What you need to know about freelancer taxes
The gig economy and the Internet in general has made part-time income and freelance work easier than ever. A recent Gallop poll found that 36 percent of all American workers are currently engaged in freelancer work or an income-generating side hustle.
Getting an extra income stream, having more job freedom, or even generating passive income from a self-running online business feels really good. At least until the tax man comes calling.
That’s because while freelance work feels pretty darn good in the moment compared with work as an employee, from a tax perspective it isn’t as nice. Small business owners have to pay more taxes on their income than they do as employees, and there’s extra tax work from running a small business.
If you’ve been doing your side hustle for years, you probably already know and gripe about this fact. But if you’re new, welcome to the club. Here’s what you need to know about taxes as a freelancer or small business owner.
Who Suffers This Burden
If you earn more than $400 a year from income outside of a W2 from your employer and investment income, you’re running a small business. You can be a freelancer, an Uber driver, or an owner of an LLC business. Anything other than work as an employee of a corporation classifies your work as self-employment. By default, any work that doesn’t generate a W2 falls under the category of self-employment income.
The Really Bad News About Your Side Hustle
The reason that small business owners hate taxes more than everyone else is because the taxation on freelancers and small business owners is larger than the taxation on employees. You pay the same tax on your small business income as you do as an employee, plus you also get taxed an additional 15.3% on all income from your small business.
This is known as the Self-Employment Tax, and it basically covers your Social Security and Medicare contribution that normally is paid by the employer. Whereas employers pay part of the contribution and deduct the rest from an employee’s paycheck, as a self-employed person you get to pay the full amount. That’s 12.4% of business income for social security, and 2.9% for Medicare—which is why your tax burden is a combined 15.3% higher than what you are taxed on your W2 income.
Wait, But There’s More: Your Tax Filings Also Are More Complex
If you earn more than $400 of self-employed income per year, you not only suffer the injustice of higher taxes. You also have more tax paperwork. This additional paperwork consists of three things.
1. Sending Clients a W-9
If you sell products as your side hustle, you’re just a small business. But if you sell services such as writing work, plumbing or web design, you’re considered a contractor according to the IRS. And all parties that purchase more than $600 in contractor services must report the work to the IRS and to the contractor in the form of a 1099-MISC. These 1099-MISC filings are equivalent to the W-2 tax forms issued by employers at the end of the year for tax-filing purposes.
Issuing these 1099-MISC forms requires knowing some basic info about you, however, including your name and social security number (or Employer Identification Number in the case of an LLC). So as a freelancer, you need to fill out a W-9 tax form and send this form to any customer who is expected to issue you a 1099-MISC.
It is worth noting that if your side hustle USES contractors, too, you’ll also need to collect W-9s from each contractor and issue 1099-MISC forms to them and the IRS each year.
2. Completing a Schedule C, Profit or Loss from Business (Sole Proprietorship) Form When Filing Taxes
When you run your own business, April 14th becomes just a little more onerous, too. That’s because you must fill out Schedule C when you file your year-end taxes, the form that lists your business income and any expenses from the business.
This isn’t a terribly complex addition to your annual tax filings, but it does require a bit more work than the typically free options for having your taxes completed.
3. Pay Quarterly Taxes
Then there’s quarterly taxes. This is the tax gotcha that usually gets freelancers and those with a side hustle.
When you’re just an employee, all you have to do is file an annual tax return; the business that employs you is the one that regularly sends tax withholdings to the IRS.
Because you are the business when you have a side hustle, the IRS therefore requires you to make quarterly estimated tax payments. Failure to send the IRS quarterly payments comes with a small penalty for late payment.
The gotcha for small business owners is not just that you must make an estimated quarterly payment to the IRS, but that the amount is prescribed; the precise amount required by the IRS is what you would owe on a quarterly basis based on last year’s business income.
So if you owed $10,000 in taxes in 2018 from your business, the IRS expects that you’ll make payments of $2,500 each quarter in 2019. You can’t just estimate a weak quarter and send the IRS what you actually expect to pay in taxes for the quarter, since that gives taxpayers too much leeway for gaming the system.
Of course, if your business paid more in quarterly taxes than actually is due at the end of the year, you get a refund. And if your business grew from the previous year, you’ll need to pay more to the IRS come year-end tax time.
The due dates for quarterly taxes:
- April 15
- June 15
- September 15
- January 15 of the following year
Tax Perks from Your Side Hustle
If all of this is demoralizing, there at least is one considerable tax consolation from running your own business: business deductions. Much of what you spend on your business can be deducted, meaning that if you are taxed on $50,000 of business income but spend $20,000 on expenses such as supplies, web hosting, contractors and the like, you actually are only taxed on $30,000 worth of income.
“Tax deductions can be particularly important for people working as independent contractors,” notes a recent blog post by online tax service, Picnic Tax. “Since you need to pay for all of your business expenses as well as your taxes, you need to make sure that you are filing correctly and claiming all of the 1099 write-offs that you deserve.”
Most business expenses can be written off, including sales, marketing and advertising costs, travel expenses for business purposes, postage and delivery costs, phone service specifically for your business, and things like web hosting.
There are a few tricky categories when it comes to business deductions, however.
One is deducting the cost of a home office. You can deduct on your taxes the expense of maintaining a place to work, but only if it is a dedicated space that is used solely for work. So the kitchen table doesn’t count, nor a bedroom desk. If you use the space for personal use at all, it can’t be deducted.
The second tricky category is business-related meals. You can deduct the cost of meals and entertainment, but only 50% is tax-deductible.
Ready to Get Serious About Taxes?
All of these considerations make taxes a more important than when you were just an employee. You now have opportunities for engineering tax efficiency and paying less taxes—but you need to put some thought into it. And even if you don’t do any tax planning, there’s a lot more tax complexity involved than before you started your side hustle.
Welcome to the club.