Managing your work as a self-employed person can be hectic. You have to market yourself, deliver a product or service and handle dozens of other tasks. Because they’re so busy, many freelancers don’t invest the time to understand how to pay taxes. If you’re uninformed, you may end up paying penalties, fees and interest on your tax return. Use these tips to plan for income taxes on your freelance business earnings.
How freelancers pay their taxes
To understand how freelancers should plan for taxes, consider how employees make their tax payments. Keep in mind, however, that all both employees and freelancers pay income tax using the same tax tables. Also, both types of workers pay the same rate of tax on FICA and Medicare. The primary difference is that employees pay taxes passively (funds are withheld from checks) and independent workers pay actively (they estimate and pay taxes quarterly).
Assume that Angie is a video producer for Gateway Financial, and she earns $60,000 per year. Angie fills out an IRS W-4 form to determine her federal income tax withholdings. She also completes a state income tax withholding form and signs a document to withhold her share of health insurance premiums from her pay.
- Based on her withholding documents, Gateway withholds 25% of her gross pay ($60,000) for federal taxes, 5% for state taxes and 5% for health insurance premiums.
- Gateway submits the tax amounts withheld to the IRS and Angie’s state department of revenue.
- At year-end, Gateway issues Angie a W-2 form, which includes the total amounts withheld for taxes.
Once Angie decides on her withholdings, the employer submits the withheld amounts and completes the tax reporting. She doesn’t need to initiate anything else to get her tax payments in. Angie may or may not have an additional amount due when she files her personal tax return.
How to calculate income tax when you’re self-employed
After five years at Gateway, Angie decides to leave the firm and work as a freelance video producer. The majority of freelancers are considered to be sole proprietors for tax purposes. Angie’s CPA explains that she should report her business income and expenses on Schedule C of her personal tax return (Form 1040).
Now comes the hard part: Angie must estimate her annual earnings and plan tax withholdings based on the earnings estimate. Every freelancer should consider working with a CPA and using a cloud-based accounting software to get this process in place.
Estimate and make your quarterly tax payments
To succeed as a freelancer, you have to be proactive. Freelancers have to take the initiative to find business, and you need that same mindset to plan for your tax payments. If you don’t plan ahead, you may end up paying penalties, fees and interest on your tax underpayments. The process is completely in your hands.
Angie thinks that she can earn $50,000 in her first year as a freelancer. Her CPA estimates that she should pay 20% of her earnings for federal taxes and 5% for her state tax liability. Angie must make estimated tax payments based on this schedule: