Numerous people opt to work as freelancers to make a side income and some even make a full-time career out of it. However, freelancer taxes work differently than it does for employees.
Freelancing, as the name suggests, provides freedom to work the way you want, when you want, and as much as you want.
It attracts both ambitious and laid-back people, as it is one of the most flexible ways to get work done.
However, freelancing requires you to be your own boss and to handle your own finances, accounting, and the most dreaded of all – freelance taxes.
Due to this, a lot of people who are exploring the possibilities of entering into freelancing get quickly demotivated. For this reason, in this guide, we are going to explain income tax for freelancers.
Table of Contents
- Freelancer Taxes – Overview
- How Freelance Taxes Work
- Freelancer Tax vs Self-Employment Tax
- Understand Your Freelancer Tax Return
- Calculate Deductible Expenses For Freelance Tax
- Payments Dates for Income Tax for Freelancers
- Conclusion – Freelancer Taxes
Freelancer Taxes – Overview
Let’s start this freelance tax guide with some questions I frequently receive, such as the amount of tax freelancers have to pay, the tax forms, and more.
How Much Tax Freelancers Pay?
Freelancers’ tax rates depend on their income level and location. In the U.S., freelancers pay both income tax and self-employment tax.
The self-employment tax rate is 15.3%, covering Social Security and Medicare. Income tax rates vary based on taxable income and filing status, falling into different brackets (10% to 37%). Freelancers need to estimate and pay these taxes quarterly to avoid penalties.
The total tax burden combines these rates, adjusted for deductions and credits, making effective tax rates highly individual.
Are There any Specific Tax Forms For Freelancers?
Freelancers typically use specific tax forms for reporting income and expenses. In the U.S., the main form is Schedule C (Form 1040), used to report profits or losses from a business or profession.
Additionally, the Schedule SE (Self-Employment Tax) form is used to calculate self-employment tax owed. If payments are received from clients, Form 1099-NEC (Nonemployee Compensation) is often involved.
These forms help freelancers accurately declare income and calculate tax liabilities, ensuring compliance with tax regulations.
What are the Tax Deductions Available to Freelancers?
Freelancers have access to various tax deductions that reduce taxable income, which is a good way to reduce your taxes. Common deductions include home office expenses, if a part of the home is used regularly and exclusively for business.
Internet, phone bills, and office supplies that are used for work purposes can also be deducted. Travel and mileage for business, health insurance premiums, and retirement contributions are deductible too.
Educational expenses to improve skills relevant to the freelance work are eligible too, which is an added bonus.
What are the Consequences of Not Reporting Freelance Income?
Failing to report freelance income can lead to serious legal and financial consequences. If the IRS or relevant tax authority discovers unreported income, the freelancer can face back taxes, penalties, and interest on the unpaid amount.
Penalties can be substantial, sometimes outweighing the original tax owed. Continuous non-compliance might lead to criminal charges, including tax evasion, resulting in fines or imprisonment.
Additionally, it can lead to future scrutiny on tax returns, complicating financial matters further. For this reason, accurate and timely reporting of all freelance income is instrumental.
How Freelance Taxes Work
Being a freelancer, independent contractor, or gig worker is like running your own business.
Usually, when you’re employed, you’ll get a payroll slip from your employer that tells you how much income you’ve made and how much tax was already deducted.
But when you’re a freelancer it’s up to you to figure out what you made, and what you have to include on your return.
Keep in mind that any sort of income will have to be reported in your tax return. Yes, even cash you receive.
Whether you’re earning extra cash by delivering groceries through Airtasker, or if being an Uber driver is your main source of income, or if you’re earning a couple of extra bucks through Upwork and Fiverr, you’ll have to declare all of it to the tax authorities.
As long as you do something with the intention of making a profit, it is considered ‘a business’ and therefore, needs to be included in your tax return as taxable income.
Keep in mind that occasional earnings aren’t considered income and they don’t need to be reported.
However, if you often make money off of your hobby (for example, if you’re regularly paid to take headshots of your friends), that’s a sign that your hobby is actually a business and your income needs to be reported on your return.
Freelancer Tax vs Self-Employment Tax
It is important to start out with a distinction between what a freelancer is and what a self-employed person is. In general, one can say that a freelancer is someone that works alone, for themselves.
Kind of more of a side-hustle style of business. Whereas a self-employed person tends to have a proper business and even employ people who work for them.
Although freelancing is a popular style of working, the term does not exist for tax purposes. Instead, you are classified as a sole trader, sole proprietor, a partner in a business, or by trading through a limited company.
In practical terms this means that you will have to register for self-assessment, you may have to pay several different kinds of taxes, including income tax and value-added tax (VAT).
Taxes are paid by filling out a self-assessment return every year. The amount of income tax you will pay as a self-employed professional, or sole trader, depends on how much money you made and the allowable expenses you have incurred.
You can easily calculate your profits by deducting your expenses from your income. There are certain business-related expenses that you can subtract from your income when calculating your taxable profit.
As a sole trader, all business profits belong to you personally. Tax on profits as a sole trader will be added to your other personal income and assessed at your personal tax rate.
Please note that some countries have in recent years adopted an actual “freelancer tax” regime to attract more freelancers. A commonly well-known one is the Italian freelancer regime that provides very attractive taxes for freelancers.
How to Invoice Clients as a Freelancer?
One of the most important questions you should be asking yourself as a freelancer is: How are you invoicing your clients?
Do you simply send them invoices in your personal legal name? Or do you send them invoices by including a legal entity name (for example your name + business name).
If the latter is true then you want to make sure that you’ve setup properly a business entity. Just to make things clear: you do not necessarily need a business entity in order to be a freelancer. You can run a business simply in your personal name by being self-employed.
In some instances you might have to register as being self-employed or getting a self-employment license and in German-speaking countries, it is common to register as an Einzelfirma.
Once you start making invoices you also need to figure out what you need to charge. This can include things such as figuring out whether you need to add value-added taxes/GST/sales taxes to your invoices.
Usually, there will be a threshold and once you cross that threshold you’re legally required to register for any sort of value-added taxes and begin charging your clients VAT.
Lastly, you might also want to keep in mind when you’re invoicing clients that you will have to pay and cover your own social security contributions (medicare, pension contributions, employment insurance etc.). So make sure you’re charging enough to cover those fees too.
Understand Your Freelancer Tax Return
Even if you hire a bookkeeper or a tax accountant to do your tax return, we highly recommend you to have a look at a tax return so that you know what the tax office actually wants to know from you.
Familiarize yourself with the tax return form that you’re required to fill out each year so that you understand the detailed list that you will have to provide each financial year relating to your income and expenses.
This will also help you guide in deciding how to keep your records during the year.
Most tax authorities these days offer online tax filing services, so you can e-file your tax return entirely online, and go back to make changes, if necessary. You can also auto-fill your tax return using last year’s figures to speed up the process.
Lastly, do not throw away your spreadsheets or any record-keeping tool that you use when you’ve finished and filed your tax forms. Just in case you get audited and need to provide said documentation.
Calculate Deductible Expenses For Freelance Tax
So, if you are a freelancer, you will be able to get some deductions of business expenses from your income even if you don’t have a separate place of business and you work from home.
However, those deductions should be justifiable as business-related expenses and not personal expenses.
Some of these expenses include:
- Internet expenses
- Phone expenses
- Traveling expenses
- Stationery and utility expenses
- Education expenses related to business (E.G. Online courses)
- Part of your house rent depending on what portion of your home you use.
- Business development expenses (For instance, meeting new clients at coffee shops etc.)
- Depreciation on assets like computers, laptops etc.
(We have created a business tax deductions list for online business owner which you can download in our Free Resources Library)
Keep in mind that these expenses should have a nexus with your business to be tax-deductible. You should be able to prove that the expenses were incurred during the course of business, else your expenses might be disallowed.
To play safe and avoid getting into trouble with the tax office, keep separate entries and invoices for personal expenses and business expenses.
Payments Dates for Income Tax for Freelancers
After knowing in what manner freelancers are taxed and which taxes you must pay it is important to know when you are supposed to pay tax as a freelancer. Every country has its own tax deadline. So, make sure to look up the tax deadline for your country of residence.
In some instances, you are also required to pay quarterly estimated advance tax for the current year as a business owner.
This is required so that your burden of tax for the entire year doesn’t fall on one single occasion. Non-payment of quarterly taxes or underpayment of quarterly tax (more than a certain limit) attracts penalties.
So be sure to calculate and pay your taxes in a timely manner.
Conclusion – Freelancer Taxes
A good standard practice for any freelancer or self-employed person is to put 25-30% of your income to the side for when tax season comes around.
That way you’re not taken by surprise come tax time. It is also a good idea to keep track of your income and expenses all throughout the year.
There are many software and online tools available to calculate and estimate the taxes you will owe provided you have kept proper records of your income and expenses.
If you feel that you’re starting to pay too much in taxes and you would like to minimize them, then you might want to start thinking about setting up an entity to attract instead lower tax rates. Be sure to check out our mini-course Low Tax Business Setup.
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NOTICE: The content of this article is not to be considered as a legal opinion or tax advice. Wanderers Wealth does not hold itself out as a legal or tax advisor. If you want to receive a legal opinion or tax advice on the matter in this article please contact us directly and we will refer you to a legal practitioner.