Tax Strategies for Freelancers and Independent Contractors
Freelancing, at its best, offers the promise of freedom: The ability to make money while choosing your clients, choosing your projects and choosing where and when to work.
But even under this idyllic scenario, freelancing still has a downside: navigating the complicated world of taxes for freelancers and independent contractors.
We won’t sugar-coat it: Self-employed taxes are a bear. But you still need to know their ins and outs. The following are some tax strategies for freelancers and independent contractors — including details on your tax obligations, estimated tax payments and possible deductions.
When Freelancers Owe Taxes
When you work for another company as a W-2 employee, that business withholds taxes from every paycheck. You might owe a little more or less each year you file depending on how accurate the withholdings are, but point is: You’ll only ever have to deal directly with the IRS — whether that’s to pay up more or receive a refund — once each year.
Not so for freelancers, at least at a certain income threshold. Specifically, if you expect to owe $1,000 or more in a year, you must pay estimated taxes quarterly. Well, kind of quarterly. The due dates in a given year are typically Jan. 15, April 15, June 15 and Sept. 15.
If you don’t pay enough in estimated taxes, you’ll have to make up the difference come your annual filing. Worse: If you short the IRS by too much throughout the year, you’ll also have to pay a fine.
What Taxes Freelancers Owe
Freelancers effectively owe most of the same types of taxes as W-2, but with one significant twist:
- Federal income taxes
- State and/or local income taxes (where applicable)
- Self-employment taxes
How much you’ll owe in income taxes will ultimately come down to your business structure, whether you’re a sole proprietor, LLC, S corp, C corp, etc. You can calculate how much using IRS Form 1040-ES.
That last type is the twist. When you’re a W-2 worker, 6.2% of your pay is withheld for Social Security taxes, and 1.45% is withheld for Medicare taxes — a total of 7.65%. That actually represents half of what is kicked in, with your employer contributing an equal amount. Freelancers, however, are responsible for bothcontributions — for a total of 13%.
It’s also worth noting that if you form an LLC or corporation, you’ll probably also owe unemployment taxes.
Tax Strategies for Freelancers: Deductions, Credits & More
One of the friendly complexities of the freelancer tax code is a large number of deductible expenses, credits and more. (Many apply for small businesses of all sorts.) Your best bet? Don’t wait until it’s time to file to figure out whether you’re eligible for these and other tax breaks — instead, start the year with these tax breaks in mind, and know which ones you’ll automatically qualify for, which ones you’ll need to work toward and which ones are out of reach:
- Home office: Any space in your home that’s primarily used as office space can be deducted from your taxes. It’s calculated by square footage, so you’ll want to take a proper measurement of the room(s) used for your work. Among things you might be able to deduct: Rent/mortgage interest, property taxes, utilities, even home repairs.
- Internet and cell phones: You can also deduct the cost of both internet and cell phone service. But like with the home office, you can only deduct the percentage that’s used for business. When it comes to cell phones, it’s best to purchase a separate business cell phone and account. You can also deduct the cost of the device on either a one-time basis or depreciate it over time.
- Vehicles: Depending on how you use your car, you can deduct some or all costs related to operating and maintaining it. For mixed-use driving, you can deduct only costs related to business usage. However, you can deduct all related costs if the vehicle is only used for business. There are actually two ways to claim “mileage” for a car: deducting the actual costs (fees, insurance, gas, etc.), or the standard mileage deduction, which is 65.5 cents per mile in 2023.
- Startup expenses: Startup expenses within a tax year are deductible, but with certain restrictions. You can deduct up to $5,000 of your startup costs if you spent less than $50,000 in total. However, if you spent more than that, it reduces your deduction on a dollar-for-dollar basis. So, if you incurred $52,500 in start-up costs, you’d only be allowed to deduct $2,500. However, you can amortize the remaining costs in subsequent years.
- Travel expenses: This is one of the best-known deductible expenses for small businesses. As long as your trip is necessary to your business, taken away your business’s “tax home,” is longer than a normal workday (usually eight hours) and requires sleep or rest, you can deduct virtually any kind of travel expense. That includes expenses such as hotels, airfare and meals.
Freelance Taxes Aren’t Easy. We Can Help.
As any W-2 worker who has converted to freelancing will tell you: Taxes are so much easier when you’re on a company’s payroll. But you don’t have to deal with the extra complexities alone.
McManamon & Co. is a accounting, tax, fraud, forensic and consulting firm that offers custom services to small and midsize companies across a broad spectrum of industries. And we can provide expert advice on a wide range of issues — including the best tax strategies for minimizing your obligations as an independent contractor.
Reach out and get the info you need today! Just call 440.892.8900 or contact us online.
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