Whether we like it or not, now is the time when we need to be thinking about taxes. Unfortunately, many freelancers worry about a hefty bill. But paying taxes doesn’t have to turn into a nightmare. We want to offer you some tips to help you navigate and prepare for the process.
Making Smart Decisions to Avoid a Freelance Tax Penalty
Let’s start by explaining why freelancers need to concern themselves with taxes. After all, people who work for an employer don’t usually have to think too much about it! That’s because employers are responsible for withholding state and federal taxes from their employees’ paychecks.
On the other hand, freelancers receive payment from clients—not employers. It’s up to YOU to pay those state and federal taxes. Failure to do so will result in a freelance tax penalty.
Your accountant can tell you if you need to pay quarterly taxes or if you can pay an entire year’s worth in one lump sum on April 15. But regardless, you’ll have to pay taxes.
So make sure you set money aside to pay those taxes!
A Cautionary Tale
I used to work with someone who had a full-time job as a W-2 employee and did freelance work on the side. While he was an excellent service provider and did fantastic work for his clients, he wasn’t so good at being the CEO of his business.
My colleague spent all of his freelance income as it came in—on bills, rent, and even professional development. The problem is that he didn’t set any money aside for his tax bill!
His accountant ran the numbers, and my friend ended up owing over $22,000 in taxes, just from his freelance business!
Even though he’d already spent the money, he had to scrounge around to find $22,000 to pay the IRS.
Save as You Go to Save Yourself a Headache
The panic my colleague felt when faced with his tax bill is completely preventable. All you need to do is remember that April 15 happens every year (even leap years!) and that you will have to pay taxes on (almost) every dollar you earn. (Talk to your tax pro about eligible deductions!)
Here’s what I do to avoid a massive freelance tax penalty:
- Set up a no-fee bank account which is separate from your regular business account.
- Every time you get paid, set aside a percentage. I recommend students save 25%-40%, but check with your accountant or tax pro to find out what number makes sense for you.
- Keep an accurate record of all your freelance income. You do NOT want to get a bill from the IRS a few years from now because they found income you forgot to report!
I’ve found that squirreling tax money away in a money market account makes the most sense for me. I earn a bit of interest, the money is easy to access, and I often end up saving a bit more than I need for taxes. Having extra money left over after tax time is definitely a bonus!
Your turn! How do you (legally) keep from getting stuck with a tax bill that’s more than you can afford? What are your saving secrets? Let us know in the comments below!
Note: We are not legal experts or tax preparation professionals, so always consult an accountant, tax prep professional, or attorney if you have concerns. This information is aimed at freelancers in the United States who have questions about avoiding a freelance tax penalty. Freelancers in other locations may find this information useful for determining what questions they need to ask and answer based on their city, country, or region.
Last Updated on July 1, 2023.
