Freelancing can have it's perks: choosing who you want to work with, having the freedom to take a midday nap and, of course, the joys and challenge of taxes.
If you've made pretty good scratch as a freelancer, then you've probably worried about the tax bill that may come due on April 15.
It's not uncommon for new freelancers to do well only to discover their profits get wiped out by taxes.
Here's a list of the best things you can to do prevent taxes from harshing your mellow.
1. Work with a tax professional
Doing your own taxes might seem virtuous, but it has risks. If you aren’t familiar with the tax code, it’s possible to misinterpret it. Who knows the potential impact of your limited knowledge? You might take deductions that don’t apply to you or miss ones that do apply to you.
Humans still do it better than robots. And although it might be more expensive to hire a tax pro, a great one is definitely worth it.
2. Work with someone who understands your business
It's important to work with tax pro who is familiar with how your business runs. If they've never worked with anyone in your industry before, make sure to explain how things work.
This information will impact the deductions you take or the tax advice they give. For example, let's say a graphic designer has contractors working for her. But after explaining to her accountant that the contractors work out the designer's office, on the designer's computers and they're expected to be at the office at specific times, the accountant advises that the contractors should actually be classified as employees.
3. Get a basic understanding of what you need to pay and how much.
Yes, it’s fucked up that as freelancers and small business owners, all of the responsibility falls on your shoulders to understand your tax situation. You don’t have to be able to reference tax code, but you should at least have a very basic understanding of what taxes you need to pay and how much.
A common tax for all freelancers is the concept of the self-employment tax. I say concept because the self-employment tax is a bit of a misnomer. Here in the states, all employees and employers pay social security and medicare taxes. Employees have these taxes deducted from their paycheck and employers pay them each time they pay their employees.
In 2017, the social security tax was 12.4% on up to $127,200 of income and the medicare tax was 2.9% on all income. A self-employed person must pay the employee and employer’s share of taxes, while an employee only pays for half the social security taxes (6.2%) and half of the medicare taxes (1.45%). If it sounds like a shit deal, that’s why as a freelancer, you often charge more than you would as an employee and the silver lining is that the employer portion is deductible.
4. Keep your business and personal separate
Make sure your business has its own checking accounts, savings accounts and credit card that are separate from your personal accounts and cards. Make sure to only use the business accounts for business expenses. Make sure that your business income is going into your business checking account.
Yes, even if you don’t have a formal entity formed, like an LLC or S-corp. Run your sole proprietorship like a goddamn business.
Having things separate makes it easier for you, your accountant and/or your bookkeeper to understand what’s happening in your business. It’s easier to sort and organize all the information, which should make it easier to file taxes and make financial decisions within your company.
5. Save for taxes
As an employee, your taxes are automatically deducted from your paycheck; when you’re self-employed, you are the responsible party. If you have an S-corp, you can set yourself up on a payroll, just like an employee is setup. Using a payroll service will ensure your taxes being withheld and paid.
If payroll isn’t an appropriate option, setting up an income tax savings account is a solid way to make sure you’re saving for taxes. Talk to your account about how much they think you should be saving and each time you pay yourself, set aside a percentage for taxes in your tax savings account.
It's generally accepted that if you save 30% of your income, you should have enough for taxes. But make sure to chat with your tax pro in case 30% is too much or too little.
6. Pay quarterly taxes
Legally, you’re supposed to pay taxes as you earn them. If you don’t, you’ll owe a penalty.
So make sure to pay your taxes quarterly. You'll avoid paying a penalty and you can avoid having a high tax bill (assuming, of course, the reality lines up with the projection). You want to have your tax pro help you figure out what you should be paying each quarter.
They may do a projection up front and give you all the details like how much you owe and when it’s due. They might even prep little vouchers for you that have who to write the check to, how much to write it for and when it’s due. (Or, you can sign up on the IRS’s Electronic Federal Tax Payment System to have the payments automatically withdrawn from your account.)
Alliteratively, your accountant might want to review your books every quarter and let you know what to pay after examining the financials.
Here’s a pro tip: Make sure you put the payment due dates in your calendar. Here are the due dates for quarterly tax payments in 2018:
April 16, 2018 for income earned in quarter 1 (Jan 1, 2018 - March 31, 2018)
Friday, June 15, 2018 for income earned in quarter 2 (April 1 through May 31)
Monday, September 17, 2018 for income earned in quarter 3 (June 1 through August 31), and
Tuesday, January 15, 2019 for for income earned in quarter 4 (September 1 through December 31).
7. Know what expenses are deductible
The IRS states that you can deduct business expenses that are “ordinary and necessary” in your industry. For example, a musician may be able to write off her Spotify monthly subscription because it’s part of her job to stay current with music. Whereas, a freelance business consultant might have a harder time arguing that her Spotify subscription is both ordinary and necessary in her industry.
Your accountant will most definitely be able to give you a breakdown of the things you are able to write off and pay for through your business.
8. Keep track of your income and expenses
The most sophisticated way to keep track of your income and expenses is through a bookkeeping software like Xero or QuickBooks.
If you’re just starting out, you can’t afford to outsource bookkeeping and the thought of bookkeeping makes you want to scratch out your own eyeballs, that’s ok. You can totally create a hodgepodge system using a spreadsheet, photos of receipts and a server, like Dropbox or Google Drive.
If you’re going to do that, here’s a pro tip: use each month as a reference point. Keep each month’s invoices, income, receipts and expenses grouped together so you can easily reference it while not being too overwhelmed with too much data.
If you can’t pay all the taxes that you owe, you should still file and pay what you can so you can reduce the penalties and interest you’ll owe. Talk to your tax pro about calling the IRS to figure out your payment plan options are.
There's plenty of scary shit in the world and taxes doesn't have to be. It's all about working with a great tax pro, being consistent and staying engaged.