Unfortunately, one of the most common mistakes that freelancers make is that they don’t properly budget for taxes. When you work for an employer, they automatically deduct the right amount of taxes from your paycheck. However, as a freelancer, it’s up to you to remember to set aside money for taxes. Keep in mind that just because you receive a $1,000 check from a client, not all of that money is yours to keep; the government gets a portion of it as well.
1099 Misc Income Forms
If a client pays you over $600 during the course of the year, that client should send you 1099-Misc form that reports your yearly earnings. The 1099 form is to freelancers what a W2 form is employees; it is essentially a yearly report of your income. Keeping track of your 1099 forms is important because after your client sends it to you, he or she also has to file a copy with the IRS, so you can be certain that they will be expecting you to report that income.
It is important to remember that even if a client doesn’t send you a 1099 statement, or you do less than $600 worth of business with a client, that income is still considered taxable. Many people are under the mistaken belief that if your income from one client is less than $600 then you don’t have to report it. That is most definitely not true. By law, you are supposed to report ALL your income when you file your yearly tax return.
The Importance of Record-Keeping
It’s always a good idea for freelancers to keep track of their earnings. For one thing, clients do occasionally make mistakes and they may accidentally underpay you. Another reason to track your earnings throughout the year is so that you can double check your 1099-Misc forms when they come in to make sure there aren’t any errors. Never just assume that your client or his or her accountant got everything right. Have your own records as well.
The most important thing is that you keep track of all your earnings as well as your expenses. Don’t just shove check stubs or receipts into a drawer where they might get lost. Set up a filing system and keep track of income and expenses just like any other business would. It may seem tedious at the time but it will go a long way towards helping you prepare your taxes and it will also help keep you from making mistakes on your tax returns.
Don’t Wait Until the Last Minute
Start on your taxes as soon as all your forms are in so that you have time to do something if any of the forms have errors, or if you need time to raise money to pay your taxes. Taxes are due the same time every year, so they really shouldn’t come as a surprise. According to debtconsolidation.com, if you fail to file before the deadline, you could end up owing 25% of the amount of your past due taxes in penalties.
By the same token, you don’t want to wait until the end of the year to start putting money away for taxes either. If you’re disciplined enough, a good rule of thumb is to set aside 30% of every payment you receive and put into a special account for paying taxes. Another good option is to set-up and pay quarterly estimated taxes with the IRS. Either way, you won’t get hit with a whopping bill when you go to file your taxes in April if you plan ahead.
Can I Deduct That?
Freelancers often don’t realize how many things they actually can deduct. For example, freelancers can deduct PayPal fees as a business expense. You may also be able to deduct part of your home as a business deduction provided that area is used solely for business purposes. Supplies, medical expenses, and transportation expenses are all potential deductions for self-employed individuals.
Rather than miss out in potential deductions, your best bet is to hire a qualified tax accountant who will look for deductions that you may not even have thought of. In many cases, the advice of a good tax account will pay for itself by him or her finding “lost deductions” that you would have missed. You can do your taxes on your own, but be aware that you might potentially miss a lot of potential deductions, which is like leaving money on the table.
Why Tax Planning is So Important
If you earn $28,000 from your freelance business in one year and don’t pay estimated taxes, then you could end up owing nearly $3,500 in taxes at the end of the year. Even worse, that’s just your federal taxes. Don’t forget that you have to pay state taxes too. Freelance work is often feast or famine. With that kind of precarious income, you don’t want to get hit with a whopping tax bill when you file your return because you may have to go into a lengthy negotiation process with the IRS if you don’t have the money to pay.
It’s a good idea to periodically calculate your self-employment taxes throughout the year so that you don’t wind up with a nasty surprise. At some points you may want to raise how much you’re setting aside for taxes, at others you may decide that you are doing okay and you can ease up a bit. The most important thing is to keep track of it throughout the years so that you’re ready when tax time comes.
Taxes are not a mystery or some kind of puzzle you should have to solve every year. If you set up a good accounting system and stay organized, you’ll be ready when you sit down with your accountant to do your taxes. Planning for taxes does add more work to the business end of being a freelancer, but it will ultimately be worth it when you don’t have to scramble to find information and you get through your taxes without owing a fortune.
About the Author: Angela Quint is a freelancer with a passion for finance and planning. She encourages anyone with a business idea to research taxes, finances, and planning before embarking on a new venture!
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