What Taxes Do I Owe On My Freelance Wages?
As an independent contractor, you might earn freelance wages regularly, or sporadically. When you get paid, clients don’t withhold taxes, meaning that you’re responsible for all the accounting and tax planning required in order to pay any taxes you owe. The following is provided to help understand the difference in these earnings and employee wages as well as some tips to help stay organized.
Tax Implications of Being an Independent Contractor versus Employee
The IRS has standards to classify workers as either employees or independent contractors. Independent contractors report their income via 1099 forms, whereas employers must file W-2 forms to report employee income and withheld taxes.
The following list highlights some of the tax implications of being an employee versus being an independent contractor:
- Payroll taxes: An employer calculates payroll tax payments and deducts those taxes from an employee's paycheck, whereas independent contractors are responsible for calculating their own payroll taxes. An employer issuing a W-2 will also pay half of the employment taxes, which is approximately 7.5%. On the contrast, an independent contractor is responsible for 100% of their employment taxes.
- Documentation requirements: Upon the close of a taxable year, a business is required to send a W-2 statement to all employees and a 1099 to qualifying contractors. Businesses are only required to issue a year-end 1099 statement if the employer paid the independent contractor at least $600. Therefore, if a business had independent contractors perform services for less than $600, they would not have to issue 1099 statements for this.
Even if a 1099 is not received, the contractor must still include this income on their tax return. Documentation can sometimes be obtained through payment processors, such as Paypal or Square, since contractors are often paid through such services and processors are typically required to report payments to the IRS.
Note, even if an employer fails to send a 1099 form to an independent contractor, that contractor is still required to report income to the IRS. - Deducting business expenses: In general, a W-2 employee does not have as much leeway with deducting work related expenses under IRS rules. On the other hand, a 1099 independent contractor may be able to deduct most work-related expenses. Examples of deductible expenses can include mobile phones, computer equipment, office supplies, internet connectivity and maintenance, vehicle expenses, and more.
Note, both W-2 employees and 1099 contractors should maintain records of any deducted work-related expenses in the event of an audit.
Organization Really Helps
To avoid unnecessary stress at tax time, consider the following tips for staying organized throughout the tax year, and make filing your taxes a breeze.
Use One Small Business Accounting Application
To help keep track of how much money you have coming in, pick one accounting software package and stick with it. You might choose a versatile application that allows you to send invoices, swipe credit cards, accept checks, and even produce receipts for cash payments. Such software typically allows you to generate reports that show exactly how much money you earn to the penny when you’re ready to file your taxes. Cloud-based software that allows you to access your data across all devices may be the best solution to keep track of your earnings, whether you’re in the office or on the go.
Use One Credit Card for Just Expenses
Being self-employed means you need to buy everything to support your freelance business. You can best keep track of your expenses by using one credit card for all your business purchases. You can turn using one credit card into a bigger benefit by selecting one that offers travel rewards, and other money-saving bonuses. You can review your credit card statements, and organize your expenses by category, so you know where to look for deductions. Depending on the type of accounting software you choose to process payments, you may be able to upload your expenses into the software as well, so you’ll have all your accounting data in one place.
Keep Up-to-Date Spreadsheets
In the absence of accounting software, consider using simple spreadsheets to keep track of your earnings and expenses. You can set time aside daily to fill in data about your income and expenses on your spreadsheets or hire a virtual assistant to do the task. Having detailed spreadsheets on hand when you’re ready to file your taxes can alleviate the frustration and stress that goes along with being disorganized.
Pay Estimated Taxes
The more money you earn, the more taxes you owe. If you wait until the end of the year to calculate how much you owe, you can wind up with a larger than expected bill, as well as penalties for not making proper estimated payments. Paying quarterly estimated tax payments can make your life easier. If your income is inconsistent and you overpay, you will get a refund.
Employees and independent contractors are treated very differently by the IRS. Both should be aware of their obligations when filing their income taxes. More information on this can be found here:
Treatment of Employer-Provided Benefits
Deductions for Self-Employed Individuals