One of the most harrowing tasks you’ll undertake as a freelancer is paying your taxes. Get that right and you’ll feel like Mario after rescuing Princess Peach–like the plumber supreme of the Mushroom Kingdom.
As a freelancer, taxes are very different than when you’re an employee. Knowing what steps you need to take throughout the year and during tax season is key if you want to avoid a deadly encounter with your taxes.
To help you navigate the complicated world of taxes for freelancers, we’ve written this guide so that you can seriously one-up your tax game next year.
Just keep in mind that, while we’ve made every effort to ensure that this information is up-to-date and accurate, it does not constitute legal advice, nor should it be considered a substitute for legal advice. If you have any tax questions, it’s always best to consult with a tax expert or a lawyer who can steer you in the right direction.
Taxes When You’re an Employee vs. a Freelancer
When you’re an employee, you don’t need to worry too much about your taxes.
That’s because your employer calculates how much money needs to be withheld from your paycheck. Then, those taxes are paid directly to the IRS and the state tax department. Your only responsibility is to file a tax return each year.
But what happens when you’re a self-employed freelancer? Now you’re working as your own boss, which means you don’t have anyone else taking care of all those tax requirements for you. #Responsibilities
Things can get complex quickly since you’re required to pay your taxes directly to the IRS and your state through periodic tax filings. Oh, and you’ll also have to calculate how much you owe.
Plus, to make the filings, you’ll have to keep accurate records of your business income and expenses. And let’s not forget about your annual tax return, you need to file that too…
On top of all of that, tax season is more complicated because you won’t just be reporting the amount on your W2. Instead, you’ll need to report all your freelance income and claim deductions. #MakeTheResponsibilitiesStopAlready
The Good news: Thanks to the many deductions that freelancers can take when filing their taxes, they often end up paying less tax than employees who earn a similar income.
Taxes That Freelancers Must Pay
All levels of government—federal, state, and local—will impose taxes on you.
This means that you need to be familiar with the requirements for each. Don’t worry; we’ll break it all down for you.
Let’s start off with federal taxes. This is likely going to be your biggest tax burden.
Here’s what you need to know:
- You’ll have to pay personal income tax on the profits that your freelance business earns.
- By April 15 of each year, file an annual income tax return with the IRS. This shows your income and deductions for the previous year, along with how much estimated tax you paid along the way.
- Self-employed freelancers are entitled to Social Security and Medicare benefits when they retire, just like employees, so you have to pay Social Security and Medicare taxes to help fund those programs. Often referred to as self-employment taxes, or SE taxes, you must pay these if your net yearly earnings from self-employment are $400 or more.
If you hire employees:
- You’ll have to pay federal employment taxes for your employees. These consist of half of your employees’ Social Security and Medicare taxes and all of their federal unemployment tax.
- You must withhold the other half of your employees’ Social Security and Medicare taxes and all of their income taxes from their paychecks.
- You have to pay these taxes monthly or bimonthly by electronic deposit to the IRS.
- Keep records so that you can correctly file quarterly, and annual, employment tax returns with the IRS.
While most freelancers tend to focus on federal income and employment taxes, every state also has its own taxes that you’ll need to pay.
- All states, except Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, have their own income taxes for businesses and freelancers.
- In most states, you’ll have to pay your state income taxes during the year in the form of estimated taxes. These are usually paid at the same time as your federal estimated taxes.
- File an annual state income tax return with your state tax department.
Note: Each state has its own tax forms and procedures, so contact your state tax department to learn about the requirements and get the necessary forms. Find your state’s tax agency on the IRS website.
If you hire employees:
- You’ll likely have to withhold state income taxes from your employees’ paychecks and then send that money to your state tax department.
- You’ll have to provide employees with unemployment compensation insurance by paying taxes to your state unemployment compensation agency.
Set up an LLC for your freelance business?
You might have to pay additional taxes, depending on your state.
For example, if your LLC was formed or registered to do business in California, you have to pay a minimum $800 annual LLC tax to the California Franchise Tax Board, even if your LLC earns no income. Plus, California LLCs must also file their own California tax return.
Click here to read about taxes for LLCs in California.
As a self-employed freelancer, you might have to pay local taxes.
- Roughly 5,000 cities, counties, and other local jurisdictions impose their own income taxes. New York City is the most famous example.
- Some areas also charge annual business registration fees or business taxes.
- You can check your local government’s website or your local chamber of commerce to find out if you have to pay local taxes.
Finally, there are sales taxes that sometimes need to be paid when you operate a freelance business.
- Almost all states, as well as many municipalities, have sales taxes of some kind. The only states without a sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon.
- All states that have sales taxes will impose them on sales of goods or products to the public. If you only provide services to clients, you probably don’t have to worry about sales tax.
- Most states either don’t tax services at all or they’ll tax only specified services. Notable exceptions are: Hawaii, New Mexico, South Dakota, and West Virginia. They impose sales taxes on all services, subject to certain exceptions.
- If the products or services you provide are subject to sales tax, you’ll have to fill out an application to get a state sales tax permit. Many states impose penalties if you make a sale before obtaining your permit, so it’s a good idea to find your state sales tax agency and get the information you need to receive your permit in advance.
How to File Your Income Taxes as a Freelancer
Federal and state income taxes, as well as self-employment taxes, will probably make up most of the taxes you’ll pay as a freelancer.
Most freelancers file their taxes as sole proprietors. This is the case whether they personally own all of their business assets or formed an LLC.
So, what do you need to know about filing your taxes as a sole proprietor?
- You and your business are considered one and the same for tax purposes. Report the income you earn or losses from your business on your own personal tax return (IRS Form 1040).
- If you earn a profit, the money is added to any other income that you have. This could include interest income from a savings account, or your spouse’s income if you’re married and filing jointly. Then, the total amount earned is taxed
- In order to show whether you have a profit or loss from your sole proprietorship business, you must file IRS Schedule C, Profit or Loss From Business, with your tax return. This is where you’ll list all of your business income and deductible expenses.
A note about deductions:
You’re entitled to deduct all of your business-related expenses, such as mileage, office rent, equipment, and insurance!
- File IRS Form SE, Self-Employment Tax. This is used to report and pay your Social Security and Medicare taxes for the year.
- Add the SE tax to your income taxes on your personal income tax return (Form 1040) to determine your total tax due for the year.
Wow, that’s a lot of forms! But, don’t worry, once you get the hang of things, you’ll be moving from one level to the next in no time.
What if you formed an LLC?
If your LLC has only one owner (that’s usually the case for freelancers), it’s considered a disregarded entity for IRS purposes.
What does this mean? Put simply, it’s as if the LLC doesn’t exist for tax purposes, so you’re treated exactly the same as a sole proprietor.
If your LLC has two or more owners, it’s ordinarily taxed the same as a partnership.
What if you want to be taxed as a corporation?
You don’t have to file your taxes as a sole proprietor if you’re running a one-owner freelance business. Instead, you can form a corporation or choose the S Corp form of taxation if you are running an LLC.
Being taxed as a corporation makes your tax life a lot more complicated, though, so it’s a good idea to discuss the pros and cons with a tax professional.
So what’s so hard about being a corporation?
First off, you’ll need to work as an employee for your corporation and pay yourself a reasonable salary.
Secondly, the business will have to file its own tax return.
It is worth noting, however, that sometimes you can actually save on taxes with corporate taxation. This is more likely if you’re a higher-income taxpayer who’s earning at least $100,000 to $200,000 per year.
Check out The Smartest Business Entities for Freelancers to learn more about the different forms that a freelance business can take, along with the pros and cons of each.
Tax Traps to Avoid When You’re a Freelancer
Tax traps: these are like those vines in Mario with the pointy teeth. You want to avoid them at all costs!! And, when it comes to working as a freelancer, there are two main traps that you should know about.
Failing to Pay Estimated Taxes
As we mentioned before, when you’re working as an employee, your employer usually withholds taxes from your paycheck and sends the money to the IRS.
When you’re working as a self-employed freelancer no money is withheld from your compensation by clients or customers., It’s all on you to pay what you owe.
As a freelancer, you aren’t supposed to wait until April 15 to pay your taxes in one lump sum with your annual tax return. Instead, you typically have to make four quarterly tax payments (known as estimated taxes) throughout the year.
You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. The IRS will impose a penalty if you underpay your estimated taxes.
If you don’t pay your estimated taxes along the way, you could find yourself with a large tax bill at the end of the year, and you might not have the cash to pay it.
To make sure you have money to pay estimated taxes, every time you get paid, set aside the money that you’ll need to cover your income taxes, as well as your Social Security and Medicare taxes.
Here’s how to file your four estimated tax installments:
|Income received for the period:||Estimated tax due:|
|January 1 through March 31||April 15|
|April 1 through May 31||June 15|
|June 1 through August 31||September 15|
|September 1 through December 31||January 15 of the following year|
A lot of freelancers set up a separate bank account that’s just for putting money aside for taxes.
Deposit a portion of every payment you receive from clients in order to gain some assurance that you’ll have enough money to cover taxes when they’re due.
The amount to deposit will depend on your income, your federal and state income tax brackets, and your tax deductions, but you’ll likely need to deposit 25-50% of your pay.
Failing to Keep Records
Another big mistake that many freelancers make is not keeping adequate business records. After all, without good records of income and expenses, you’ll find it hard to prepare accurate tax returns.
Plus, if you’re ever audited by the IRS, you could end up losing valuable tax deductions if you don’t have records to back up those deductions.
Here’s an example: thousands of freelancers have lost their business mileage deductions because they haven’t keep an adequate log of their business mileage.
Ultimately, losing deductions due to poor records is expensive. Depending on your income, every dollar in deductions that you lose costs about 25 to 50 cents in extra taxes.
What types of records do you need to keep? This depends on the nature of your business.
But, you do need to have a record of some kind of every penny that you spend on your business and every penny that you take in.
Also, while some expenses need to be backed up with a receipt, many smaller expenses (less than $75) don’t require a receipt.
Pro tip: There’s a lot of super helpful accounting software packages, including those designed for individuals who are self-employed. These can help you maintain solid business records.
Need Extra Help with Taxes? Collective Can Help
If all of this information is a little overwhelming, we get it. You aren’t alone if you’re feeling confused and frazzled about running your own business and making sure you pay all of the right taxes on time.
That’s why, at Collective, we’ve developed a platform supports you at every step. When you sign up with Collective, we’ll help you legally set up your business, going through every form that needs to be filled out to make your company legit.
Then, we’ll give you a Dashboard that you can use to track your business income and expenses. Plus, we help you calculate the taxes that you owe, and remind you when you need to file your quarterly taxes and your annual tax return.
Think of Collective as the Luigi to your Mario.
You won’t be alone, and you won’t have to worry about forgetting important dates and deadlines, especially when it comes to your taxes!
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.