One of the major financial beasts freelancers must slay is filing taxes both quarterly and annually. This is my third go-round paying Uncle Sam as a solo entrepreneur and I’ve learned a thing or two about how to do taxes — and how not to. While my troubles with self-employed taxes weren’t as terrible as they could have been, there were things I could’ve done better.
Here are important lessons for new freelancers on doing taxes:
It hurts to see a chunk of your take-home pay go bye-bye, but you don’t want the IRS to penalize you. I save a portion of each paycheck, even when I’m tempted to spend that money. Since my cash flow is unpredictable, I wait until several paychecks drop into my small business checking account, then transfer a percentage into a savings account dedicated to freelancer taxes.
Business taxes are due quarterly. You’ll need to stay on top of this. Otherwise, you’ll have to catch up when quarterly payments are due. How much do you owe? You must pay 90% of your taxes for the current year (you’ll have to estimate), or 100% of the taxes on last year’s return.
When in doubt, save more
Not sure how much to save? What makes this tough is there’s no set percentage that applies to all freelancers — this depends on factors such as your income, industry, expenses, where you live, whether you have dependents and tax credits.
The good news is there is a general range to go by. Argel Sabillo, a certified public accountant who runs a tax preparation service for self-employed folks, recommends saving the following percentage per paycheck (according to your income):
• If you make between $30K to $75K a year, save 33% of your paycheck
• If you make between $75K to $150K a year, save 43% of your paycheck
• If you make $150K to $300K a year, save 48% of your paycheck
This should cover your federal, state and self-employed taxes. If you’re not sure you’re saving enough, save more. For instance, if you make less than $75k a year, aim to save 35% of each paycheck.
I’ve heard horror stories from freelancer pals who neglected to save enough for self-employed and annual income taxes their first year. It wiped their savings. No bueno. When I started freelancing, I started by saving 25% per paycheck. But after hearing these tax woes and talking to tax pros, I upped the amount to 40%.
Update your records regularly
During my first full year freelancing, I had no system for keeping track of my business-related expenses. Come tax season I had to figure out what expenses I could deduct for taxes. On top of that, I had to spend hours digging through credit card statements and looking for old receipts.
I learned the hard way just how important it is to stay on top of mundane tasks like tracking your business-related expenses and holding on to receipts. You’ll also want to make sure you are on track for quarterly tax payments. (If you anticipate owing less than $1,000 in taxes that year, you don’t need to file.)
I track my expenses with FreshBooks, which links to credit and debit card transactions. While FreshBooks requires a paid subscription, you can track expenses with a spreadsheet or the free version of Expensify. If you’re just starting out or freelance part-time, you can probably track expenses on your own.
Budget for tax-related expenses
This includes hiring a tax professional, tax filing software and any money spent on cloud accounting software such as FreshBooks or Xero. This could cost hundreds of dollars. To avoid being surprised by tax-related expenses, include them in your business budget.
I have separate savings accounts for each tax year. Money I earned in 2017 goes in the “2017 Freelance Tax” account, money I’ll earn this year goes in a separate account, and so forth. If I’m short, I’ll pull money from my rainy day fund into my freelance tax fund.
It’s difficult to handle taxes as a freelancer. Staying informed and tending to your taxes throughout the year will help make them less intimidating.