You are here: Home » Taxes » Tax Considerations for Freelance Workers

Tax Considerations for Freelance Workers

by Kevin Mulligan

Being your own boss through freelance work is a great challenge and great experience. You set your own hours, you pick the clients, and the buck stops with you. There is no system for you to follow, no rules of engagement passed down from some drone at the corporate office.

That also means you have to make decisions on how to handle your taxes, expenses, and reporting of income to the government. There are many tax issues to consider before you sign your first client; issues that could change how much your charge and which clients you target. Settling these tax considerations before opening up shop is key to long term success.

4 Tax Issues to Decide as a Freelance Worker

Here are four main tax issues to consider as you embark on your journey as a freelancer.

Sole Proprietor, Limited Liability Corporation, or S or C-Corp

tax consdierations for freelancers

Set up your freelance business right before you start!

First you must decide how you want to receive your income: as an individual working independently as a sole proprietor, or taking the time and expense to set up a limited liability corporation (LLC). Forming an S or C Corp can provide even more protections and benefits, but it can also be more complicated.

From a “liability and getting sued to the moon and back standpoint,” the LLC is significantly better than a sole proprietorship. However, it costs money, is complicated in some states, and doesn’t guarantee you protection. You may be better off going the sole proprietor route and getting a hefty umbrella policy for liability. The S or C Corp trumps both of them because the company becomes it’s own “individual” and your personal assets normally cannot be touched.

Aside from liability protection, this decision will alter how you claim the income on your taxes significantly. There is some difference between sole proprietorship and an LLC, but the idea for the LLC is pass-through taxation. Either way, the income hits your personal income tax return. With a S or C Corporation the corporation pays taxes and pays you a wage, dividend, or some other form of compensation. It can get very complicated very quickly and you can face double taxation issues as well.

If you need advice on which type of business structure to set up or whether you should incorporate your business, then it’s a good idea to set up a meeting with an accountant or small business attorney for more information. It will be time and money well spent!

Income Tax Payments

Most freelancers work on a 1099 basis rather than a W2 basis. W2 employment means you are an employee, so that doesn’t make sense for freelancing situations. Working on a 1099 basis means you are an independent contractor. The income is reported on a 1099 form and doesn’t have any income tax taken out of it. If you do a project for $500, the client cuts you a check for that amount. They don’t take out 20% and send it to the IRS for you.

That means your income tax payments are your responsibility. You may have to pay income tax on a quarterly basis with estimated tax payments. This is something your normal employer does for you, but now falls on your shoulders. Don’t forget to add this cost into your quotes for new business, either.

Employment Tax Payments

Likewise, when you work as a W2 employee you only pay half of the Social Security and Medicare tax required of you. The other half of the tax is paid by the employer.

Now that you’re freelancing, (congrats!), you now have to pay the full tax because you are now the employer. This should add an extra 7.65% to your tax burden (on top of the 7.65% you normally pay). As with income tax costs, make sure you are quoting a high enough rate to be able to pay the extra taxes without going broke.

Business Deductions

The last big piece you need to get right on the front end, rather than scrambling at tax time, is your business deductions. What counts as a deduction, what doesn’t count as a deduction, how to track your spending and receipts, and how to make sure you don’t get audited over incorrect business deductions are all big issues to handle.

At the minimum, you need to keep strict records of your business income and expenses. If you are a sole proprietor, you might be able to get away with mixing your funds if you keep detailed records. However, if you have an LLC or a corporation, you probably need to maintain separate funds. If you are freelancing or running a business, it is a good idea to set up a business checking account, or even get a business credit card. These will help you keep your business income and expenses separate. If you ever get audited, you can prove that your business and personal income and expenses are separate, and you can more easily show profits and losses and other key factors the IRS looks for to determine your business activities.

Conclusion

Being a freelancer is a rewarding way to earn a living or add income to your bottom line. But to do it the right way, you need to make sure you set up your business properly. This will help you earn more, save more, and stay on the right side of the law when it comes to your taxes. If you have any doubts or questions about your tax obligations as a freelancer, then book a meeting with an accountant or small business expert. A few minutes on the front end of your business endeavors can save you hours and thousands of dollars in the long run.

Photo credit: kenteegardin


Published or updated February 21, 2013.
Print or e-mail this article:
Print Friendly

{ 3 comments… read them below or add one }

1 Michelle

These are all important things to think about. I currently have lots of freelance side hustles, and also plan on opening a business soon.

Reply

2 John

Great things to think about here. I’m thinking about turning what I do into an LLC this year, and I wish I would have known about this stuff from the beginning! Personally, I use a tax professional who can help me with all this – others should too (tax laws are COMPLICATED!).

Reply

3 Ryan Guina

John, if you are doing a lot of freelancing or business activities, I highly recommend setting up an LLC or something else to formalize your business. It will be helpful for opening business accounts, and make it easier to keep everything separate. This is essential when it comes to taxes and certain business deductions. I set up my LLC on my own when I lived in Ohio (it’s incredibly easy there). But each state has different laws or rules, so look into it, and get assistance if the process is difficult. I also hire an accountant to do my taxes, even though I’m fairly well versed in taxes. It has paid for itself each year with deductions that I didn’t know about, or by voiding mistakes that could have cost me money.

Reply

Leave a Comment

Previous post:

Next post:

.