If you’re used to working on-staff for a company, tax time could catch you by surprise if you’re not prepared. Whether you’re freelancing full-time or as a side hustle, there are some things you need to know.
Now, I am not a tax or financial professional. So, while I can tell you what I do, personally as a business-owner, I strongly encourage you to talk with a licensed tax professional.
1. Think about tax time year-round.
When you earn money, you need to pay taxes on that income. As an employee, your company withholds money from each paycheck to go towards your taxes.
But when you’re freelancing or contracting, your client is not withholding taxes for you. Instead, your client pays you the full amount and it’s up to you to set aside money for taxes.
You will owe taxes according to your income—at least Federal, and often State income tax as well, depending on where you live. You will also be responsible for paying self-employment tax.
Neither type of tax is cheap, though it does vary by your income level and location. In order to prepare, each time you are paid by a client you should set aside 25%-40% in a separate savings account. It should be in an account which you will not draw from until you pay your taxes, due on April 15 every year.
Warning: If you spend this money on something other than taxes, you’ll be in big trouble when tax time rolls around!
Personally, I choose to reserve 50% of each check I get. This system helps me put savings for taxes on autopilot. And if I’ve over-saved, then I simply transfer the remainder back into my personal account after I’ve settled my tax bill.
2. Find out if quarterly taxes apply to you.
Depending on how much freelance income you have, you may have to pay quarterly taxes. Typically, you have to pay quarterly taxes (estimate tax payments) if, according to the IRS:
- “You expect to owe at least $1,000 in tax for the current tax year after subtracting your withholding and refundable credits.
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the tax to be shown on your current year’s tax return or,
- 100% of the tax shown on your prior year’s tax return.”
Consult a tax professional to find out if this applies to you. As you can tell, a bit of math applies! You can also use the IRS Publication 505 to learn more about estimated taxes, how to calculate whether you need to pay, and how much your payments should be.
3. Keep track of your eligible deductions.
Here’s something else a tax consultant can help you with. Freelancers qualify for all kinds of deductions. You may be able to deduct things like:
- Travel expenses such as mileage.
- Home office space.
- Advertising expenses.
- Professional development opportunities.
Now, be careful because deducting things you shouldn’t is a great way to get in hot water with the IRS!
4. Find a tax professional who can guide you well.
As I’ve mentioned numerous times, I highly recommend working with a professional on your taxes. It’s best to find someone who has specific experience working with freelancers and contractors. These professionals will know all the information to make sure you pay enough—but not too much!—in taxes.
Your turn! How do you remember to set aside tax money? Let us know in the comments below!
Last Updated on July 1, 2023.
