Freelancing is becoming increasingly popular, and while freelancing certainly has its benefits, there are also unique cons to freelance work. One of the drawbacks of freelancing is the complication of taxes when tax season comes. That is the reason why tax planning for freelancers is a must
The Internal Revenue Service (IRS) files freelancers under self-employed, which can be a complicated tax process, especially when compared to taxes for a traditionally employed person. There is no W-2 form at the end of the year when you are a freelancer, and most freelancers will have to submit additional tax forms.
In addition, freelancers are subjected to the self-employment tax rate, which is 15.3%. But because freelancers are self-employed, they are also allowed to take additional deductions on their income other employees would not be able to. Freelancing can be a lucrative but confusing business, at least when it comes to taxes.
Know Your Income
When you are a freelancer, you are your own boss, which means the responsibility of calculating your income total is also on you. Most freelancers work with multiple clients throughout the year, and most clients will not provide a tax receipt. Freelancers have to keep track of their income, regardless of whether their clients provide a 1099 form or not. The IRS will expect annual incomes that total over $400 to be reported, and there are no exceptions. Even freelancers who receive social security or medicare are not excluded from self-employment taxes. It is normally the industry standard to receive 1099-NEC forms following a business transaction, but it is not unheard of to simply be paid by a client and not be given a tax form. Freelancers have to be diligent and on top of recording their annual income.
Freelancers are considered self-employed because they are their own bosses. Freelancers have an additional tax, also known as the self-employment tax. In 2022, the self-employment tax is 15.3% and covers Social Security (12.4%) and Medicare taxes (2.9%). Self-employment tax is not the same as income tax. It is an additional tax for freelancers, but it actually is just double the traditional taxes a traditional employee would have paid. Social security and medicare taxes would have been taken out of your paycheck before you received it had you worked under a standard employer.
Unfortunately, freelancers are responsible for the employer and employee’s portion of the social security and medicare tax. This means they are paying double the amount of social security and medicare taxes as traditionally employers are usually responsible for the other half of taxes in traditional employment. High-income freelancers whose annual income exceeds $142,800 in 2022 will be able to avoid social security taxes on income that exceeds that amount. But if your income approaches $200,000, you will be responsible for an additional 0.9% in Medicare taxes for any income exceeding $200,000. If you are married, this amount will increase to $250,000.
It is not all bad for freelancers. As a freelancer, you are also eligible for unique tax deductions. You can claim your additional taxes (from your position as an employer) as a deduction. Depending on the nature of your work, there are even more tax deductions available for you. Many co-workers work from home, and this is also known as the home office deduction. The portion of your rent/mortgage, utilities, and maintenance spent on your home office is deductible, but the space has to be used exclusively for business purposes.
Many common day things that regular employees cannot claim as a deductible are able to be deducted from a freelancer’s taxes. Health insurance premiums, including dental, can be deducted from annual income. If your car is used for business purposes, that is also tax-deductible. Retirement savings for freelancers are also tax-deductible. This is a common deductible that regular employees are able to enjoy with their 401k plan. These are just a few of the many deductions freelancers are able to enjoy from being their own employer.
Taxes are difficult enough even without being a freelancer. Some freelancers can find themselves in a difficult situation due to the inability to separate their taxes from their income resulting in federal or state tax debt.
If this happens, the IRS can issue a tax lien against you. A tax lien allows the government legal claim on your property, and this includes personal assets. This will make it difficult to qualify for credit, rentals, or even a car loan.
It also greatly damages your credit report. If that is the case for you, seek professional help for IRS tax lien removal. An attorney can help you navigate the confusing world of taxes.