8 Tax Tips for Your Freelance Business
With the economic changes of 2020 through 2021, many have gained a new perspective on life. People began working from home and spending more time with loved ones. Suddenly, so many employees were leaving jobs in search for better work-life balance, benefits, and permanent remote work opportunities. The U.S. recorded more new businesses than ever before. Many with the perspective that life is short opted to follow their dreams and became first time entrepreneurs or picked up some side work with Uber, Doordash, Fiverr, or Upwork. The “Gig Economy” is thriving now more than ever.
The IRS has noticed the exponential growth and now requires payment apps like Zelle, Venmo, and Cash App to report earners making more than $600 per year. As a freelancer, you get to set your own schedule and decide how to do your work – you call the shots now. As it turns out, you now need to make some decisions on your taxes. Fortunately, there are tons of deductions, credits, and strategies for business owners. In this article, we cover 8 tax tips for your freelance business. Our tips can help you minimize your taxes owed while keeping you compliant, so you stay out of trouble with the IRS.
The IRS is Paying Attention to Freelancers
#1: Understand How Freelance Work is Taxed
Whether it is called gig work or freelancing, you are self-employed and hiring out or selling products or services to others. Whether you are an Uber driver, Instacart delivery person, freelance writer, or an IT consultant, you are subject to self-employment taxes on your income (this is in addition to income taxes).
When you worked for an employer, they withheld your Social Security and Medicare taxes from your wages or salary. You didn’t have to deal with it, and the employer paid half of it. As a freelancer, however, you must deal with it and pay the whole amount. You get some step-by-step help in staying on the good side of the IRS on the IRS website publication titled Manage Taxes for Your Gig Work. Get details there about these important tax-related activities:
- Keeping Records – Save all income and expense documentation, such as:
- Expenses – keep all receipts for business purchases, as many will be deductible from income to reduce your taxes. Credit card statements are not sufficient records – make sure you keep the receipts and accompanying documentation. There are lots of apps that can help keep your organized.
- Income – Even if you don’t receive a 1099 form from those you do work for, even freelancer sites like Upwork and Fiverr, you are still responsible for reporting the income you receive from every source.
- Estimated Tax Payments – Because you are the employer, there is no withholding happening on your income unless you do it. Depending on your income, many freelancers are responsible for paying estimated taxes throughout the tax year. You estimate your income and send in taxes on the 15th of April, June, September, and the following January.
- These are estimated payments – you are simply estimating what you will have for income tax liability and sending in about a quarter of that amount each of the four payments. Failure to send in minimum amounts required can result in penalties and interest.
- If you use an accountant (recommended), they can give you the four payment vouchers at the beginning of the year with the amounts to send in based on the previous year’s taxes you had to pay. If you do so, even if you make more money during the year, you simply owe the extra tax, not penalties or interest.
- Self-Employment Taxes – If you are liable for paying self-employment taxes, the rate for 2022 is 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare. This would be part of your calculations for estimated tax payments. Strategies exist to significantly reduce how much you pay in self-employement taxes.
Freelancer taxes can be confusing, so do your research and hire help!
#2: What is Your Business Structure?
Most freelancers begin as sole proprietorships, but here are the three most common filing statuses with the IRS.
Freelancers and Business Structures
You are personally liable for activities and debts of the business
Income from the business passes through to your personal tax return
Two or more owners
All owners share liability for activities and debts of the business
Business income passes through to owners’ personal tax returns
LIMITED LIABILITY COMPANY (LLC)
Single Member or Multiple Member
Owners are not liable for activities or debts of the business
Taxed twice, at corporate level and at owner personal level for distributions
**Can elect S-Corporation status to pass through income
By far, this is the most common way that freelancers file with the IRS. It requires no special actions or forms to elect this status. Once the business profit/income after deductions is calculated, it’s all just considered personal income of the owner. Taxes are reported with a Schedule C on the owner’s personal tax return. You’re liable for self-employment taxes. You’re also liable for the actions and debts of the business.
The partnership structure is very much like a sole proprietorship but with two or more partners. They share, according to a partnership agreement, the income, liabilities, and expenses of the business. Income passes through to the partners to file on their personal returns, and they are responsible for self-employment taxes. The partnership reports income to the IRS with Schedule K-1 and Form 1065.
Limited Liability Company (LLC)
You can have a Single Member LLC just for you or a Multiple Member LLC for two or more owners. The main advantage of the LLC structure is to limit your liability. Owners (and their personal assets) are generally protected against legal actions or debts against the business. The LLC can elect to pass through income to owners who then pay self-employment taxes on the income received and file on their personal returns. Tax reporting is on Form 1120-S.
The S-Corp is not a business structure. It is a tax election that allows the business to pay owners a salary in the business and distribute profits to them as well. This is an advantage for owners as they avoid paying self-employment taxes on salary and the business can deduct the taxes as a business expense. If salaries are “reasonable” per the IRS, the owners can structure salaries and distributions for their individual tax situations. It’s not uncommon for small business owners to operate at a sole proprietor or LLC and file taxes as an S-Corp.
#3: Think About Taxes More Than Just Once a Year
A surefire way to be forced to send a much larger check each year to the IRS is to only think about taxes once a year just before the tax filing deadline. Every trip to the office supply, think about where that receipt is going and when you are going to get it into your bookkeeping system. Stay on top of your bookkeeping system, look at monthly or quarterly reports.
See where you are spending money, and where you are making it. The IRS doesn’t care how you use your time, if you work parttime, fulltime, or whenever you want. You may be a freelancer, but on paper, the IRS sees a business. Think like you are in business, and any decision involving money may have tax considerations. Make it a habit to think that way.
#4: Report Every Dollar of Income
It can be easy to forget a side gig or one-time client who paid you and you never heard from again. This includes cash payments. Though every business that pays you more than $600 is required to file a Form 1099 with the IRS and send you a copy, don’t rely on that. You keep records of all income.
Even if you get a 1099, check the numbers on it against your records. Companies or their bookkeepers can make mistakes. Differences between what they and you report to the IRS are the kind of situations that generate IRS question letters or worse, an audit.
#5: Know Your Deductions
Sure, you’ll likely hire a bookkeeper or use Quickbooks or similar software, but how do you know if they’re doing a good job if you don’t have at least a basic knowledge of your business type’s deductions? Also, if you don’t tell your bookkeeper about purchases and financial decisions, how can they know to book the expenses for deductions?
If you can pull together a basic knowledge or list of deductions, not only general business, but your business type as well, you are way ahead. Consider taxes before making major financial or capital investment decisions. An example would be whether to purchase or lease a business vehicle. You will be far better off with a basic understanding of depreciation and that there are ways to accelerate it or even write off items in the year purchased.
Learn about the home office deduction if you work from home. If your use and space qualify, there is a nice deduction in it for you. Only if you know about it and discuss it with your accountant or bookkeeper can you assure that you take a proper deduction.
Do You Qualify for the QBI Deduction?
The Qualified Business Income (QBI) deduction applies to many sole proprietorships, LLCs, and partnerships. It’s a deduction of 20% from the income of a qualified domestic business. This could be a whopper for your business, but you need to check to see if you qualify.
#6: Learn About Business Tax Credits
There’s a long list of business tax credits at this IRS resource. The difference between a tax credit and a deduction is huge. A deduction comes off income before taxes due are calculated. A tax credit comes off taxes due after they are calculated. That’s a dollar-for-dollar value.
The government gives business tax credits to incentivize businesses to do something. Your business may not qualify for any on the list, but it changes often. There are quite possibly some credits related to the COVID pandemic that could apply to you. At least know to discuss this with your accountant. There are also state tax credits in many states.
#7: Plan for Retirement and Get Tax Breaks Along the Way
It’s easy to get lost in the weeds of running a business day-to-day. Profits, losses, customer relations, and marketing are usually your biggest focus. Retirement could be decades away, so you stay laser focused on your business operations. This can be a costly mistake every year until you take control.
Even for sole proprietors, there are 401(k) Plans, Traditional, Roth IRAs, and SEP IRAs you can set up inexpensively and save on taxes at the same time. You might even qualify for a tax credit that covers administration and setup of a retirement plan. Plus, contributions to some plans are tax deductible in the year made. Why not let the government contribute to your retirement?
#8: Hire Pros – It’s Cheaper Than You Think
Sure, accountants and tax advisors cost money. But, especially after reading this, you should be able to see how many factors play into the money you send to the government. You have a few choices:
- You can take the DIY approach and do it all yourself. Consider not only saving the cost of the experts but also the lost opportunity costs of taking massive amounts of time away from your business.
- You can simply hand it all over to experts, pay hefty fees, and simply send them every piece of financial paper you generate or receive.
- Preferred: Build a relationship with an accounting and tax service that will work with you and take your input after some of this financial education. They will set up your bookkeeping and tax functions to squeeze every legal dollar out of the IRS.
We didn’t include all possible tax tips for your freelance business, but this is enough to cover the basics. A good tax professional should save you more than they cost. Look at tax planning as an investment that pays big returns.