Making the transition from traditional employment to freelance work comes with a number of challenges, not the least of which is dealing with new accounting and bookkeeping responsibilities. Instead of having taxes withdrawn from your paycheck as a conventional employee, you must estimate your own tax payments every quarter as a self-employed person.
Additionally, freelancers must keep accurate and detailed books if they hope to manage their businesses successfully and avoid fraud and other issues as they grow. For this reason, it’s crucial to have a basic understanding of the specific accounting requirements for freelancers and the self-employed.
Important Financial Documents
Good preparation starts with keeping track of a number of essential financial documents and forms. Here are a few documents you can expect to come across in the process of managing your freelance accounting.
Form W-9 is a request for taxpayer identification number and certification. It’s similar to a W-4 form, except it signifies that you’re working as a separate business, and thus won’t have any taxes withheld. As a freelancer, you will likely have to send a copy of this form to every client and vendor with whom you contract, so be sure to keep them handy.
Schedule C (Form 1040)
Another essential form for the self-employed, Schedule C is used to report profits and losses from a business when you pay yearly taxes. It’s also where you will list any business-related deductions. Freelancers need to calculate cost of goods, gross profits and expenses in order to fill out this form correctly.
Schedule SE (Form 1040)
Schedule SE helps you figure out your self-employment tax. This tax includes your federal income tax amount as well as contributions to Social Security and Medicare. Schedule SE is filed annually with your regular tax return.
If you anticipate doing enough business to generate over $1,000 in taxes, you will be responsible for paying quarterly income taxes. Form 1040-ES helps you estimate your quarterly tax burden throughout the year using the enclosed instructions. You can complete each payment voucher to mail in or pay your bill online.
A 1099 form is the form that your clients will use to report how much money was paid to you during the previous tax year. You can think of it like a W-2 form, but for freelancers. There are multiple types of 1099 forms for different types of payments, but only two are relevant for most freelancers:
- 1099-MISC: Clients are responsible for sending a Form 1099-MISC to self-employed people whom they pay $600 or more in a single year. The person or company that pays a freelancer must file a 1099 tax form with the IRS and send him or her a copy.
- 1099-K: This form is for people that have accepted credit card payments. You should only receive a Form 1099-K if you have made 200 or more transactions and your accepted amount exceeds $20,000. This form will be sent to freelancers by either their merchant account provider or a website service with whom they do business, such as Uber.
Accounting Best Practices for Freelancers
As a freelancer, you may not have the financial resources to hire an accounting team to assist you throughout the year. Still, it’s important that self-employed individuals follow the best practices for accounting and bookkeeping. Here are some tips for keeping your finances in order.
In order to manage your business successfully and fulfill all tax obligations, you will need to track any income you receive with accuracy and care. Even if a client did not send you a Form 1099, you must still report the income received from this sale to the IRS.
Just as it’s important to track income, freelancers must record all business-related expenses. Along with payments to suppliers and employees (if any), self-employed persons can often write off costs related to business advertising, office space and supplies, mileage, health insurance and travel. Be sure to keep detailed receipts of purchases so you can back up every exemption you claim in your tax return.
Calculate Net Income
Once you’ve calculated the values of income and expenses, you can determine net income with the following formula:
Net Income = Revenue – Expenses
Revenue refers to all inflows and other types of sales, while expenses include all costs associated with generating said revenue. Calculating net income is one of the first steps to finding your cost of goods sold and contribution margin, which assesses how a particular item or group of items is helping or hurting your bottom line.
Follow Up on Invoices
Because self-employed persons don’t receive regular salaries and paychecks, it’s important that they take steps to secure sufficient cash flow. Along with sending your clients invoices that look professional and arrive on time, be sure to follow up on any late invoices. Doing this helps to ensure your livelihood and continue your business’ operation. Additionally, it’s wise to retain hard copies of paid invoices in case you experience computer problems down the line.
Invest in Software
If you don’t have a solid background in finance, you may want to consider purchasing a small business accounting software program to help keep your books in order. QuickBooks Self-Employed helps freelancers prepare quarterly estimated payments, track expenses and deductions, and even fill out their Schedule C and other important forms.
In the IRS’ view, not having an accountant is no excuse for making mistakes on your tax return. If you can’t afford an accountant, a good software program can help keep your freelance business organized. Whatever option you choose, make sure it’s the best one for your business’ size and needs.
For more accounting tips, check out our complete guide to taxes for the self-employed.