Freelance Taxes: 5 Top Tips

  • November 1, 2022

In today’s gig economy, a growing number of people are leaving the 9-to-5 corporate grind and choosing instead to work as full-time freelancers.

While being a freelancer can be an amazing career choice as it offers flexibility and lets you be your own boss, there are some financial considerations if you work for yourself. It’s especially important for freelancers to have a plan when it comes to how to do their taxes, as mistakes here can be costly!

I began my career as a full-time freelance writer in 2009 after spending 24 years working for various publishing companies. I went through lots of adjustments in making the switch from full-time employee to freelancer, such as learning how to block out distractions while working from home and figuring out how to find new clients. But the biggest adjustments by far had to do with managing taxes and finances for my freelance business.

For example, I could no longer count on getting my salary directly deposited into my bank account every other week. Nor could I rely on an employer to make sure that the right amount of income and FICA taxes were withheld from my pay.

I’ve learned some important lessons over the past decade working as a full-time freelancer with regard to tax and financial planning. Here are a few that have been the most valuable.

1. Choose the right entity structure for your freelance business.

One of the first things you’ll do as a freelancer is deciding how to structure your business. The simplest option is to operate as a sole proprietorship. Here, no new business entity is created — instead, you’ll report your business income on Schedule C and file this with your personal income tax return (Form 1040). Your business profit or loss is lumped in with any other personal income you may earn.

While this option is simple, there are some drawbacks. One of the biggest is that it offers no liability protection, which means you can be held personally liable for any debts and obligations of the business. This is one reason why I decided to structure my freelance business as a Limited Liability Company, or LLC. As an LLC, I’m protected from personal liability and my business profits flow through directly to me in order to avoid potential double taxation.

You can possibly realize big tax savings by going one step further and electing to have your LLC taxed as an S corporation. Here, you will pay yourself a reasonable salary as an employee of your freelance business. You’ll then only pay self-employment tax — which totals 15.3% — on your salary, instead of on the business’ total net income.

Note that when you were an employee, your employer paid half of your Social Security tax, or 6.2%. But as a freelancer, you must pay the entire 12.4% the tax (which is part of the self-employment tax) yourself on the first $147,000 in freelance income. This strategy can result in significant tax savings for freelancers.

2. Set aside funds to pay income and FICA taxes.

Businesses are required to withhold enough money from their full-time (or W-2) employees’ pay to cover income and FICA taxes each pay period and then submit these tax payments to the government. As a freelancer, however, this is your responsibility.
More specifically, if you are operating as a sole proprietor, you must make estimated tax payments throughout the year.

These are made quarterly on the 15th of January, April, June and September. You can use Form 104-ES to figure out how much tax you owe and then make quarterly payments using vouchers that come with the form or electronically via the IRS’ Electronic Federal Tax Payment System (EFTPS).

3. Take advantage of available tax breaks.

A great thing about freelancing from a financial standpoint is the many freelance tax deductions that are available to you. These typically include advertising and marketing expenses; computers and software; office furniture and equipment; vehicles and miles driven for work; and travel, meals and entertainment related to your business (up to certain limits).

One of the most popular tax breaks for freelancers working from home is the home office deduction. If you use a portion of your home regularly and exclusively for business like I do — such as a spare bedroom or basement — then you may be able to claim this deduction. The simplest way to calculate the home office deduction is to multiply the square footage of your home office area by $5. Note that this area cannot exceed 300 square feet. You can also use the more difficult method of determining your home office deduction, which involves measuring your actual expenditures against your housing costs. While this is laborious, it can sometimes mean that you can deduct mortgage, interest, taxes, utilities, repairs, and other residence-related expenses.

4. Get tax advantages with a retirement savings plan.

As an employee, you may have had the opportunity to participate in a retirement plan offered by your employer. But as a freelancer, it’s up to you to establish and fund a retirement savings plan. The good news is that there are several options available to you, including traditional and Roth IRAs.

Or you can open a SEP-IRA if you really want to sock away money for retirement, which is what I did.

The annual contribution limit in 2022 for traditional and Roth IRAs is just $6,000, or $7,000 if you’re 50 years of age or over. But with a SEP-IRA, you can contribute up to $61,000 or 25% of net earnings in 2022 from your freelance business (whichever is less). And these contributions are tax-deductible, which may lower your current taxes.

Read More: Retirement Plans for the Self-Employed

5. Hire a tax professional.

When I was an employee, I always prepared and filed my tax returns myself using tax prep software. But once I became a full-time freelancer, I decided to hire a CPA to handle my taxes for me.

This has turned out to be a great decision because tax preparation and filing are much more complicated for a business than an individual — even a one-person freelance business. My CPA makes sure that I take full advantage of all the tax breaks available to me as a freelancer. For example, tax reform introduced a new 20% deduction for freelance businesses that are structured as pass-through entities, including sole proprietors and LLCs. This deduction saved me several thousand dollars in taxes last year.

Read More: Tax Management Tips