Tax Tips Every Freelancer Should Know

It’s the perfect time to start or grow a freelance career. An Upwork survey of 1,000 hiring managers shows that 53% of businesses are open to using freelancers as a result of the pandemic. This means current contractors may see more business, and a new wave of freelancers may enter the market.

Working for yourself as a freelancer is an exciting prospect, but it’s not just about breaking free of a boss and finding your dream clients. Running a business requires managing behind-the-scenes details, too, such as developing good strategies for setting aside, reducing, and paying taxes as a self-employed professional. Learning how to pay taxes as a freelancer is a crucial step for every self-employed contractor.

Being prepared and starting off on the right foot is one of the best tax tips for freelancers. To figure out how much to set aside for taxes, pick a percentage and stick to it. Personal finance expert Laura Adams advised that self-employed business owners set aside 25-30% of their earnings for taxes.

No one wants to be surprised by a massive tax bill with no savings. Setting aside a percentage of every dollar earned makes it simple to write a check for quarterly taxes and to cover any underpayments when filing annually.

The self-employment tax may surprise many freelancers. Planning for it can reduce anxiety on tax day.

“One of the most common things I see with freelancers is not realizing the tremendous tax benefits our tax code holds in the corporate tax election,” said Todd Keffury, founder and lead financial planner of Cadenza Financial Planning. “Self-employment tax usually takes the biggest bite out of a freelancer’s wallet every year as they are forced to pay both the employer and employee’s portion of payroll taxes (around 15.3%).”

Invest in good accounting software early on because it can help you come tax time. It may be helpful to use software that connects to your business bank account and third-party processors, such as Stripe or PayPal.

Each month, set aside time to match up checks, ACH deposits, and other incoming funds in your accounting software. Tools like Xero, GoDaddy Bookkeeping, Wave, and Quickbooks can help a freelancer set up their accounting quickly and easily.

Keeping these records can simplify reporting your earnings to the IRS and your state revenue office as you figure out how to pay taxes as a 1099 contractor. You can also use this information to make important business decisions because it shows exactly what you’ve earned and spent each year.

Freelancers expected to owe at least $1,000 in taxes must pay quarterly estimated taxes. This is where good records and accounting software come in handy.

If you previously filed taxes as a freelancer, your accountant might provide you with credits based on your previous year of income. You can use those credits — or run your own numbers — to pay your estimated taxes.

You should pay quarterly estimated taxes to keep on top of your tax obligations. If you fail to pay IRS quarterly payments, you could receive a big bill come tax time or even tax penalty payments.

Freelancers are eligible for many deductions. This can significantly lower the amount you owe in freelance work taxes when added up over a year.

If you’re keeping good records, it should be easier to create deduction categories you can review and total at the end of each year. Some common deductions for freelancers include:

If you have questions about whether something is deductible, ask your accountant for help.

Treat your business like a business from day one. Get a business bank account and credit card. Receive payments only to that account, and don’t use your personal funds to purchase business-related items. This can help you have cleaner records and avoid the appearance of co-mingling funds.

Pay yourself from the business bank account to your personal bank account. Don’t forget to set aside a portion of your income for taxes before making any payments to yourself.

If you do have an LLC or other formal name for your business, make sure that’s the name on the relevant bank account or credit card.

Unless you file official paperwork stating otherwise, your business is structured as a sole proprietorship by default. There’s no legal or tax benefit to operating as a sole proprietor, but it’s a simple way to get started as a freelancer.

According to CPA George Birrell of Taxhub, it can be a mistake to stick with a sole proprietorship over time.

“The most common mistake we see with freelancers who are new to the game is not properly structuring their freelance business,” Birrell said. “The gold standard entity structure for freelancers is always the LLC. The point of confusion for freelancers is what state to form the LLC in and if they should convert to an S-corp. This is the more nuanced question and can vary widely depending on individual circumstances.”

Taxhub offers an S-Corp calculator to help freelancers determine if that structure is more appropriate for their situation.

Keffury agreed with this logic. “Don’t assume the corporate tax election is only reserved for big-money businesses and ultra-high earners,” Keffury said. “If you are a freelancer netting more than $40,000 per year, it’s likely worthwhile to consult a professional that can model out what this looks like and whether this structure makes sense in your particular case.”

A good CPA is worth their weight in gold for a freelancer. They’ll file your taxes for you and can also represent you and provide evidence to the IRS if you get audited. As your company grows, your tax situation might get more complex.

It’s very helpful to have a professional at your side to assist you with any unexpected situations that arise. They can also teach you more about how to plan for your future, such as what amount to set aside for retirement.

An experienced CPA who understands self-employed tax issues can help you leverage every possible deduction come tax time. They can also serve as a vital resource for making big decisions in your business as your revenue grows.

To know how to file taxes for freelance work, you need to know about 1099s. This term is used to describe an end-of-year tax reporting form you’ll receive from certain clients.

When you work with a new freelance client, they might ask for a W-9 form for their files. If you earn more than $600 in a calendar year with any given client, you should receive a 1099-NEC form from that client the following January with a total of all your earnings. Keep a running list of every client you expect to get a 1099 from and cross-check what they send you with your own records for freelance taxes.

However, there are a few exceptions to the 1099 rule. Overseas clients are not required to send U.S.-based freelancers a 1099-NEC. Also, if your clients pay you through certain third-party processors like PayPal, those processors might send you one 1099-K for all income earned in a calendar year.

This exception eliminates the need for your clients who pay through that processor to send you a separate 1099-NEC. Inform your clients about this, so the IRS doesn’t think you under-reported your income on your freelance taxes.