According to the Wall Street Journal, one in three American workers is currently a freelancer. By 2040, that percentage will rise to a hefty forty percent, says the Business Insider. Clearly, there’s a benefit to working for one’s self beyond flexibility and control. Unfortunately, however, navigating taxes isn’t usually considered one of them.
Here are some tips you can use to get a handle on your tax obligations. Whether you’re a new freelancer to the market or are destined to become one, they’ll help keep you on the good side of the IRS.
Taxes to expect
There are two taxes you’ll potentially pay as a freelancer; income tax and self-employment tax. The latter is similar to the withholding you’d expect if you worked for a business or company, and it covers things like Social Security and Medicare. If you make $400 or more in net earnings, self-employment tax payments are required.
No client will withhold these taxes for you, so you’ll have to pay them yourself on a quarterly basis. IRS form 1040-ES shows how to estimate taxes and includes vouchers to send with each payment. A rough rule of thumb is to allocate one-third of your pay towards income and self-employment taxes.
How does the IRS know how much you’ve made (and therefore how much tax you should be paying)? Because they, like you, receive a 1099-Miscellaneous Income form from any client that paid you $600 or more. (So, if you’re even remotely successful, chances are you’ll be in the IRS’s radar.)
While taxes may take a bite out of your earnings, you can reduce your tax obligations by finding the most allowable deductions.
Here are just a few:
If you designate a space in your home or apartment exclusively for work, you can deduct the business portion of real estate taxes, mortgage interest, rent, utilities, repairs, insurance, painting and depreciation. The amount of the deduction depends on the percentage that is used for business. For example, if your place is two-thousand square feet and your office is two-hundred square feet, you can deduct ten percent of these costs.
If you’re not sure what’s deductible it never hurts to consult your tax advisor. One contractor successfully deducted dog food and other pet-related expenses because the dog provided security for his home-run business.
By hiring your kids, you can deduct their wages on tax Schedule C, as long as the wages are in line with the type of work you give them. If they’re under the age of eighteen, their wages are exempt from Social Security tax. If they’re under 21, they are also exempt from federal unemployment tax.
A Simplified Employee Pension (SEP) plan and a Keogh plan are two common ways to minimize taxes. They allow contributions up to twenty percent of net earnings and are capped at $52,000 for 2014. By contributing to these plans, you’re reducing your net earnings, and therefore your tax liability. IRAs also provide tax advantages, however, contributions are capped at a maximum of $6,500 for those 50 and older.
If your business requires you to drive to visit clients, meet suppliers, etc., you can deduct the cost per mile, which is 56 cents for 2014. If you fly for business, you can deduct airfare, lodging, meals and other out-of-pocket expenses – numbers that can really add up. Keep an accurate log of driving miles and all your travel related receipts, should the IRS request them in an audit.
Freelancers are known for their ability to take on and comprehend all types of work. When applied to taxes, these same skills can help keep taxes in perspective.