * 0.9235) to calculate your net self-employment income. This effectively subtracts that deductible 7.65% before you actually calculate the self-employment tax.
- Then, take that number and multiply it by 15.3% (plug in X * 0.153). This is your total self-employment tax liability. Your software will likely factor this in for you when calculating your taxes, but it helps if you want a more specific breakdown of what you’re paying.
- Finally, divide that result by 2. This is the amount you are eligible to deduct from your adjusted gross income (AGI) to reduce your federal tax liability on form 1040.
It’s certainly not the simplest process in the world, but it can save you some money if you’re filing on paper or with software that doesn’t calculate this automatically.
Other Common Self-Employment Business Expense Deductions Explained
In this section, we’ll go over some of the expenses that you may be able to claim when filing taxes as a freelancer, as well as the IRS rules for claiming them on your Schedule C form.
Internet costs: Most modern freelancers conduct their business partially or fully via the Internet. Figure out how often you use the Internet for business via personal reasons, and deduct the appropriate percentage of Internet expenses from there.
Home office: Do you have an area of your dwelling set aside for work use only? Congrats–that’s a home office deduction. Estimate the square footage of your home and the square footage of the office space for this deduction.
Equipment/assets: Larger business-related purchases like a new computer for work fall under this category. Purchases over $200 fit here. They can usually either be written off as a one-time expense, or you can write off depreciation over several years.
Office supplies: This includes smaller standard things like pens, paper, printer ink, folders, etc. that you use for business purposes.
Meals: If you make meal purchases while traveling for business or meeting with a client, you can deduct 50% of the cost. They can’t be lavish, and you should save your receipts.
Travel expenses: If your business requires travel (e.g. to meet with clients, get supplies, etc.) you can write that off. Traveling in your own vehicle is under “auto expenses” and means you need to keep track of the mileage driven for personal vs. business reasons.
Website/advertising: This includes web hosting, website fees, Internet ads, fees to marketing agencies, etc.
Health insurance premiums: If you don’t have an employer-sponsored healthcare plan and aren’t covered through your spouse, you can deduct the premiums you paid for health, dental, and long-term care. The deduction applies to premiums you paid for yourself, your spouse, and any dependents.
Keeping thorough records to back up deduction claims is extra-important when you’re filing taxes as a freelancer. Organize them throughout the year so you’re not tearing your hair out looking for receipts in April.
Earn Money From Paying Your Taxes
Lastly, an opportunity most people don’t take advantage of is the chance to earn some extra cash from paying your taxes. You can do this by utilizing credit card sign-up rewards.
If you owe $1,000+ on your taxes, consider applying for a card that gives you a large bonus for signing up and spending a certain amount in the first three months. For instance: the Chase Sapphire Preferred, which gives you an equivalent of about $625 in travel value after you spend $4,000.
Tax software will typically charge you around 2.5% as a credit card processing fee, but if you pay through one of these other IRS-sanctioned tax payment processors, you can reduce that to as low as 1.87%.
So, let’s do a sample calculation here. Say you owe exactly $4,000 in taxes, and you pay it through Pay1040 with your new Chase Sapphire Preferred. You’ll pay a total of $74.80 in credit card fees…and enjoy $625 in rewards. This way, you come out way ahead as opposed to paying it via check or bank transfer.
If you can’t afford to pay your full tax bill immediately, though, work out a payment plan with the IRS instead of putting it on a credit card. The interest you pay on credit cards won’t be worth it.
Making Estimated Quarterly Payments for Freelancers
Yep–freelancers have to worry about taxes all year, not just in April. Once you become self-employed, if you expect to owe over $1,000 during the next tax season, you’ll need to make quarterly estimated tax payments to the IRS. This essentially takes the place of employer withholding; you’re pre-paying your own taxes for the year.
If you don’t make estimated payments, you could face an IRS penalty for underpayment when you do file, so it’s worth going through the extra hassle each quarter.
Being self-employed can come with a lot of extra work, but if you truly love working for yourself, you’ll agree that the trade-offs are worth it in the end.