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As a freelancer, your taxes look a bit different, and it’s important to know how. Here we look at three ways your taxes will change when you make the leap from employed to self-employed.
1. Self-Employed Tax vs. Employee Tax
Tax forms can sound like their own language, with terms like 1099’s, W-2’s, FICA tax, and self-employment tax, to name a few. So what is all this stuff, and how does it apply to you now that you’re a freelancer? The main difference between self-employed tax vs. employee tax can be summed up with the IRS’s favorite question: Who pays?
As you may remember from back in the day, when you’re employed, your employer withholds taxes from your paycheck. They withhold your regular income tax based on your income bracket, then send it to the IRS each quarter. They also withhold FICA Tax, which is a payroll tax everyone pays at 7.65% of their annual salary. In addition to withholding that FICA Tax, the employer has to match it, so they pay another 7.65% of your salary, making the total FICA Tax 15.3%. The employer reports all of this on Form W-2.
When you’re self-employed, you now get to act as employer AND employee. This means you need to make your own quarterly estimated tax payments (more on that in a minute). These payments will include a) your regular federal income tax, and b) all 15.3% of your FICA tax.
The latter of those two taxes is referred to as self-employment tax, and both types of taxes will be combined and paid on your personal tax return. As a freelancer, consultant or independent contractor, your clients will report the amounts they paid you for each year on Form 1099.
2. Quarterly Taxes Explained
So what are quarterly taxes? In short, you’re making the quarterly tax payments that your old boss used to make for you. Quarterly taxes aren’t tax returns, just tax payments you make based on the amount of tax you *think* you’ll owe for the current year.
So with that in mind, is there a magic 1099 tax calculator or self-employed tax calculator you can use to figure out how much to pay? (If you find one, please let us know!) The best answer is to try and estimate your income for the year, then estimate your total taxes due for the year, then pay one fourth of that each quarter. Simple right?
Well yes, and no, and maybe. Everybody’s tax situation is different, and depending on your income sources, available deductions, total income level, and home state tax laws, your quarterly tax target could change month-to-month. It can be a tough calculation that may require help from a tax pro, but in our opinion, it’s one worth making.
3. Three Tax Deductions Every Freelancer Should Know
Now that you know how to pay quarterly taxes, let’s talk about three tried and true ways to reduce those payments.
Tax Deduction #1: Home Office
If you’ve ever wondered if you can deduct personal expenses as a freelancer, you’re about to get some good news. The IRS allows you to deduct home office expenses when you use a dedicated area of your home for business. It should be a room or area you use regularly and exclusively to work, and it should serve as your primary office space for the business.
The home office deduction is based on the square footage of your office space as a part of your home, and allows you to write off a portion of your rent, utilities, insurance, and other general home costs. Just make sure your office space qualifies.
Tax Deduction #2: Health Insurance
Healthcare can be one of the biggest costs of your new freelance lifestyle, so you might as well get a tax break for it. If you pay for health insurance as an independent contractor, whether through the marketplace, a COBRA plan, or other options, you can write off those monthly premiums as self-employed health insurance. The only catch is that you or your spouse can’t have an employer-sponsored option available, so be sure to check if that’s your situation.
Tax Deduction #3: Retirement Contributions
Most people know that 401(k) contributions help you save on taxes. But did you know that freelancers have unique options that let them save even more?
In addition to Traditional IRA’s and Roth IRA’s, freelancers have specialized options like a SEP IRA, SIMPLE IRA, and Solo 401(k). Some of these accounts have higher contribution limits, which means higher retirement savings AND higher write-offs. The amount you contribute to these accounts is usually 100% tax deductible against your freelance income, so they can be a great way to save both now and in the future. We definitely recommend talking to an investment advisor about these to figure out which option works best for you.
Self-employed tax is definitely different from tax as an employee and can be confusing. But you’re not alone - we’re here to help!
IRS CIRCULAR 230 DISCLOSURE: To comply with requirements imposed by the Department of the Treasury, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written by the practitioner to be used, and that it cannot be used by any taxpayer, for the purpose of (i) avoiding penalties that may be imposed on the taxpayer, and (ii) supporting the promotion or marketing of any transactions or matters addressed herein. Our use of a disclaimer does not change the high degree of care and attention that we devote to our tax advice. Moreover, the inclusion of the disclaimer does not indicate that penalties could be imposed on the transaction at issue, but rather merely indicates that the advice we have provided you in such communication does not preclude the IRS from asserting penalties. Finally, please be assured that the use of such a disclaimer to avoid unnecessary legal expenses is similar to the approach adopted by most other tax practitioners. If you have questions about the new U.S. Treasury rules, please do not hesitate to contact us.
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I specialize in helping businesses-of-one and start-ups achieve financial and tax compliance while saving them tens of thousands of dollars each year.
