Nothing is certain except death and taxes—and if you’re a freelancer or small-business owner, managing the tax-related aspects of your side hustle can be mind-boggling, especially if you come from a corporate employment background.
“When you work for someone else, they pay half of your Social Security and Medicare taxes for you and withhold the other half from your check and send it to Uncle Sam for you,” says CPA Douglas Reiling of Oelerich & Associates. “When you’re self-employed, you’re both the employer and the employee, so you pay both halves yourself.”
It’s critical to plan appropriately for self-employment taxes. (I learned this lesson the hard way when I received a $1,000 bill last year due to a couple of small errors!) Below are six tips that all freelancers should keep in mind when it comes to tax preparation.
Do keep track of your expenses.
When you’re engrossed in chasing your dreams, it’s easy to forget to keep careful, accurate records—but small-business audits are an easy way for the IRS to make a quick buck.
As a freelancer, every dollar that counts as income must be reported—even cash.
Your best line of defense is to stay organized. Keep a record of all business expenses for the year with totals by category as well as the receipts to back everything up. Remember that the IRS also suggests keeping records for at least three years.
Resist the urge to rely on your memory or “do it later.” Instead, set calendar alerts to remind yourself to track expenses per day, week, or month so that you can stay on top of the details. If you’re unsure, keep the receipt and ask your tax preparer; better to err on on the side of documentation to avoid being at risk for disallowed deductions.
Don’t fail to report all of your income.
As a freelancer, every dollar that counts as income must be reported—even cash. When you have an all-cash gig, it can be very tempting to put the money in your pocket and forget all about it when tax time rolls around.
However, that’s technically illegal. “The law says that all of your income is taxable—even if it’s not much, even if it’s not reported to the IRS, even if it doesn’t seem fair,” says Reiling.
Do plan ahead for payments.
Whether you pay quarterly or annually, it’s smart to open a savings account in order to help with tax payments. Amounts vary, but a CPA can look at your ballpark freelance income and help you set up a few general guidelines to get started. The IRS website also has a handy estimator tool.
I have two side hustles—teaching yoga and writing—and I set aside 30 percent of each freelance paycheck. This approach is generous, but gives me peace of mind; I know I will be able to pay my taxes when the time comes. Pick a percentage that works for you, and use an automated service to move that number of dollars to your savings account per week or month.
Don’t miss the easy savings.
You might be entitled to a number of other deductions in addition to actual cash expenses paid. Using your personal vehicle for business? You could take $0.54 per mile off of your income. Have a home office? You may be able to deduct $5 per square foot on your next tax return. Additionally, retirement contributions often qualify as deductions, such as the Simplified Employee Pension, SIMPLE IRA, and 401(k)s.
The tax code is full of cool ways to save money and nasty snares for the unwary.
And for certain professions, deduction allowances change year-to-year, so be sure to stay educated about what’s allowed and what’s not. If you aren’t sure what you can deduct, ask your tax preparer.
Do pay quarterly.
If your sole means of income is from freelancing, you should plan to make tax payments every April, June, September, and January. Because self-employed people don’t have an employer withholding taxes from their paychecks and sending them to the IRS, they are required to estimate their taxes each year and send in a quarter of that amount, you guessed it, each quarter. You can use the IRS website to calculate how much you might need to pay.
There’s one exception: those with a day job who freelance by night may want to pay annually instead of quarterly. “If you still receive a W-2 from one job while freelancing on the side, the tax withholding from your W-2 could prevent you from paying late penalties,” advises Nick Foster, a CPA in Des Moines, Iowa.
Do find an advisor you can trust.
Most CPAs don’t recommend a shortcut when it comes to taxes, especially for the self-employed. In my experience, the best way to find a CPA is to ask family and friends for personal recommendations. Another great option is to reach out to other freelancers, particularly in your field of focus, to find out who they use and why. Google is always an option as well, but if you go that route, you may want to set up an introductory phone call or meeting to make sure the relationship is a good fit.
“Don’t mistake the five minutes you spent looking for an answer on Google with the formal education, ongoing study, and experience it takes to be a CPA,” says Reiling. “The tax code is full of cool ways to save money and nasty snares for the unwary. Just like you’re passionate about what you do as a freelancer, there are people who love knowing and learning about all of the ins and outs of the tax system. Let them help you!”
Your financial information is sensitive, confidential, and maybe even emotionally laden, so don’t be afraid to take your time. Pick a tax advisor whose personality and work style fits your preference, and whose tax experience directly meets your needs.