5 Essential Tips for Keeping Track of Your Freelance Taxes
Freelancers, also called independent contractors, generally are considered self-employed by the IRS, so they're responsible for managing their own finances and filing their taxes on time. If you are a freelancer, keeping track of your tax obligations can be a bit overwhelming, but it can have serious consequences if you don't.
Successful freelancers keep accurate records of their income and expenses, pay their estimated taxes, understand their tax forms, and get help with their taxes. You could face penalties, fines, and even legal action if you don't. Proactively managing your freelance taxes will ultimately help you avoid unanticipated financial hits and ensure you are in good financial standing with the government.
Tip #1: Keep accurate records
It's essential for freelancers to keep detailed records of their income and expenses so they can file their taxes correctly. Keeping track of your income lets you budget and plan for estimated tax payments, preventing surprises.
Tracking expenses can also help you save on taxes by identifying legitimate tax deductions. If you keep thorough records, it's easier to justify audits, inquiries, or even if you're sued, the records will serve as adequate financial details for insurance companies, lawyers, or to attract investors.
Lastly, keeping accurate records saves you time, stress, and minimizes mistakes. You can track your income and expenses using Excel spreadsheets, accounting software such as QuickBooks Online, or by hiring a bookkeeper.
Whether you use paper receipts or electronic receipts after scanning them, independent contractors should review, organize, and backup their records regularly. You can have peace of mind throughout the year if you maintain an organized system for tracking your finances.
Tip #2: Make estimated tax payments
One of the challenges of being a freelancer is having to handle estimated tax payments. Self-employed people have to pay estimated taxes quarterly, since taxes aren't automatically deducted from their earnings.
Estimated taxes are calculated by estimating a freelancer's income, multiplying it by the federal and state tax rates, and splitting it into equal quarterly payments. Freelancers' estimated tax payments are calculated based on their projected income, minus any deductions or credits they may qualify for. Tax laws are complex, so freelancers often hire tax professionals to calculate their taxes accurately.
Failure to pay estimated taxes can result in a number of consequences. To start with, not paying your estimated taxes can lead to big penalties and interest charges. You'll avoid underpayment penalties by paying estimated taxes come April 15th. If you don't pay estimated taxes, the IRS may take your money from your bank account, or in extreme cases, freeze your assets. Also, a huge tax bill can add stress and delay bills, employees, or force freelancers into debt.
The best way to avoid these penalties is to make quarterly estimated tax payments, keep track of your freelance income and expenses, and seek professional assistance when necessary.
Tip #3: Know which tax deductions you qualify for
There are a number of tax deductions that are available for freelancers that can significantly reduce the amount of their taxable income. As a freelancer, you may be able to claim the following tax deductions:
Home office deduction
If you are a freelancer, you can deduct expenses for your home office like rent, utilities, and internet. To be tax deductible, the area designated as your home office must be used exclusively and regularly for work. Try to choose a room that can be closed off with a door or partition. In light of previous tax court decisions, you can be assured that your business can claim the room as a deductible expense.
Equipment and supplies
Computers, printers, cameras, and other equipment purchased for business use can be deducted as equipment expenses. Expenses like office supplies, books, and magazines related to the business can also be deducted.
Freelancers can claim travel expenses related to business trips, such as transportation, lodging, and meals. The deduction is more complicated than most people realize, and you should speak with a tax professional before assuming a trip is deductible. Track your travel expenses in real time by implementing a receipt management process.
Professional development expenses
Professional development expenses can be tax-deductible for self-employed taxpayers if the expenses are incurred while the freelancer is actively working. Training courses, seminars, and workshops related to the service or product their business provides may be included in these expenses. Professional development expenses can be considered as ordinary and necessary business expenses when they are incurred to maintain skills or expand knowledge of an existing profession, or to acquire new skills to operate within the business or industry. It is important to note that the expenses must be relevant to the taxpayer's current profession or the proposed profession they intend to apply the skills learned to. The IRS, therefore, considers any educational expense that helps a self-employed individual remain current with their skills or enables them to expand their skill set as deductible. To claim the deduction, self-employed taxpayers need to document the professional development expenses with receipts, invoices, classes, conferences or workshops attended, and any other relevant supporting documents. In summary, self-employed taxpayers can legally deduct professional development expenses directly related to their professional business activities to reduce their taxable income and ultimately lower their tax liability.
Health insurance premiums
The majority of self-employed individuals can deduct the costs of their health insurance premiums from their taxable income.
Records and receipts should be kept for all business-related expenses that can be deducted from your taxes. For tax deductions to be substantiated, the IRS requires supporting documents. Documents such as receipts, invoices, bank and credit card statements, and other financial records can assist in verifying business expenses. The lack of documentation can result in the loss of valuable tax deductions due to inaccuracy or insufficient record keeping.
Keeping track of all business-related expenses, storing receipts and invoices in an orderly fashion, and reviewing them regularly can save you time and money during tax season. Nowadays, you can use software like QuickBooks Online to help you create, track, and file all this stuff quickly and easily.
Tip #4: Understand the tax forms you need to file
In order to fulfill your tax obligations as a freelancer, you'll have to file different forms. These are some of the most common tax forms freelancers need:
This is the main tax form for individuals. It's the form freelancers have to use to report their income for the year and claim any deductions, exemptions, or credits they qualify for.
Schedule C reports the income and expenses of a sole proprietorship, also known as Profit or Loss from Business. Those who are considered sole proprietors have to fill out this form to report their income and expenses. However, this isn't true for freelancers who form an LLC and elect to be taxed as S or C corporations. A tax professional can help you decide what's best for you and your business.
Schedule SE is used to calculate self-employment tax, which is based on the freelancer's net income from self-employment. Self-employment taxes cover your Social Security and Medicare contributions. This form calculates Social Security and Medicare taxes owed by self-employed individuals. Social Security tax is a percentage of your net income at a fixed rate and capped at a certain amount. Medicare tax is calculated using a flat percentage on your entire net income. Freelancers are eligible for Social Security or Medicare when they retire based on the amount of self-employment tax they paid.
This form is used when deducting the costs of your home office and calculates how much freelancers can deduct for home office expenses.
In order to work with clients, freelancers may need to provide personal information like their name, address, and tax ID number on a Form W-9.Your clients will use this form to file a 1099-NEC for you if the total payments exceed $600.Use this form to file 1099-NECs for any subcontractors or labor you pay over $600 in cash.
Tip #5: Seek professional help if needed
Tax professionals can be a big help to freelancers who find tax filing overwhelming, complicated, or time-consuming. Here are some benefits of hiring a tax pro:
Tax professionals can help freelancers save time by filing their taxes on time and accurately. It helps if tax professionals offer training and will create more efficient workflows related to things like bookkeeping and receipt management that you can use.
Tax professionals can make sure freelancers meet their tax obligations and take advantage of all tax deductions available to them. Freelancers can benefit from the expertise of a tax professional in making sure they are up-to-date with all tax laws and regulations that apply to them.
Peace of mind
By hiring a tax professional, freelancers can avoid the stress of tax preparation, knowing their taxes are being handled accurately. A freelancer can look for qualified tax professionals through trade and professional organizations, like the National Association of Tax Professionals or the American Institute of Certified Public Accountants. Additionally, freelancers can get referrals from other freelancers or business owners.
To sum it all up...
Freelancer taxes can be tricky, but with proper planning, organization, and professional help, it's doable. Hire qualified professionals and leverage available resources to maximize your deductions.
Proper tax management can really improve a freelancer's financial situation. Freelancers can manage their taxes effectively by keeping accurate records, making estimated tax payments, knowing what forms to file and what deductions they can claim and keeping receipts to prove it. Lastly, get professional tax help when you need it.