A Freelancer’s Guide to Income Taxes

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:

2019 Estimated Tax Payments Schedule

For the Period: Payment Due:
January 1st to March 31st April 15th
April 1st to May 31st June 17th
June 1st to August 31 September 16th
September 1st to December 31 January 15th (2020)

Many self-employed people see large fluctuations in their income from one month to the next. Each month, Angie needs to total her income for the current quarter so far, and her year-to-date income. Once she has those numbers, she should estimate her income for the remainder of the year and determine if her estimated taxes will be enough to pay the tax liability.

Say, for example, that Angie’s results are better than expected. By June, she increases her estimated annual income to be $70,000. She needs to meet with her CPA to plan for higher estimated taxes. Her 20% federal withholdings may not be high enough, because the increased income may put her into a higher tax bracket.

Estimated quarterly taxes can be tricky. QuickBooks Self-Employed is designed to help freelancers avoid surprises by estimating quarterly payments based on income and write-offs.

Take FICA and Medicare Taxes Into Account

Employers also withhold each worker’s share of FICA and Medicare taxes from gross pay. Freelancers, on the other hand, must pay those taxes using Schedule SE (Self-Employment Tax). Currently, freelancers pay a 15.3% tax rate for FICA and Medicare taxes, with one-half of those taxes posted as a business expense on Schedule C.

Reduce Your Taxable Income as Much as Possible

The tax laws for business expenses are complicated and can change frequently. Some expenses require extensive documentation, and those records need to be monitored throughout the year. Here are some common business expenses for freelancers:

  • Retirement accounts: Freelancers have several types of retirement accounts that can be set up and funded, but the rules are complex. Fortunately, some of your retirement plan contributions may be tax deductible on your Schedule C.
  • Health insurance: The premiums you pay for health insurance are also deductible. Many freelancers find that paying for their own health insurance is far more expensive than the cost they pay as an employee. This additional cost should be considered when you price your services for clients.
  • Home office expenses: Be careful here, because the IRS may closely review any deduction you take for a home office. Using this deduction requires careful record-keeping.

Once Angie completes her Schedule C, she will include it with the other documentation in her Form 1040 personal tax return. The net profit on Schedule C is added to any other income on her 1040 form, and she will file her personal return by April 15th of each year.

Plan, Document and Thrive

A career as a freelancer offers you flexibility and a chance to focus on work that you enjoy. If you choose to work as a freelancer, invest the time to plan for your taxes and submit estimated payments on time. Ask a CPA for help, get yourself setup with a professional tool like QuickBooks Self-Employed and you’ll be able to file an accurate tax return and focus on growing your business.

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