Freelancer Taxes Bootcamp: What You Need to Know
tax tips | May 31, 2019 | By Susannah McQuitty
Freelancer taxes can be overwhelming; you have to report your business income, your freelancer expenses, and all the ins and outs of a self-made profession for an entire year on a single tax return. It’s a lot to handle, even when you have mid-January to mid-April to get it done.
The key to streamlining your freelancer taxes depends entirely on how you stay organized throughout the year. Sounds simple, but half the battle is knowing how to organize the bucketloads of information that get thrown at you from all sides.
Here are the biggest points that will help you lay a strong foundation throughout the year to coast through your taxes come April.
Be mindful of your business structure
If this is the first you’ve heard of business structures, don’t panic; just think of them as the basic groundwork for how you run your business. How many people own it? Is it considered its own entity or just an extension of the business owner? Depending on the structure, your business taxes will be processed differently.
Freelancers offering a service or running a commission-based business usually fall into the sole proprietor business structure. Sole proprietors (a fancy way to say “business owners”) don’t file a separate tax return for their business; all you have to do is add a Schedule C to your personal tax return and report your business information there.
You could also opt to become a Single Member Limited Liability Company (SMLLC), which is similar to a sole proprietor but reduces personal liability from business debts:
- There are some costs associated with becoming a SMLLC, but for some, the benefits outweigh the costs.
- You don’t need an Employer Identification Number unless you plan to hire employees. If you decide not to treat your SMLLC as a corporation, your business will instead be treated as a disregarded entity. This means the business and owner are treated as one and the same for tax purposes, using a Schedule C to report income and expenses.
The next business structure is a partnership, which is generally run by more than one person or entity.
- In this case, the partnership will file an information tax return using Form 1065. The partnership’s income and loss are separated based on ownership percentage and reported to each partner on Schedule K-1.
- Each owner then includes their own income and loss information on a personal tax return.
- Partnerships are considered pass-through entities, because the income passes through to the partners to be taxed at the individual level rather than being paid by the business.
Most freelancers won’t mess with the more complex business structures, like the corporation and the Subchapter S (S corporation). If you’d like to know more about them, check out our Tax Guide for the four different types of self-employed business structures.
Get an income and expense tracker
Unless you only make a few transactions per year, accounting software or expense trackers are enormously helpful for keeping your records organized and easy to access. You can always use bank statements to refer back to your income and expenses, but when you’re checking the entire year, it gets overwhelming pretty quickly.
For instance, there are certain details about your income and expenses to keep track of:
- Certain equipment used for an extended period of time is probably depreciable and can get you some sweet tax breaks if you keep track of them.
- Online shops need to keep track of the states where buyers live, determine whether they need to collect sales tax at time of purchase, and file sales tax returns in the states where they ship products.
- Assets for both business and personal use have to be split and tracked for the business expense deduction (think vehicles, computers and cell phones).
As you can see, income and expenses get complicated quickly—just imagine trying to put all that together for an entire year without a program to help you. Be sure to update your accounting software or expense tracker on a regular basis, whether weekly, monthly, or quarterly (more on that in a bit).
Make estimated tax payments—even if you technically don’t have to
For anyone who expects to owe more than $1,000 in taxes on freelancer income, it’s strongly recommended that you calculate and pay quarterly estimated taxes (so $250 or more per quarter). This rule is designed to help freelancers stay on top of their taxes owed so that April doesn’t hit like a freight train.
But even if you only expect to owe a measly $100 on your earnings, it may still be a good idea to pay quarterly estimated taxes (so $25 per quarter). You aren’t required to by law, but quarterly payments help you regroup, reorganize and strategize at regular intervals throughout the year.
Not sure what you’ll owe? This is a concern for startups especially. As long as you pay in quarterly payments what you owed on last year’s tax return, you’ll protect yourself from penalties. If you end up owing more, that extra amount will be due in April. On the other hand, you might owe less and end up with a sweet refund instead.
Remember to deduct your self-employment taxes
Self-employment (SE) taxes are typically considered the bane of freelancers’ existence, but there’s some relief. Technically, the 15.3% SE tax rate consists of 12.4% for social security and 2.9% for Medicare taxes. Typically, you must pay SE tax if you had net earnings from self-employment during the year.
However, half of your SE tax can be deducted; if you file your taxes online with 1040.com, this deduction will be applied for you automatically. Your Adjusted Gross Income (AGI) and taxable income get reduced, which in turn provides some SE tax relief.
Know what you’ll need to report on your Schedule C
Schedule C is the section of your tax return where you report all your income and expenses for your business. If you have more than one business (good on you, go-getter!), you’ll need to fill out a Schedule C for each.
Schedule C will ask you for the following information:
- A short description of your business
- A business code for your operation
- The name of your business (or your personal name)
- Your Employer Identification Number (if you have one)
- Your business address (or your personal address if you consider home your place of work)
- Your accounting method
- Your business activity type (passive or not passive)
- Your income (broken down into categories)
- Your expenses (broken down into categories)
- The cost of goods sold (for retail businesses)
If you’d like more information on any of the details above, check out our Tax Guide breakdown of the Schedule C.
Stay organized throughout the year, and your taxes will be a breeze
Yes, there’s a lot of work on the front end to keep your finger on the pulse of a freelancer business. There’s no sugar-coating that—but the more organization you do from month to month, the easier it will be to plug numbers into your tax return and finish with deep-rooted and hard-earned confidence.