As freelancers and consultants, we handle our business operations largely on our own, and tax filing for many of us is no exception. Freelance taxes and tax write offs are not especially thrilling topics, but understanding how taxes for freelancers are different from traditional employment is integral to mastering the self-employed lifestyle.
We assembled this guide to help new and veteran independent contractors properly manage their freelances taxes and to avoid the major pitfalls that often burden 1099 workers throughout the tax preparation process.
Whether you’re planning to file your freelance taxes on your own, or work with a tax professional (which we highly recommend), the points below will give you a basic understanding of your obligations and how to best handle them.
Two caveats before we start:
- This information is about freelance taxes in the U.S. Let us know if you have insight on how freelancers are taxed in other countries.
- This isn’t expert advice about your personal situation. Consult actual experts before making any big decisions.
Freelance taxes vs. employee taxes
If you’ve recently transitioned from the standard 9-5 employment, one of the most immediate changes you will notice in your freelance tax responsibilities is that you now have what is called a “self-employment tax.”
Self-employment tax accounts for both the social security and medicare taxes that your employer would have covered in a traditional job. As a freelancer, you are essentially both the employee and the employer, so you have to cover both pieces.
That means that the 7.65% that would have been your share to pay is now doubled to 15.3%.
Did this come as a rude awakening? Then look critically at your pricing structure going forward.
From the get-go your project/hourly rate needs to be about 30 percent higher than it would have been in a traditional work setting to compensate for the added tax burden you now face as an independent contractor.
If you set your rates by using your old salary or hourly wage as the foundation, you are automatically going to be behind at the end of the year when you settle up with the IRS. So your freelance rates need to account for your freelance taxes.
For tips on securing this higher figure, check out our post on negotiating freelance rates.
Freelancers have to pay quarterly estimated taxes
As independents, we find ourselves a little more preoccupied with our civic responsibilities than our W-2 peers. This in part is due to the estimated tax, which is the freelancer’s equivalent of income tax.
Estimated taxes are how independent contractors give the IRS a steady stream of tax revenue, as standard employers would account for, again, via employee withholdings.
In the case of people generating 1099 income, the government prefers not to receive our full tax payouts in one end-of-year lump sum and can actually penalize us for not managing them on a quarterly basis.
In fact, according to recent reports, the IRS penalized 10 million tax filers for underpayment in 2015. Ouch. Even worse, the penalty has increased from three percent of what was owed to four percent.
You can find the deadlines for 2017’s quarterly estimated taxes in the table below:
I recommend estimating an appropriate quarterly number with your accountant based on your earnings from the prior year (or what you should have paid by the quarter last year). You submit these payments via the 1040 form.
The IRS also provides worksheets for estimating your quarterly freelance taxes.
You can dodge the underpayment penalty if: you owe less than $1000 in taxes from your freelance work (excluding withholdings and estimated tax payments) or have paid 90 percent of what you owe for the current calendar year, or 100 percent of what you owed on the prior year’s tax return (whichever is smaller).
Pro tip: Make doubly sure that you get your first estimated tax payment in on tax day (April 18th)! This will get you on track for 2017 and minimize the chances of you paying the four percent penalty for the last year.
Rigorously track your freelance income & expenses
Don’t count on your clients to handle this or prompt you to pay your taxes. Technically, they are supposed to report payments that they have made to you above a certain amount. $600 was the threshold in recent years. And they are supposed to do that before January 31.
What form do your clients report payments to you on? The 1099, of course! That’s where our name comes from. That’s why you are called a 1099 worker instead of a W-2 worker. They aren’t going to send you a W-2 at the end of the year like they give to employees.
However, when it comes to 1099 reporting for freelancers many of your clients may be a little “lax.” Don’t let their laissez-faire reporting 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.
So, whether or not you ever get all your 1099s from the clients who owe them to you, you need to report all your income to the IRS. The easiest thing to do is to keep an account of every payment you receive by the source of that payment and regardless of whether or not any client pays you more than $600 in a year.
It also helps to open a separate checking account specifically for your freelance deposits and expenses to keep these transactions very neatly documented.
Pro tip: Receipt scanning apps have gained a lot of popularity with freelancers, and while there are some great tools out there specifically for this purpose, you can save yourself a little cash and log your receipts for free in Evernote using the camera function in the mobile app.
Independent contractor tax deductions
Your freelance business has a very special power. It can turn most things that it touches into a tax deduction. Pretty cool trick, huh? Let’s see how it’s done.
Solo businesses may not have all of the same trappings as their small business and corporate peers. However, you still need your workspace to serve the core functions of an office.
• Office supplies
• A coffee machine
• The approximated electricity used to power your work space*
*These items are contingent upon you sufficiently proving that you have a space in your house or apartment that is dedicated solely to work-related activities. The multipurpose “dining room office” usually doesn’t count!
You also have expenses unique to your freelance work, be it consulting, engineering, design, writing or art. Susan Lee of Freelance Taxation wrote up an incredibly useful guide that outlines potential tax deductibles specific to several distinct freelance fields.
Is health insurance tax deductible for freelancers?
While it would be a bit of a stretch to call your health an “operating expense,” it doesn’t matter — your health insurance premiums are 100 percent tax deductible!
Even non-ACA plans from independent or short-term coverage providers are still deductible as medical expenses (although they don’t currently preclude you from the individual mandate tax).
Take a look at our expert guide, if you’re still figuring out what to do for freelance health insurance coverage after open enrollment.
Continuing education tax deductions
Continuing to grow your skills is a good thing, right? Fortunately, independent contractors and employees alike have the ability to write off substantial expenses that accompany continued education. These items include:
• Tuition costs
• Costs of educational materials (textbooks and software)
• Online education
• Any form of learning that improves your skills within your current profession
• Any educational opportunity that is necessary for advancement in your current position
• Any work training you are required to pay for
This is a boon to reducing freelance taxes, because according to the Upwork/Freelancers Union 2016 survey, over half of us had taken some kind of training in the previous six months.
However, there are a few little nuances here. You might have thought to yourself: “what about student loans?” The interest you pay on student loans is not tax deductible, unfortunately. However, you qualify for a deduction by paying back a student loan. You can learn more about this on the IRS page for this topic.
While all kinds of personal enrichment are great, there are also limitations to their tax deductibility. Any education that qualifies you for a new career is not considered a qualified expense for your freelance business. (i.e. going to law school, getting an MBA)
Travel expense tax deductions for freelancers
Sometimes freelancers have to actually get out of the house and mingle with the outside world.
It’s okay, though, because your superpower still works away from home. Any gas, bus, train or even plane expenses that are necessary in order to conduct your freelance business matters are all fair game, as is the lodging (provided that you were good and documented everything as we said above).
Your dining is covered too, but with further qualification. You can deduct 50 percent of your meal expenses that were used to entertain clients and 100 percent of your food expenses for employees (if you have them). Going out for your daily coffee shop chai will not stick, unfortunately.
What about taxes for expats?
While we’re on the topic of travel, let’s talk expat taxes. You’re working abroad — you’re loving life — you’re free of that frustrating U.S. tax burden . . . right? NOPE.
While you don’t need to worry about the ACA’s individual mandate and have a nice built-in extension until the second quarter (June 15th) to file, there is no getting around paying U.S. taxes if you are earning income as a freelancer.
However, granted that you qualified for resident status abroad, you can deduct your housing expenses if they amount to over 16 percent of your foreign earned income.
And speaking of foreign earned income, you can also exclude the first $101,300 you make abroad from your tax reporting (whether from a U.S. company or not). This is reported via the 2555 form.
It’s important to remember, though, that this is only your freelance tax obligation for the United States. You still have to settle up your finances in the country you reside in as well. While many territories have agreements in place to prevent “double jeopardy” situations for expats, you will need to be vigilant in researching the tax policies in your country of residence.
HELP! I need to file an extension on my freelance tax return!
Behind on your accounting? Waiting on a big client to give you a 1099? If for whatever reason it doesn’t look like you’ll be able to file by April 18th, now is the time to act. Pull up form 4868, fill it out, and get it over to the IRS by April 18th for a six-month extension.
Sounds great, huh? Well, if you really don’t need an extension, I wouldn’t recommend going this route. As solos, there will never be a convenient time to file freelance taxes. If you have the information you need to file on time, do it, and save yourself the stress later on.
Note: It’s important to understand that this is not an extension on paying the taxes you currently owe. You are just extending the time you have to produce your documentation of 1099 income.
You still need to pay your estimated quarterly income taxes on time. So you’re going to be mailing something in by April 18 no matter what. You may as well get the freelance tax return in.
Work with a tax professional (really . . .)
Above all, you should work with a professional accountant. I know … I know. Another expense. Fortunately, accountants usually scale fees to the size of a client’s business, and expenses toward filing your freelance taxes are in themselves tax-deductible!
There are more affordable options like tax prep software, but if you are serious about running your freelance career as a business, you need to budget for professional help on your taxes.
You can find qualified tax preparers right in your backyard with this search feature.
Make your life easy
If you found yourself muttering “ahhh sh#1!!” while reading this guide, I can assure you that you aren’t alone. Fortunately there is still time to organize your 1099 income and tax write offs — and find the right professional to help you take care of it all.
Managing freelance taxes can be . . . taxing, but it’s also a very educational experience.
If you’re like me, you probably had some habits in the past that made your life a little more stressful than it needed to be when it comes time to pay your freelance taxes. If you’re facing underpayment fees, a mountain of last-minute paperwork or general disorganization, you know that you need to change your process for the next year and you have the opportunity to do this now for 2017.
Pro tip: Start proactively planning your quarterly payments and rigorously documenting your business expenses. Also set some clear expectations with your clients for what they need to do to make your tax reporting as easy as possible. There’s no reason to continue doing this the hard way.
Ben Shanbrom is a freelance writer, musician and copy editor who works with artists and clients within his native New Haven scene and well beyond.