Five tax tips for freelancers

Freelancers, folks with side hustles, and basically anyone who isn’t exclusively an employee on someone else’s payroll may be enjoying the flexibility and freedom that comes from working for themselves.

The less enjoyable part: taxes.

When you’re on someone else’s payroll, the only thing you know about income taxes, Social Security, and Medicare is that they’re deducted from your paycheck. When you make money outside of a salary or hourly wage, guess who’s responsible for all of that?

That’s right, you. Whether you’re fully self-employed or have a side hustle for extra cash, the IRS considers you a business and expects you to pay taxes. Here are five tips to help you stay on the right side of the tax laws.

1. Keep accurate records

Keep records of every penny you earn and spend related to your business, no matter how small. If you use a home office for any part of your business, monitor your housing expenses, such as mortgage interest, rent, real estate taxes, and utilities. You’ll need those records to do your taxes and explain yourself if the IRS or your state tax agency has any questions.

If you exclusively use a portion of your home or a separate building for your income, some of your housing expenses may be tax deductible. Office supplies, fees paid to professionals (such as an accountant or attorney), and other money you spend on behalf of your business can help you save on taxes.

Here’s a real-world example.

Say you sell a $400 hand-knitted sweater on Etsy. With no records of any expenses, you’d owe taxes on the entire $400. But if your materials, fees paid to Etsy, and other business expenses totaled $100, and you have proper documentation to prove it, you’ll only owe taxes on your net profit of $300. Paying taxes on $300 rather than $400 will cut the amount you’ll owe by 25%, so it’s worth keeping good records.

Some of the most common expenses deductions from freelance or self-employment income include:

• Home office space
• Vehicle expenses
• Travel expenses
• Internet and phone bills
• Health insurance
• Office supplies
• Hardware and software
• Advertising materials
• Legal or professional services
• Contract labor
• Licenses and taxes
• Business meals

2. Understand what you owe

When you’re on someone else’s payroll, your employer pays half of your Social Security and Medicare taxes: you each pay a 6.2% Social Security tax (against the annual wage base- $160,200 in 2023)  and a 1.45% Medicare tax on your earnings. Without an employer, you pay both halves, which means a combined 15.3% of your earnings goes towards Social Security and Medicare (12.4% Social Security and 2.9% Medicare). Of course, you’ll still owe your usual income taxes, which an employer does not partially pay.

Not only are you responsible for those taxes, but you’re also responsible for ensuring that they’re paid in a timely fashion. Depending on how much your freelance or self-employment activities earn, you’ll have to pay your estimated taxes quarterly rather than waiting until you file your tax return each year.

3. Estimate your taxes

Unless your side hustle or self-employment generates very little income, chances are you’ll have to pay estimated taxes. The IRS has a handy form, 1040-ES, to help you calculate what you owe. This tool will help you get organized. It is not submitted to the IRS.

For almost all taxpayers, estimated taxes will be due for 2023 if both of these factors apply to you, according to the IRS:

• After subtracting your withholding and refundable credits, you expect to owe at least $1,000 in income tax for 2023.
• You expect your withholding and refundable credits to be less than the smaller of 90% of the tax to be shown on your 2023 tax return or 100% (110% if Aggregate Gross Income exceeds $150k) of the tax shown on your 2022 tax return.

When you pay your quarterly estimated taxes, you have two choices. Form 1040-ES includes vouchers you can print and mail with a check each quarter, but paying online is much easier. Most states that charge income taxes will have similar quarterly deadlines and generally offer an online payment option .

Keep copies of checks or any receipts if paying online. You’ll need that information when you file your annual tax return.

4. Use the right tax return form

If you form a corporation for your business, you’ll need to file a separate tax return. For tax purposes, a corporation is considered a separate entity even if only one person owns the corporation. Some, but not all, corporations will have to pay quarterly taxes as well.

For almost everyone else, business income and expenses are reported on a tax form labeled Schedule C. This is where good record-keeping will come in handy. If you do your own taxes using software, make sure you select a package that includes this form. (Most software companies will ask you a series of qualifying questions before recommending a tax preparation product.)

If this is the first year you’ll have enough business income to require estimated taxes, it may be worth consulting a tax professional, even if you’ve done your own taxes for years. Some items that can rarely be deducted by payroll employees, such as healthcare expenses, may be fully or partially deductible if you’re self-employed.

5. Hold onto your paperwork

Statistics show that self-employed taxpayers are far more likely to be audited by the IRS, which means the IRS might ask for receipts or other proof of income or expenses years after a tax return has been filed. In many cases, the IRS can ask for records up to 3-6 years later, depending on the tax issue. But keep in mind that there is no statute of limitations on tax fraud. If the IRS suspects fraud, an audit can happen at any time.

And, yes, the IRS can ding you for taxes, interest, and penalties if you don’t have the paperwork to support whatever issue they’re questioning. If it takes the agency three years to pursue a tax question and they determine you owe, you could be on the hook for three years worth of interest and penalties.

Being self-employed or generating income from a side hustle can be fun and rewarding. Following these tax tips and understanding your tax obligations can help keep it that way.