Freelancing, or in newly coined terms “Gig Economy” has taken the US by storm. In fact, the U.S. Bureau of Labor Statistics published a report stating that 16.5 million people now make up the gig economics and approximately 59% of U.S. companies are now using remote workers and freelancers. Some predictions indicate that by 2020, over 40% of American workers would become independent contractors.
It’s not surprising why the gig economy or freelancing has become such a trend. With flexible work schedules, variety in projects, demand for skilled contractors, and more mobility with technology, freelancing is taking over the workforce.
With such a major shift in the ways in which Americans earn their income, much has been asked about how to manage reporting, filing, and preparing for taxes. As more people get away from employer issued W2’s and more responsibly for tracking expenses and revenue become the task of the Freelancer.
The more a freelancer works and begins bumping up the income from their side hustle, the more important it is to understand how to handle their taxes.
Freelancer Tax Basics:
For any freelancer or side hustler who makes $400 or more in any given year, they are expected to cover their self-employment taxes of 15.3% on that earned income. This covers your Medicare and Social Security taxes. The IRS views you responsible for this because in that situation you are both the employee and the employer. If freelancing is a side hustle, and you receive pay stubs from an employer, they typically are covering those costs through your withholdings in the year. You can utilize a Schedule SE tax form to help calculate your self-employment tax, which then gets reported on your standard Form 1040.
What should you save?
Because the self-employment tax that gets assessed (15.3%) is in addition to your regular income tax rate, it’s advised to set aside at least 25% up to around 35-40% to be extra safe. It may seem like a lot considering it’s close to have of any earned income, but you need to cover both taxes throughout the year.
In addition, since taxes from the freelance work are not being withheld throughout the year, you may need to estimate taxes for the upcoming year and pay the IRS quarterly (typically every three months).
A general rule to follow:
- if you expect to owe at least $1000 in taxes this year, file quarterly. If you rely on the freelance work for most if not all the earned income you are most likely responsible for estimated payments.
- freelancing is in addition to a job that pays you a salary, quarterly payments depend on how much you’ll make during the year.
If you make $2000 or less each year in freelance income, you can probably skip estimated tax payments and report your freelance income when you file your yearly tax return.
Tracking your Income
In most cases you will receive a 1099-MISC form from each client once you hit the $600 mark if earned income from that contract/gig. In some cases, you will not be given the 1099-MISC, rather you may receive a 1099-K instead. One kicker: clients are not mandated to send the 1099-K unless you earn more than $20,000 or more than 200 “payments” to you. It’s important to note that not ALL contracts will issue the 1099. Programs like UpWork for example, do not issue out 1099, rather you are issued a summary of earnings. At the end of the day, it is you sole responsibility to track income earned from contracts throughout the year.
While this is general advice, it’s important to consult with a tax professional to ensure you are filing on the correct forms when it comes to tax time.
What to keep records of
It’s important to track the earned income you receive as you go, to ensure you capture all of the revenue you will be reporting out on taxes. In addition to revenue, tracking costs out of pocket, or in other terms “deductions” is important to help lower that taxable income. As a freelancer there are several deductions you can take.
According to the IRS, you can claim deductions or expenses on things that are "ordinary and necessary" for the operation of your business.
These often include:
- Home office
- Office supplies
- Travel for business
- Advertising and marketing
- Office supplies
*Key Tip: open a separate banking account for your freelance work to keep your personal transactions separate.