Tax Preparation for Freelancers

As a freelancer, it’s important to understand the various tax requirements and responsibilities that come with running your own business. Globally, the freelance platform industry is valued at around 3.39 billion USD. So, due to the huge income aspects, freelances are also subject to paying taxes properly. 

With the rise of the gig economy, more individuals are entering the world of freelancing and need to understand how to properly prepare for tax season. Tax preparation for freelancers involves keeping track of expenses, understanding deductions, and making estimated tax payments. 

This article will provide an overview of tax preparation for freelancers, including key terms such as estimated tax payments, deductions, and self-employment tax. 

Understanding Tax Obligations for Freelancers

Individuals who work as freelancers have the responsibility of determining their own tax liabilities and the appropriate timing of tax payments. Apart from the standard income tax, freelancers are also accountable for paying the self-employment tax (15.3% in 2022).

If you work as a freelancer, you must use IRS Form SE (Self-employment Tax) to report and pay your Social Security and Medicare taxes when filing your income taxes. 

As a self-employed person, you must also file an annual return and pay estimated quarterly taxes if you anticipate owing $1,000 or more in federal income tax for the year.

For the newbie freelancers, ensure that you report your freelance income correctly and maintain records of all expenses related to your business. Initiate the tax filing process early and allow ample time to complete it since people usually make errors on minor details.

It is crucial for freelancers to utilize all possible deductions or credits that are accessible to them to lower their overall tax obligation.

Tax Deductions for Freelancers

Freelancers can benefit greatly from tax deductions, which can help to lower their tax liability by reducing their taxable income. These deductions can be made for expenses that are related to their business and can provide significant financial benefits.

Below are some tax deductions that freelancers can request:

• Deduction for self-employment tax.
• Deduction for business startup and organizational costs.
• Deduction for health insurance premiums.
• Credit card interest deduction.
• Deduction for home office expenses.
• Training programs and educational expenses deduction.
• Deduction for cellphone or car usage for business purposes.
• Car expenses, travel expenses, meals and entertainment, health insurance, and retirement contributions deduction.

Regarding the benefits of deductions for freelancers, why not consider reducing taxable payments?

Common tax deductions for freelancers

Deductible expenses can help you reduce your taxable income and save money on your tax bill. 

There are some tax write-offs that self-employed freelancers can deduct to reduce their liabilities.

Take a look into the ten common expenses that freelancers can deduct on their taxes:

1. Advertising, marketing, and internet-related expenses: For example, promoting your services or maintaining a website.
2. Office and work supplies:  Paper, ink, or software.
3. Car costs: Keep in mind that you can only deduct expenses such as gas, maintenance, and repairs that related to the business use of your car.
4. Self-employment tax deduction: Fortunately, as a freelancer you can deduct half of these taxes on your income tax return.
5. Business startup and organizational costs deduction: If you’re just starting out as a freelancer, you can deduct certain costs associated with starting and organizing your business, such as legal fees and incorporation expenses.
6. Health insurance premiums deduction: You are also eligible to deduct the amount that exceeds 7.5% of your adjusted gross income.
7. Home office expenses: House rent, utilities, and internet costs can be deducted if your home office is exclusively used for business purpose only.
8. Travel expenses: Traveling cost for business purposes, such as airfare, lodging, and meals.
9. Meals and entertainment: You can deduct the cost of meals and entertainment that are directly related to your business, such as a lunch meeting with a client or a business dinner.
10. Retirement contributions: Freelancers can deduct contributions to certain retirement plans, such as a Simplified Employee Pension (SEP) or a solo 401(k). 

It’s important to keep track of all your business-related expenses throughout the year so you can take advantage of these deductions when it’s time to file your taxes. By understanding which expenses you can deduct, you can save money on your taxes and keep more of your hard-earned income.

How to File Taxes as a Freelancer

The Internal Revenue Service (IRS) views freelancers as self-employed individuals, and as such, they are responsible for filing their taxes accordingly. Usually, they report their income as sole proprietors, using a Schedule C form that is linked to their personal tax returns. 

Freelancers should keep records of all their income and expenses. Additionally, they are required to pay self-employment tax, and if they earn a substantial amount of net profit, they might want to consider filing as an S-corporation.

Schedule C (Form 1040) is a document used to declare the income or loss resulting from a business that an individual operates or a profession they practice as a sole proprietor. 

On the other hand, for federal tax purposes, S corporations opt to distribute corporate income, losses, deductions, and credits to their shareholders.

Sole proprietors are taxed differently than S-corps. Some basic differences are given below:

• Self-employment taxes are imposed on all business income for sole proprietors, whereas S-corps only pay self-employment taxes on their salaries.
• As a result of the difference in taxation, S-corps may have lower overall taxes.
• S-corps are subject to more formal requirements regarding record-keeping and meeting holding compared to sole proprietorships.

Additionally, freelancers are responsible to report all types of income including cash payments. During an audit, freelancers should be able to explain any unreported or underreported income. 

Freelancers also need to compare their accounting records with the figures on their 1099 forms, as companies can make mistakes that could result in the payment of taxes on income that was not earned or received by the freelancer.

Quarterly Tax Payments for Freelancers

Freelancers are required to pay estimated taxes four times a year, known as quarterly tax payments. These payments are due on April 15th, June 15th, September 15th, and January 15th of the subsequent year. 

Since employers do not withhold taxes from their income, freelancers who expect to owe $1,000 or more must pay estimated taxes quarterly. 

To determine the estimated tax payments, self-employed taxpayers can use the IRS Form 1040-ES and allocate 25-30% of their taxable freelance income for both quarterly taxes and any additional tax they owe.

Let’s discover the process up to the point: 

• Freelancers can use IRS Form 1040-ES to calculate their quarterly tax payments.
• The form includes a worksheet to determine if quarterly estimated tax payments are necessary.
• Alternatively, freelancers can estimate their annual earnings and calculate 25-30% of that amount, then divide it by four going forward.
• Free online tools are available to help freelancers calculate their estimated quarterly taxes.

Freelancers can prevent additional charges from the IRS by paying their quarterly taxes promptly and precisely estimating their earnings during the year.

Self-Employment Tax and Estimated Tax Payments

Freelancers are accountable for both self-employment tax and income tax, which includes Social Security and Medicare taxes that businesses typically pay and employees have deducted automatically from their paychecks.Total tax amount is 15.3% which is made up of two components (12.4% for Social Security and 2.9% for Medicare). 

Self-Employment Tax:

Self-employed tax is reported on IRS Form 1040, Schedule SE. In addition, self-employed individuals are obligated to pay Federal Federal Insurance Contributions Act (FICA) taxes which is also known as SE.

Sole proprietors and freelancers are required to pay self-employment tax if their net earnings from self-employment exceed $400 for the tax year. Self-employed workers are responsible for paying their own taxes, as they do not have taxes withheld automatically from their paychecks.

Not paying self-employment tax as a freelancer can result in penalties from the IRS, which may include fees up to $205 after 60 days and a penalty of up to 25% of the total amount owed for both failure to file and failure to pay.

Estimated Tax:

Another term “Estimated Tax” refers to a tax payment that must be made quarterly, which is calculated based on the income that a taxpayer reports during a specific period. These payments are made to the Internal Revenue Service (IRS) throughout the year on income that is not subject to federal tax withholding.

A freelancer may face penalties from the IRS if they fail to meet a quarterly tax deadline. The penalty for not making a quarterly tax payment on time is typically 0.5% of the unpaid amount for each month, or partial month, that the tax remains unpaid.

For self-employed freelancers, taxes do not automatically withhold from their earnings, so they are required to make estimated tax payments on a quarterly basis. 

This is necessary to ensure that freelancers cover their self-employment tax obligation, in addition to their federal and state income tax obligation. It is worth noting that taxpayers can claim a deduction of 50% of what they have paid in self-employment tax, as an income tax deduction on Form 1040.

Best Freelancer Tax Software

There are multiple tax software options available for freelancers and self-employed individuals.

• TaxSlayer Self-Employed: It is recognized by Forbes as the best overall tax software which supports self-employment tax forms, including Schedule C and Schedule SE, and is relatively low-cost.
• FreeTaxUSA: It is suggested as the best value tax software for freelancers by CNET. Offers a broader range of IRS forms, allows multiple state returns, and includes more extensive help and support features than other free options.
• TurboTax: CNET also recommends this for its user-friendly interface, efficient questionnaire process, comprehensive help and tax documentation, and ability to snap photos of all 1099 forms for instant uploading.
• H&R Block Self-Employed Online: This software is also considered by prominent digital news media to be the best overall option for freelancers and self-employed individuals. Offers built-in support from experienced tax professionals and can be used either online or in-person.
• KPMG Spark: Another option that provides exceptional online tax support, complete with a team of qualified tax professionals.
• QuickBooks Self-Employed: The best benefit of this software is that it seamlessly integrates with bank accounts and credit cards to automatically track and categorize business expenses.
• TaxAct Self-Employed: It is a low cost software compared to other tax software options while still offering comprehensive support for self-employed tax filing needs.
• Sage Business Cloud Accounting: which streamlines various accounting tasks like posting expenses and payments, issuing invoices, and sending overdue payment reminders.
• FreshBooks: Recommended for the top invoicing accounting software, also essential for freelancers to consistently receive payment on time.

Conclusion:

To summarise, tax preparation is a crucial aspect of freelancing that requires careful attention and planning. Freelancers need to understand their tax obligations and take advantage of available deductions to minimize their tax liability. 

By keeping accurate records, consulting with tax professionals, and utilizing tax software, freelancers can streamline the tax preparation process and avoid potential penalties from the IRS. 

With the increasing number of individuals turning to freelance work, it’s important for freelancers to stay informed about tax regulations and take proactive steps to ensure their financial success.