The shift from 9-5 life to the freelance world can be liberating and energizing — it can also be quite the shock when taxes enter the equation. 1099 life means many new responsibilities and a lot of information to digest. This piece serves as a solid introduction to best practices in managing freelance tax duties and avoiding the major pitfalls that afflict many new 1099ers.
If you’ve ever worked in an office environment, then you are likely very familiar with the thrill and ensuing heartbreak of reading over your weekly pay stub and looking at the big ol’ chunk of it that vanishes into the abyss of tax withholdings. Now that you’re on your own, your pay-outs go directly to you — no more withholdings — great!
Unfortunately, in the 1099 world our responsibilities have merely shifted and there are a good handful of them. As independent contractors, we handle our businesses and operations largely on our own, and taxation is no exception.
Paying taxes for independents is not especially inspiring, but understanding their intricacies and the policies that surround them is integral to mastering the self-employed lifestyle — and certainly to growing your business!
Freelance tax compliance — a little different from the other side
There are a few key items you need to understand, especially if you have recently transitioned from the standard 9-5. One of the most immediate changes you will notice in your freelance tax responsibility is that you now have what is called a “self-employment tax.” This accounts for both your social security and medicare taxes, which would have come out of your paycheck in an office job.
Nothing new or crazy there, but the unfortunate difference in this case is that the portion of these taxes an employer is required to cover now falls on your shoulders. The 7.65 percent that would have normally been your share is now doubled to 15.3 percent.
This is very important to consider when budgeting your cash flow, especially if you are just starting out. You will also have a state self-employment tax to budget in. From the get-go your hourly rate needs to be about 30 percent higher than it would have been in a traditional work setting. For tips on securing this rate, take a look at this article on negotiating pay.
Quarterly estimated taxes are annoying . . . but potentially helpful
Let’s just say as independents we find ourselves a little more preoccupied with our civic responsibilities. This in many cases is due to the estimated tax, which is the freelancer’s equivalent to income tax.
Estimated taxes are paid quarterly and functionally imitate the consistent flow of taxable income to the government that standard employees part with via withholdings on each paycheck. The IRS prefers not to receive your full income tax in one lump sum and can actually penalize you for not paying quarterly.
To avoid these fees and keep yourself organized and on track with your personal tax withholdings, we recommend adhering to their quarterly tax cycle.
If you estimate paying $1,000 or more in income tax from your freelance venture, it’s best to look up the quarterly estimated tax schedule for the current calendar year. From there, estimate an appropriate number with your accountant based on your earnings from the prior year and submit it via the 1040 form. As long as your contribution amounts to 100 percent of what you paid last year or at least 90 percent for the current year, you are in the clear.
Obviously, this means a little more micromanagement but this additional work forces you to consider your allocation of funds and current expenses long before tax season rolls around. You do not want to be slapped with an income tax at the end of the year that you can’t pay!
You can find the quarterly tax dates for 2016 in the table below.
Be extremely vigilant and work with a professional
When it comes to freelance tax responsibilities many clients can be a little … how should we say this … “lax.” Don’t let laissez-faire tax compliance jeopardize your bank account and mental health! And do not just assume your clients got everything right — you can be held accountable for their errors. Be extremely vigilant and work with a professional.
Every receipt, every check, every client 1099 and beyond: hang on to them and keep them well organized!
Radio host and web entrepreneur Kim Komando put together a great list of receipt scanning apps that I highly recommend exploring. Digital storage is a no-brainer.
It also helps to open a separate checking account specifically for your freelance deposits and expenses.
Above all, you should really work with a professional accountant. I know … I know. Another expense — yikes. Fortunately, accountants usually scale fees to the size of a client’s business and expenses towards filing your taxes are in themselves tax-deductible! Had to catch a break somewhere!
Software like Turbotax and commercial chains like H&R Block are very tempting but risky. You still really need to know what you’re doing when using them and it can be very limiting working with a commercial tax preparer who does not understand the full ins and outs of your business (potentially meaning less money back from your tax return). Save yourself time and anxiety and get your compliance done the right way the first time.
Make your life easy
We’re now in the clear after 2016’s tax season, which means you have plenty of time to get your self employment taxes and estimated taxes straightened out — but that doesn’t mean to wait! Managing freelance tax items can be, well, pretty taxing, but proactive planning, consultation and communication with your clients can make your life a whole lot easier. Don’t do this the hard way.