How to properly file your taxes if you're a freelancer, with best practices from accountants, tax experts, and self-employed professionals

  • Filing taxes is one of the more challenging aspects of being a freelancer.
  • They must report all income and keep extensive records of all payments, according to experts.
  • They also advised knowing what deductions you’re eligible for and not being afraid to file for an extension. 
  • Visit the Business section of Insider for more stories.

More than a third of freelancers are not paying taxes, according to a 2018 survey conducted by QuickBooks on 500 freelancers.

In a blog post about the study, QuickBooks copywriter Danielle Higley pointed out that one reason this many independent workers may be dodging their duty with taxes is because the process is so complicated. The study found that doing taxes was the No. 4 challenge for freelancers, cited by 20% of them — 30% worried that they’re filling the tax forms out incorrectly, and one in four were stressed about making inaccurate estimations about how much they must pay.

“There are good reasons why doing taxes makes the top five of anxiety-inducing struggles for the self employed,” Higley wrote. “While 17% of workers worry about finding deductions, one in five says they’re concerned about saving enough money for taxes in the first place.”

Freelancers may also, for good reason, fear being audited by the Internal Revenue Service (IRS).

“Unfortunately, there are many errors and pitfalls [with taxes] for freelancers,” Paul Miller, certified public accountant and founder of Miller & Company LLP, told Insider. “Freelancers are considered sole proprietorships (Schedule C) for tax purposes, and this is the most audited form by the IRS.” 

“Gig workers and other self-employed individuals often think they don’t have to report income earned from a job that paid less than $600 because it’s not reported on a 1099. But that’s incorrect,” Nathan Rigney, lead tax research analyst at The Tax Institute at H&R Block, added.

Self-employed individuals must file a tax return if they have at least $400 in self-employment income, or if any other filing thresholds are met. Rigney said the $400 threshold is when self-employment tax kicks in. 

“All income must be reported, even if the taxpayer received a cash payment or if the payment wasn’t reported on a 1099,” Rigney said.

If freelancing is your side hustle, you only need to file one federal return and report it in the designated line, unless you incorporate and choose to be taxed separately as a corporation, he added. But otherwise, filing as a freelancer is a bit different than as an employee. 

Insider found accountants, tax preparers, and self-employed professionals to offer strategies that can take the fear out of freelance tax-paying requirements.

Know what you’re responsible for

In terms of gearing up to file this year, Robert Fishbein, vice president and corporate counsel at Prudential Financial, said the best way to prep for tax season is to prep your finances prior to filing and be aware of any tax rules that apply specifically to self-employed workers, such as self-employment tax. 

When all or a significant portion of your income is reported on a 1099, estimating your tax liability becomes as critical as tracking expenses, according to Fishbein.

“You must own managing your tax liability all year long, since being an independent contractor or gig worker requires you to do work that would be done for you as if a regular employee at a larger company,” Fishbein said. “You will also solely handle costs such as Medicare and Social Security tax that would be otherwise shared with your employer, so you need to track and account for it throughout the year.”

Fishbein added that gig workers are really self-employed, and thus need to consider all the things required of a small business. He shared the following examples to be aware of in terms of responsibility in this role:

  1. Business structure. “Consideration should be given as to how the business is set up,” Fishbein said. “For example, a corporation or LLC structure can shield personal assets from business liabilities.”
  2. Self-employment tax. Unlike an employer/employee relationship where each pays social security (at 6.2%) and Medicare tax (at 1.45%), the gig worker is both employer and employee and pays both parts. “A deduction is allowed for the employer portion to reduce business income,” Fishbein said.
  3. Health insurance. “An employer may provide health insurance options for an employee, but a gig worker is on his own and must consider where to obtain health insurance,” Fishbein said.
  4. Life and disability insurance. Fishbein explained that an employer may offer life insurance and disability insurance options, including providing some minimum amount of coverage at no cost to the employee. However, gig workers must obtain such protection to ensure that their family is provided for if they die prematurely or become disabled.
  5. Retirement planning. “An employer may provide savings and retirement planning options, but a gig worker must consider how to save for retirement,” Fishbein said. “A traditional IRA or Roth IRA are good candidates to save money on a tax-favored basis for retirement.”

Look for 1099s from companies you freelance for, but also rely on your own detailed records throughout the year

If your career background has been based on staff jobs, then you’re used to receiving a W-2 from your employer at the end of each calendar year, which reports wages that the employer paid to you. As a freelancer, while you won’t receive a W-2 for your freelance work, you’ll receive something else instead from your clients to reflect the income earned working as an independent contractor: a Form 1099. 

Miller said that to ensure that you capture all of your freelance income on your tax forms, you should be sure to collect 1099s from all of your clients.

“Freelancers should receive a 1099 from each business for which they perform services,” Rigney said, adding that freelancers who perform services for individuals instead of businesses may not receive a 1099 unless they get paid through a digital platform like TaskRabbit.

But the IRS still has a record, even if you don’t, Rigney pointed out: The IRS receives a copy of any 1099 forms taxpayers receive, and will match that information against the tax return to make sure the taxpayer indeed reports all of their income.

So what do you do if all of your clients don’t send you a 1099, which is a common scenario?

Melanie Hopkins, founder of Finance Friend, a financial consultancy that helps entrepreneurs start and grow their businesses and provides tax-related tips, said to give up on making sure all of your 1099s are correct. Instead, keep your own clean records and file taxes based on those.

Prior to forming her business, Hopkins was — and filed taxes as — a freelancer for more than a decade and was owed over 50 1099s from her clients one year.

Poor bookkeeping on your clients’ part and confusion about how to handle expense reimbursements could be the reason, so it’s best to keep your own notes. 

Logan Allec, a CPA, personal finance expert, and owner of personal finance blog Money Done Right, agreed. “Frankly, the 1099 forms should just be used as a check figure for your own independently kept books and records,” he said.

Robert Allman and Suzanne Vanzant-Ladas, owners of Miami-based tax firm Professional Public Accountants, LLC, have been working with freelancers for nearly 40 years. Allman and Vanzant-Ladas added that organization is extremely important for freelancers when it comes to tax preparation.

“Your accountant can only do so much if you don’t give them the entire picture,” Allman and Vanzant-Ladas said. 

Fishbein explained that a large part of taxpayer preparedness as a freelancer involves “tracking your income and expenses in real time,” as well as keeping current records of all business-related activity that you will need for your tax return. 

For example, gig workers and freelancers “must keep a contemporaneous record of mileage, meals, and other travel costs,” Dave Du Val, chief customer advocacy officer at audit defense company TaxAudit, said.

To simplify your record-keeping, Hopkins advised that freelancers avoid using cash for business expenses. Allman and Vanzant-Ladas added to run your business and personal expenses through separate accounts. 

Miller pointed out that if you are among the freelancers who gets audited, it will be even more important to have kept a complete set of books and records, which is what the IRS will look for in the event of an audit.

Consider making quarterly estimated payments 

Unlike income received from an employer, no taxes are withheld from the income you earn freelancing. Therefore, Rigney suggested that freelancers consider making estimated payments each quarter throughout the year if they want to avoid paying unnecessary underpayment penalties after filing. For the tax year, estimated payments are due in April, June, September, and January.

“In order to make such payments, you must track your income and business expenses all year long,” Fishbein said.

The IRS notes that self-employed people are among those who may need to make estimated payments, according to their “The Basics of Estimated Taxes for Individuals.” In terms of how to figure out the correct amount to pay in estimated taxes, it says to refer to your prior year’s tax return for estimates this year.

However, the IRS site also acknowledges that some taxpayers earn income at various rates and amounts during the year, providing an example of a boat repair business that might be busier in the summer months. The IRS states that in situations like this, you can annualize your income, which means making unequal tax payments based on when you actually receive income instead of sending four even payments each quarter. 

“Doing so could help the taxpayer avoid or lower a penalty, because their required payment for one or more periods may be higher with this method,” the website reads.

Hopkins suggested that if you’re among those freelancers whose income fluctuates wildly, a smart approach is to prepare quarterly estimates based on actuals, or real income from this year, instead of prepping all of your estimated payments based on the prior year. 

As an example, Hopkins explained that if you owed $10,000 in taxes last year, standard quarterly payments for the following year would be $2,500 per quarter. But if you lose your biggest client in the first quarter and then end up landing a huge client in the third quarter, your quarterly payments could look something more like $500, $2,500, $5,000, and $2,500 in the first through fourth quarters, respectively. 

“This will help with cash flow and will keep you from being slammed with a big tax bill at the end of the year,” Hopkins said.

Don’t forget the deductions you can claim

To help cut down on your tax bill, Rigney pointed out the importance of claiming expenses related to running your business as deductions on your tax return. 

Miller, whose firm offers tax planning and tax preparation services, added that freelancer taxpayers generally don’t know what is and isn’t deductible.

Another common mistake that gig workers make is failing to take advantage of all the deductions available to them, according to Fishbein. Some commonly overlooked deductions include home office space, start-up costs, business mileage, and marketing expenses. Rigney added advertising, vehicle licenses, and car expenses such as gas and repairs, noting that it’s critical to keep receipts for all of the items purchased to make claims. 

In terms of determining whether you qualify for the home office deduction, Allec explained that if you’re a freelancer who does a lot of your client work from the comfort of your own home and have a deliberately dedicated space for it, then you might be able to take the deduction.

“This would then exclude you from declaring your comfy bed as your home office,” Allec said, recommending you make a designated space.

Don’t be afraid to file for an extension

Some freelancers find it too challenging to gather all the records necessary to file their tax return by April 15. If that’s true for you, Allec said to remember that you can also file for an extension of time to file your tax return until October 15. He added that most tax software programs offer filing extensions as a free option.

As a pro tip, Allec offered that most states either automatically extend the deadline for taxpayers’ returns or don’t require a separate state-specific extension if you extended your federal return — but a few states, such as New York, require a separate state-specific extension.

“Just remember that an extension of time to file is not an extension of time to pay,” Allec said. “So run your estimated numbers through your tax software to see an estimate of what you still owe — taking into account estimated tax payments you’ve made — and make sure you pay this amount by April 15.” 

This article was originally published on Insider March 30, 2020.

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