Every freelancer is different. Yet every freelancer has the same questions.
Not the most exciting of topics, but one that is usually the #1 source of headaches for the freelance workforce. So much so that a recent study found that almost 75% of freelancers overpay their taxes. So put down the aspirin bottle and get ready for a refund – in just a few minutes, it will all makes sense and you’ll know how to do it right!
Whether you file your taxes yourself or use a professional accountant, it is important for freelancers to understand how your taxes are calculated, so you can better prepare and optimize your tax liability.
For full-time employees, taxes are automatically taken out of their paycheck and sent directly to the IRS (and state treasury for states with an income tax). As a freelancer, dealing with taxes is part of your job all year long, because calculating what you owe and physically mailing those checks falls on you.
Just like everyone else, you will owe Income Tax on your earnings. But freelancers also need to pay the Self-Employment tax, to contribute just like any employee to government funded benefits.
The answer is simple: you’re not going to pay taxes on money you’re allowed to deduct! Half of your self-employment taxes (15.3% / 2 = 7.65%) are deductible. So by removing 7.65% from your net earnings, you make sure you don’t pay taxes you don’t owe. (100% – 7.65% = 92.35%).
The percentages here will depend on your taxable income and filing status.
First things first: you don’t pay Income Tax on every cent you make. You first need to calculate your Taxable Income. And as a freelancer, it takes a couple extra steps to calculate that right!
Your Net Earnings are basically your profit as an individual from your freelance work. All your tax calculations start with this number, which is why it’s very important to keep good track of all your business expenses (see page 13). Let’s say this year, you made $85,000 from your freelancing business and all your business expenses add up to $15,000
So let’s say this year, you contributed $2,000 to an IRA, spent $3,000 on a healthcare plan, and paid $1,500 in interest on your student loans. And add to that, 50% of your self-employment taxes [15.3% of 92.35% of 70,000)] = $9,891
Every other expense that qualifies gets deducted at this step as BELOW THE LINE DEDUCTIONS (charity donations, state and local taxes up to $10K, mortgage interest, unreimbursed medical expenses…) The IRS also offers a simple option, which is to deduct a flat amount called the Standard Deduction based on your filing status.
If the total of your Below the Line deductions is higher than the Standard Deduction, you can choose to itemize your deductions, meaning you provide the IRS with your own numbers. For our example, we’re going to take the Standard Deduction as a single filer.
The quarterly payments you’re sending the IRS and State are based on what you estimate to earn during the year. For a seasoned freelancer, this shouldn’t be too tough, but for someone just dipping their toes in the self-employment pool, determining this number accurately can seem like an overwhelming task, especially since you’re risking an underpayment penalty if you don’t calculate accurately.
Bottom line is that as long as your tax payments during the current year are equal to what you paid the previous year, you’ll be in Safe Harbor. But if your business took off, you will end up owing more. For more info on how to pay and calculate your quarterly payment, you can click here!
Another day, another dollar. Work hard, play hard. Early bird gets the worm. No such thing as a free lunch. Lots of advice out there when it comes to earning and handling money. Here’s ours.