Freelance Taxes: What Every Freelancer Needs to Know

How to pay taxes as a freelancer

Freelancers must understand what they need to pay and what they can deduct. The following freelance tax best practices can ensure you follow the rules and don’t experience a tax audit. 

1. Understand the basics of freelance taxes.

As a freelancer, you may have exceptionally honed skills in your industry, but that doesn’t mean you know the difference between FICA and IRA. 

“All business owners, whether they are freelancers or big-time CEOs, need to have a basic understanding of accounting and taxes so they can make their money work for them,” said Alexis Krystina, principal accountant and founder of Pink Moon Financial.

Here are three tax basics freelancers should understand: 

• Self-employment tax: If you earn $400 or more in a year as a freelancer from any single employer, the Internal Revenue Service (IRS) considers you self-employed and requires you to file taxes as a business owner. In addition to the standard income taxes based on your tax bracket and filing status, you’re responsible for paying a self-employment tax of 15.3%, representing your half of the Social Security and Medicare taxes you would usually pay, as well as the half typically covered by a traditional employer. “Some new solopreneurs and entrepreneurs are shocked when they have to pay self-employment tax,” said Ellie Thompson, CEO of Money Therapy. “When you are working for a corporation, taxes like Medicare and Social Security are already deducted from your paycheck. As an entrepreneur, you have to account for those on your own.”
• Freelance tax forms: In lieu of the single W-2 form you’d get annually as a traditional employee, freelancers receive a 1099-MISC form from every client who pays them $600 or more. Report your 1099-MISC income on a Schedule C attachment to your tax return.
• Freelance tax requirements: Freelancers who expect to owe $1,000 or more must pay estimated taxes quarterly because employers don’t withhold freelance income throughout the year. IRS Form 1040-ES can help you estimate how much you’ll owe in taxes each quarter, and it’s essential to get these payments as close to the actual number as possible. If you underpay your quarterly taxes, you will owe the IRS the remaining balance when filing your annual tax return by April 15. If you underpay your quarterly taxes too much, you may have to pay a fine. Additionally, freelancers may have to pay state income taxes as well as local taxes. 

2. Know your business structure.

What is your business’s legal structure? Limited liability corporation (LLC)? S corporation? C corporation? Sole proprietorship? Your business’s legal structure affects your personal assets and determines how much you owe in taxes.

Freelancers typically file taxes as sole proprietors, which means they file a Schedule C form that integrates with their personal tax return.

“Once they reach a point where they are making thousands in net profit, they may want to look into filing as an S-corp,” Krystina said. “S-corp status is more complex but may offer some tax benefits.”

“Sole proprietor is a great option, but your personal assets could be in jeopardy if you are sued,” Thompson added. “A corporation is much more complex and requires additional setup fees, but it protects your individual assets.”

When it comes to LLC taxes, various LLC configurations will determine how you file your business’s taxes. Freelancers who form a corporation or LLC will pay unemployment tax, federal and state taxes, and half of the FICA tax, but they may be able to shield some of their money from the self-employment tax. 

“However, the IRS will look at how much,” said Romeo Razi, CPA and owner of Taxed Right. “This is somewhat complicated and tricky. And the advice on how much is based on profession, if they hire sub-freelancers, their income, etc., and should be determined on a person-by-person basis.”

3. Consider hiring a tax professional.

An accountant or CPA familiar with freelance taxes could be your best friend come tax time. If your income and filing status don’t change much from year to year, you might be capable of doing your own taxes, but most people’s financial situations change often. As your tax return gets more complicated, you may want to hire a CPA or find the right accountant for your business.

“Filing your own taxes means keeping track of all your receipts and statements and understanding what it all means,” said Josh Zimmelman, owner of Westwood Tax & Consulting. 

“Every transaction matters, and if your financials are kind of a mess, then you’re better off paying someone else to sort it out for you.”

Also, the IRS constantly updates its tax laws. You may need help understanding how these changes impact you.

4. Understand how to estimate quarterly taxes.

Freelancers who expect to owe at least $1,000 in taxes are required to pay estimated taxes quarterly. Refer to your prior year’s tax return to gauge how much you should be paying quarterly. 

If this is your first year as a freelancer, you may not be able to estimate your tax payments accurately. If you miscalculate – by either underpaying or overpaying your estimated taxes – the IRS will issue a correction when you file your annual tax return. You will either be asked to pay for any missing taxes or issued a tax refund for any excess amount you paid.

“The IRS wants to see that you’ve paid 90% of your taxes or the equivalent of 100% of last year’s tax bill by December,” said Wade Schlosser, founder and CEO of Solvable. “Otherwise, you’ll have to pay an estimated tax penalty.”

Visit the IRS estimated tax information page to find updated estimated tax due dates. According to Schlosser, if you don’t pay your estimated quarterly taxes, you won’t get a bill or notification from the IRS, but you will have to pay a penalty when you file your taxes. The IRS provides tools such as the 1040-ES worksheet to help approximate your annual income and determine your estimated tax payments.

If you’re a married freelancer, consider having your spouse increase their withholding taxes to help defray your tax bill, Schlosser advised.

“The biggest thing is to speak to a tax professional before the year ends,” he said. “That’s crucial to getting your ducks in a row and making strategic decisions about deductions, withholding, quarterly payments and even investments that can help reduce your overall tax debt.”

5. Think daily, not quarterly.

Tax professionals advise self-employed workers to spend time each day focusing on tax-related information, including updating income and expenditures as they come in. When you stay on top of your finances, your records are more accurate, and you aren’t rushing around in panic the week before meeting your accountant.

“I think the biggest thing to understand for freelancers is that even though they are freelancing – which tends to have the connotation that it’s just a side gig – to the IRS, it’s still a business, so keeping accurate and detailed records is key,” Krystina said. “Not only will that help freelancers understand how well their business is performing, [but] it will make filing taxes a breeze.”

6. Declare all your business income.

Freelancers should receive a 1099-MISC form by Jan. 31 from any company that paid them more than $600 for the tax year that just ended. However, whether or not you receive a 1099, you are responsible for reporting all your income, including any cash payments.

“If you’re ever audited, you’ll need to account for unreported or underreported income,” Schlosser said. “Freelancers should also cross-reference their own accounting documents against the numbers on the 1099 form. Companies sometimes make mistakes, and you don’t want to be on the hook for paying taxes on income you didn’t earn or receive.”

Even if you can’t afford to pay your taxes, it’s crucial to file accurately and on time. If you are in good standing, you may be able to tap into IRS taxpayer programs that can give you more time to pay.

“A tax debt specialist may be able to help you negotiate a payment plan with the IRS, but only if your tax filings are up to date,” Schlosser said.

7. Be prepared for Tax Day(s).

Charles Corsello Jr., a licensed enrolled agent and co-founder of TaxCure, recommends having a business credit card and setting up a dedicated savings account to put aside a certain percentage of each paycheck for tax payments.

“By doing this, it makes it way easier for a freelancer to prepare their tax return [or returns] by helping them determine profit or loss,” he said. “It also makes it easier to classify expenses when leveraging financial software.”

How much should you set aside? Financial professionals advise putting away about 30% of your total income to pay taxes.

“In fact, you probably want to withhold closer to 35% if you have high income and you live in a high-taxed state,” Corsello added.

8. Understand your deductibles before you file.

Many freelancers leave valuable tax deductions and benefits on the table each April because they aren’t sure what they can and can’t deduct. In fact, 35% of freelancers have difficulty understanding and paying taxes, and 73% don’t deduct any expenses at all, according to a report by Xero. A tax professional can help you identify small business tax deductions and credits and offer advice on lowering your tax bills.

“It’s best to talk with a tax accountant specializing in 1099 contractors because they can help you find deductions you didn’t know you had, helping you to reduce your tax bill and avoid tax debt,” Schlosser said.

These are some standard deductions freelancers utilize:

• Home office space
• Vehicle expenses
• Travel expenses
• Internet and phone bills
• Health insurance
• Office supplies
• Hardware and software
• Advertising materials
• Legal or professional services
• Contract labor
• Licenses and taxes
• Business meals

Let’s take a more in-depth look at some of the top deductions. 

• Home-office deduction: If you work from home as a freelancer, you may be able to take advantage of the home-office deduction. This allows you to write off expenses ranging from utilities to the rent for the space in your house that serves as your primary office. However, you must use the area strictly for business purposes. If you have a family room that doubles as your workspace when the kids are in school, it doesn’t meet the criteria for this deduction. If you are on the fence between setting up an office at home or renting an outside space, realize there are some tax perks with home offices. “Home-office businesses have an advantage since the minute [freelancers] walk out of their home, the miles are deductible business miles,” said CPA Gail Rosen. “If you have an [outside] office, the commute to the office is not deductible.”
• Auto expenses: Auto expenses are another common tax deduction for freelancers. However, Rosen suggests keeping detailed records of your expenses to compare the standard mileage rate and actual vehicle expenses to see which one gets you the better tax deduction. “Once you pick one of these methods for deducting your auto expenses, there are restrictions on switching to another method.”
• Health insurance premiums: Health insurance premiums are another area to consider, according to Paul Jacobs, certified financial planner, enrolled agent and chief investment officer of Palisades Hudson Financial Group. “While most employees can’t deduct medical expenses, including insurance premiums, because the tax threshold is so high, self-employed business owners can treat insurance premiums as a business expense and use the cost to offset income.” There are some caveats, though. “Health and dental insurance can be deducted as long as your spouse doesn’t have an employer-sponsored health plan you are eligible to participate in,” Corsello said. He pointed out that if your business has a loss, you cannot deduct health insurance expenses either.

Additional expenses you may be able to deduct include education costs and certifications, advertising and marketing, office supplies, computer equipment, software, and web hosting fees. 

9. Recognize that you can’t deduct everything.

While taking advantage of your tax deductions is essential, avoid crazy and illegal tax deductions at all costs. 

“Some taxpayers put themselves at risk of an audit by trying to write off bogus expenses,” Zimmelman said. “For it to be deductible, it must be ordinary and necessary to run your business.”

What does that mean?

“Think about a hairstylist and a real estate agent,” Krystina said. “The hairstylist might have expenses like shampoo – totally ordinary and necessary. However, if a real estate agent were trying to deduct shampoo, that would not go over well.” It must be a normal expense in your industry for it to be deductible.

Other expenditures that often come into question are entertainment expenses, business meals (though 50% of the cost of these is usually covered) and personal cell phones.

“Personal expenses are never tax-deductible, and personal cell phones create a very gray area,” Krystina said. “If you want to deduct your cell phone, get a second phone specifically for business.”

Rosen pointed out that many freelancers assume they can deduct all of their new business startup costs, but this can’t be done until they have their first sale. Even then, the costs are deducted over 15 years, but you can elect to deduct the first $5,000 in expenses in the first year.

“You should carefully evaluate whether you want to hold your startup costs or elect to write off the first $5,000 in the first year of business,” Rosen said. “It depends on what year you expect to be in a higher tax bracket.”

10. Don’t expect a tax refund as a freelancer.

Everyone loves getting a tax refund. However, as a freelancer, you must get used to the idea that you’re not likely to see one. When you have an employer, your taxes are automatically withheld from your paycheck, and you may get a refund if you overpaid the government throughout the year. This is less likely to happen if you are self-employed, since you are the one sending in the money you owe.

According to Razi, freelancers receive refunds under only two circumstances: They overpaid their quarterly estimated tax payments, or they made such little money for the year that they are entitled to an earned income credit (EIC), which is refundable.

“In general, most freelancers that make a decent amount in a year do not qualify for the EIC tax credit,” Razi said.

11. Prioritize planning for retirement.

For many freelancers, retirement planning is not a top priority. They’re laser-focused on the day-to-day responsibilities of growing their business and reaching new clients. They may also feel that they have few options since, as sole proprietors, they can’t tap into employer-sponsored small business retirement plans.

“One of the biggest misconceptions freelancers have about retirement plans is that they are too costly,” said Kurt Rossi, president and wealth advisor at Independent Wealth Management. “A retirement plan often provides significant net after-tax benefits.”

These are some plan options for freelancers: 

• Self-employed 401(k): For a self-employed person or a business owner without any employees other than their spouse, a self-employed 401(k) plan can be a good option, suggests Rossi. The plan allows the same contributions as a traditional 401(k) profit-sharing plan, up to $58,000 ($64,000 for those over age 50) or 100% of earned income, whichever is less. The money isn’t taxed until withdrawal.
• SEP IRA: Simplified Employee Pension (SEP) IRA plans are another way to save for retirement. A SEP IRA allows you to contribute up to 25% of your net earnings or $61,000, whichever is less.
• Traditional or Roth IRA: A traditional or Roth IRA is one of the simplest ways to start saving for retirement as a freelancer. An IRA is ideal for those just starting out, saving less than $6,000 a year or looking to roll over a 401(k) from a previous job. Roth IRA withdrawals in retirement are tax-free.

Whichever investment option you select, the most important thing is choosing a plan and getting started, according to Rossi.

“With Social Security benefits falling short of meeting the income needs of retirees, freelancers must take action in order to secure their own retirement,” he said. “The good news is there are many retirement planning options they can leverage to help stash funds away for the future while also reducing significant tax liability.”

Best accounting and tax software for freelancers

The best way to stay on top of your freelance business taxes is to use accounting software in your business to keep accurate records and update income and expenditures daily. When you combine this strategy with the services of a tax professional, you’re sure to stay organized and compliant.

We reviewed the best accounting software for small businesses and found a few great solutions for freelancers:

• Sage Business Cloud Accounting is our pick as the best accounting software for freelancers. It automates many accounting processes, including posting expenses and payments and sending invoices and reminders about past-due bills. Learn more in our full Sage Accounting review.
• Intuit QuickBooks Online is our pick for the best accounting solution overall for its affordability, ease of use and effectiveness. Read our review of QuickBooks Online to learn more about its features and functionality. 
• Xero is our pick as the best accounting software for growing businesses. Xero has tiers for freelancers, new small businesses, more established small businesses and even enterprises. Learn more in our full Xero review.
• FreshBooks is our pick as the best accounting software for invoicing, and getting paid on time consistently is crucial for any freelancing business. Check out our review of FreshBooks to learn more. 

If you’re considering filing your taxes yourself, the best online tax software can help you stay compliant, pay on time and get any refunds due. H&R Block is our pick as the best online tax software for freelancers and self-employed people. Its Self-Employed Online service tier allows you to report various revenue streams and supports a wide range of IRS tax forms.  

Staying on top of your freelance taxes

Freelancers can’t avoid dealing with taxes. If you make any freelance income over $400, you must report it to the IRS. Fortunately, the IRS treats your freelance career as a business, which means you can deduct expenses from the income. To avoid costly mistakes, it’s wise to consult a tax adviser when setting up your books and doing your first year’s taxes. 

Kimberlee Leonard, Sean Peek and Sue Marquette Poremba contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.